Jonathan Clements's Blog, page 236
January 16, 2022
Call of the Wild
CRYPTOCURRENCIES have come under selling pressure over the past few months. That might have some readers thinking about buying the dip in, say, bitcoin or ethereum. Those two cryptos, the largest by market capitalization, are off more than 30% from their all-time highs.
I���ve been dabbling in digital assets, but not in the way you might imagine. I put about 3% of my portfolio into stablecoins. Stablecoins differ from the well-known cryptocurrencies we often hear about. How so? They're pegged to the value of, say, the U.S. dollar or gold, thus offering more price stability.
Why am I doing this? I admit it, I���m thirsty for yield. Stablecoins offer interest rates of up to 9%, depending on the coin you pick, where you invest and the amount involved. Those high interest rates are made possible because the crypto exchanges involved are making even higher rates by lending out the money to, say, those who want to borrow against their cryptocurrency holdings. I bought USD Coin (symbol: USDC) through BlockFi.
I consider this speculative money. Last year, I detailed other fringe investments I���ve purchased. Fear not: Most of my money is far more conventionally invested. I still have some 80% of my portfolio in your typical low-cost index funds.
My thinking: Stablecoins complement my emergency cash position, which currently earns next to nothing in a bank account. I also have $20,000 in Series I savings bonds that will pay perhaps 3% to 4% a year over the next five years.
Stablecoins should provide an even bigger yield. But there���s also a risk that I log in one day and see it all gone. I���m fine with that possibility, though I also see the risk as small.
After reading about stablecoins and hearing from other investors, I think there���s something to the story that my generation���millennials���may come to view stablecoins as the new money market account. Whether that happens or not, I like the idea of dipping my toe into cryptocurrencies without having direct exposure to the rollercoaster ride offered by digital assets like bitcoin and ethereum.
I���ve been dabbling in digital assets, but not in the way you might imagine. I put about 3% of my portfolio into stablecoins. Stablecoins differ from the well-known cryptocurrencies we often hear about. How so? They're pegged to the value of, say, the U.S. dollar or gold, thus offering more price stability.
Why am I doing this? I admit it, I���m thirsty for yield. Stablecoins offer interest rates of up to 9%, depending on the coin you pick, where you invest and the amount involved. Those high interest rates are made possible because the crypto exchanges involved are making even higher rates by lending out the money to, say, those who want to borrow against their cryptocurrency holdings. I bought USD Coin (symbol: USDC) through BlockFi.
I consider this speculative money. Last year, I detailed other fringe investments I���ve purchased. Fear not: Most of my money is far more conventionally invested. I still have some 80% of my portfolio in your typical low-cost index funds.
My thinking: Stablecoins complement my emergency cash position, which currently earns next to nothing in a bank account. I also have $20,000 in Series I savings bonds that will pay perhaps 3% to 4% a year over the next five years.
Stablecoins should provide an even bigger yield. But there���s also a risk that I log in one day and see it all gone. I���m fine with that possibility, though I also see the risk as small.
After reading about stablecoins and hearing from other investors, I think there���s something to the story that my generation���millennials���may come to view stablecoins as the new money market account. Whether that happens or not, I like the idea of dipping my toe into cryptocurrencies without having direct exposure to the rollercoaster ride offered by digital assets like bitcoin and ethereum.
The post Call of the Wild appeared first on HumbleDollar.
Risk Doesn’t Retire
I���LL ACKNOWLEDGE THAT today���s topic isn���t the most upbeat. I want to talk about risk���and, specifically, some of the underappreciated risks related to retirement.
In thinking about risk, the hardest part���in my view���is that it defies a single definition. Because of that, there���s no uniform yardstick for measuring it and thus no single strategy for managing it. As Howard Marks states in his book�� The Most Important Thing , ���Much of risk is subjective, hidden and unquantifiable.���
Still, a lot of discussions about risk fall back on quantitative measures, such as portfolio volatility or sequence-of-return risk. While I agree that both of those are important aspects of risk, they aren���t the only ones, especially for retirees. As Marks notes, even Benjamin Graham, the father of investment analysis, whose major book is full of formulas, acknowledged that, ���The relation between different kinds of investments and the risk of loss is entirely too indefinite... to permit of sound mathematical formulation.���
Drawing up your retirement plan? Here are some risk-related topics to consider:
Stock market malaise.��What���s the biggest risk for stock market investors? Ask most people���myself included���and we���d point to the potential for a 30% or 50% drop, like we saw in 2000, 2008 and 2020. But there���s another risk to consider, which is that the market could go ���sideways��� for a period of years���in other words, that there wouldn���t necessarily be a sharp drop but that growth might simply be anemic for a long stretch. We saw something like that in the 1970s.
What does this mean for retirement planning? If you���re earlier in your career, I wouldn���t worry about this particular risk. Over the long term, I���m confident that share prices will grow in line with corporate profits. In fact, if you have a decade or more until retirement, a period of malaise might be a good thing, allowing you to buy into the market at cheaper prices.
But if you���re closer to retirement, it���s an important scenario to consider. To assess this risk, I suggest building a long-term cash flow model that assumes investment returns of just 1% or 2% a year over the next 10 or 20 years. See what the impact would be if your expenses continued to increase with inflation while your portfolio grew at a slower rate.
Of course, you can���t control the market���s performance, but at least you���ll have a sense of whether this is a risk that would impact you. You could then develop a plan B. Note that when I suggest having a plan B, this doesn���t need to be an airtight plan. I���ve found that retirees sleep better if they have at least a rough idea of how they���d adapt to a negative scenario. Until not too long ago, the Pentagon apparently maintained a contingency plan to defend against an invasion by Canada. That���s obviously unlikely, but it never hurts to have a plan.
Health.��When it comes to health, there are two distinct types of risk to consider. The first is a sudden event, such as an accident or stroke. The second is a cognitive decline that occurs over time. The financial impact of the first is what you would imagine: increased expenses for care, either at home or in a facility. For working-age people, this could also result in the loss of income, potentially permanently. While an unpleasant prospect, the solution is straightforward: to secure sufficient disability insurance.
I view the second type of health risk���cognitive decline���as more of a challenge. For starters, cognitive decline doesn���t manifest itself obviously at first. The result might be past-due bills or other mistakes. While a late phone bill is no problem, other errors can be more serious. The IRS, for example, might not be as forgiving as the phone company. If a whole-life insurance policy lapses, not only would the insurance be lost, but also it might generate an ugly tax bill. An error like that could be irreversible.
Cognitive decline can also lead to overspending and inappropriate gifts. In the extreme, it can lead to questionable estate plan changes. Marlon Brando, for example, changed his will��13 days��before his death, sparking years of wrangling.
Cognitive decline also exposes people to outright fraud. Over the years, I���ve witnessed several fraud attempts targeted at older folks. I recall a neighbor who was convinced that someone in Nigeria was going to pay her top dollar for her old TV. We found out about it when she knocked on our door, looking for packing tape. My wife tried to dissuade her, but she was absolutely convinced. Fortunately, FedEx refused to ship the package, but it was a close call. Others��aren���t so lucky.
While, sadly, there���s no cure for cognitive decline, what I recommend is that older folks begin to involve their children in their finances. There may be resistance because money is seen as a private matter. But whether you���re the parent or the child, I would try hard to push through that resistance. If you don���t have children, try to involve a trusted friend. Even a light helping hand on the tiller can help.
Latent risks.��Investment worries tend to change from year to year. But by the time a worry becomes significant enough to notice, it���s often too late to do anything about it. Inflation is today���s example. As I��mentioned��a little while back, Treasury Inflation-Protected Securities (TIPS) were a good deal a year ago. But after the inflation we���ve experienced over the past year, these bonds are now much less of a good deal. That said, I view the current bout of inflation as a good reminder that risks that may appear to be latent can often resurface.
What other latent risks should you potentially consider? An example might be pension risk. If you have a traditional pension from a private company, you might view it as ���guaranteed��� income. But it���s worth periodically checking the health of your old company. Be aware of whether your pension benefits fall within the��benefits cap��set by the Pension Benefit Guaranty Corp. Again, you don���t need an airtight plan, but ask yourself how you might adjust if your benefits were reduced.
Condo associations represent another type of latent risk. Anyone who���s ever owned a condo knows about the dreaded special assessment. These can be particularly unpleasant for folks who have downsized specifically for the purpose of better managing their housing costs. While some assessments are impossible to predict, condo owners often report that they saw certain big ones coming���roof and window projects, for example. The solution? While you can���t move to avoid every assessment, it helps to keep your ear to the ground in your community���and that might prompt you to sell sooner if you were already planning to move.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on Twitter @AdamMGrossman��and check out his earlier articles.
In thinking about risk, the hardest part���in my view���is that it defies a single definition. Because of that, there���s no uniform yardstick for measuring it and thus no single strategy for managing it. As Howard Marks states in his book�� The Most Important Thing , ���Much of risk is subjective, hidden and unquantifiable.���
Still, a lot of discussions about risk fall back on quantitative measures, such as portfolio volatility or sequence-of-return risk. While I agree that both of those are important aspects of risk, they aren���t the only ones, especially for retirees. As Marks notes, even Benjamin Graham, the father of investment analysis, whose major book is full of formulas, acknowledged that, ���The relation between different kinds of investments and the risk of loss is entirely too indefinite... to permit of sound mathematical formulation.���
Drawing up your retirement plan? Here are some risk-related topics to consider:
Stock market malaise.��What���s the biggest risk for stock market investors? Ask most people���myself included���and we���d point to the potential for a 30% or 50% drop, like we saw in 2000, 2008 and 2020. But there���s another risk to consider, which is that the market could go ���sideways��� for a period of years���in other words, that there wouldn���t necessarily be a sharp drop but that growth might simply be anemic for a long stretch. We saw something like that in the 1970s.
What does this mean for retirement planning? If you���re earlier in your career, I wouldn���t worry about this particular risk. Over the long term, I���m confident that share prices will grow in line with corporate profits. In fact, if you have a decade or more until retirement, a period of malaise might be a good thing, allowing you to buy into the market at cheaper prices.
But if you���re closer to retirement, it���s an important scenario to consider. To assess this risk, I suggest building a long-term cash flow model that assumes investment returns of just 1% or 2% a year over the next 10 or 20 years. See what the impact would be if your expenses continued to increase with inflation while your portfolio grew at a slower rate.
Of course, you can���t control the market���s performance, but at least you���ll have a sense of whether this is a risk that would impact you. You could then develop a plan B. Note that when I suggest having a plan B, this doesn���t need to be an airtight plan. I���ve found that retirees sleep better if they have at least a rough idea of how they���d adapt to a negative scenario. Until not too long ago, the Pentagon apparently maintained a contingency plan to defend against an invasion by Canada. That���s obviously unlikely, but it never hurts to have a plan.
Health.��When it comes to health, there are two distinct types of risk to consider. The first is a sudden event, such as an accident or stroke. The second is a cognitive decline that occurs over time. The financial impact of the first is what you would imagine: increased expenses for care, either at home or in a facility. For working-age people, this could also result in the loss of income, potentially permanently. While an unpleasant prospect, the solution is straightforward: to secure sufficient disability insurance.
I view the second type of health risk���cognitive decline���as more of a challenge. For starters, cognitive decline doesn���t manifest itself obviously at first. The result might be past-due bills or other mistakes. While a late phone bill is no problem, other errors can be more serious. The IRS, for example, might not be as forgiving as the phone company. If a whole-life insurance policy lapses, not only would the insurance be lost, but also it might generate an ugly tax bill. An error like that could be irreversible.
Cognitive decline can also lead to overspending and inappropriate gifts. In the extreme, it can lead to questionable estate plan changes. Marlon Brando, for example, changed his will��13 days��before his death, sparking years of wrangling.
Cognitive decline also exposes people to outright fraud. Over the years, I���ve witnessed several fraud attempts targeted at older folks. I recall a neighbor who was convinced that someone in Nigeria was going to pay her top dollar for her old TV. We found out about it when she knocked on our door, looking for packing tape. My wife tried to dissuade her, but she was absolutely convinced. Fortunately, FedEx refused to ship the package, but it was a close call. Others��aren���t so lucky.
While, sadly, there���s no cure for cognitive decline, what I recommend is that older folks begin to involve their children in their finances. There may be resistance because money is seen as a private matter. But whether you���re the parent or the child, I would try hard to push through that resistance. If you don���t have children, try to involve a trusted friend. Even a light helping hand on the tiller can help.
Latent risks.��Investment worries tend to change from year to year. But by the time a worry becomes significant enough to notice, it���s often too late to do anything about it. Inflation is today���s example. As I��mentioned��a little while back, Treasury Inflation-Protected Securities (TIPS) were a good deal a year ago. But after the inflation we���ve experienced over the past year, these bonds are now much less of a good deal. That said, I view the current bout of inflation as a good reminder that risks that may appear to be latent can often resurface.
What other latent risks should you potentially consider? An example might be pension risk. If you have a traditional pension from a private company, you might view it as ���guaranteed��� income. But it���s worth periodically checking the health of your old company. Be aware of whether your pension benefits fall within the��benefits cap��set by the Pension Benefit Guaranty Corp. Again, you don���t need an airtight plan, but ask yourself how you might adjust if your benefits were reduced.
Condo associations represent another type of latent risk. Anyone who���s ever owned a condo knows about the dreaded special assessment. These can be particularly unpleasant for folks who have downsized specifically for the purpose of better managing their housing costs. While some assessments are impossible to predict, condo owners often report that they saw certain big ones coming���roof and window projects, for example. The solution? While you can���t move to avoid every assessment, it helps to keep your ear to the ground in your community���and that might prompt you to sell sooner if you were already planning to move.
Adam M. Grossman��is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on Twitter @AdamMGrossman��and check out his earlier articles.The post Risk Doesn’t Retire appeared first on HumbleDollar.
January 14, 2022
A Day to Remember
JUST AS ANYONE around on Sept. 11, 2001, Nov. 22, 1963, or Dec. 7, 1941, remembers where they were when they first heard the news, one date resonates for investors of a certain age: Oct. 19, 1987.
As a young practicing physician, I was just finishing up the day���s charting when I took a call from one of my colleagues: ���Did the Dow fall enough for you today?��� Indeed it had, by 508 points, or nearly 23%, and 36% off its peak of some weeks before.
Gulp. My net worth had plunged nearly six figures in just a few hours. In my unhappy state, though, it occurred to me that if I was comfortable owning stocks at Dow 2700, shouldn���t I be even more comfy owning them at Dow 1800?
And so I held my breath and increased my stock exposure. This one salutary move, though, did not exactly herald a full flowering of financial wisdom. I continued to make mistakes: reading market-timing newsletters, trying to pick both stocks and active fund managers and time the market, and allowing my spirits to rise and fall on a daily basis with share prices. I even got taken in by 1989���s spurious cold fusion excitement and went long palladium futures.
Fortunately, my financial journey got better from there. Not long after, I came across the books of Burton Malkiel and Jack Bogle, and began to immerse myself in the world of academic finance, particularly Eugene Fama and Kenneth French���s work on market efficiency and factor investing. I taught myself to spreadsheet, which was far less ubiquitous back then than it is now. My portfolio, whose stock exposure now consisted entirely of low-cost passively managed funds, prospered. Perhaps most fortuitously, in the early 1990s, I came across Charles Mackay���s Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, which immunized me from the dot-com bubble that blew up a few years later.
Even so, I could have done things better. Here are two lessons that took me decades more to learn���and which could have made my financial journey far smoother:
First, a suboptimal portfolio you can execute is better than an optimal one you can���t.
Yes, it���s true that, over most long periods, the more stock-heavy a portfolio, the higher its returns will be. The problem is that we humans are overconfident about most things, and none is more deadly to financial success than overestimating our risk tolerance. It���s one thing to fire up a spreadsheet and simulate losing a large chunk of assets, but quite another when it happens in real-time. A good analogy is how experiencing a plane crash in a simulator compares with the real thing.
Never forget humorist and financial journalist Fred Schwed���s famous injunction: ���There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.���
Over the past four decades, I���ve learned that the prime prerequisite for a successful portfolio is that it survives. One occasionally comes across newspaper articles about a recently deceased janitor, secretary or kindergarten teacher���s estate that surprises a charity with a multi-million-dollar bequest. Such stories always feature two common elements: first, the departed���s frugality (anecdotes involving bus and subway transport are mandatory journalistic elements); and, second, that they invested over periods of around half a century.
By the same token, it���s not uncommon to read about star money managers who flame out after a few years of shooting the lights out. The difference between these two narratives? The first group made sure their portfolios survived long enough for compound interest to work its magic. The best way of ensuring that is to have a portfolio that can be held through the inevitable episodes of economic and financial excrement hitting the ventilating system.
To wrap this first lesson up, I���ll risk one more analogy. The financial markets are a car that conveys your assets across town from your present self to your future self. The roads are slick with ice and studded with giant potholes. If you drive fast, you might indeed get to your destination a lot quicker. But it���s usually a bad idea.
Second, mentally compartmentalize your portfolio.
For decades, whether it was my money or that of clients, I hewed to the conventional academic and financial practitioner wisdom of designing a single overall portfolio encompassing all assets. I still go through that exercise, and it still drives the security purchases and sales I make for myself and for my clients.
But here���s what I���m doing behind the scenes: I���m mentally dividing a given portfolio into two completely separate pools, the safe assets necessary to sustain body and soul���more on that in a bit���and the risky assets aimed at consumption decades hence. This mental shortcut is commonly called the ���two bucket��� approach to asset allocation. You have a retirement bucket for your basic needs, along with a risk bucket earmarked for your aspirational desires���think BMW or first-class travel���and for future generations.
Investment guru and writer Charles Ellis observes that you can win the investment game in one of three ways: by being smarter, working harder or being more emotionally disciplined than the other participants.
The first two are clearly impossible. Wall Street is packed with folks with 175 IQs working 90 hours per week. But winning the emotional game is doable. The secret is to be able to say to yourself after share prices have halved, ���I don���t need to tap my stocks for decades. In fact, if I manage my portfolio well enough, in the long run that money will be going to my heirs and charities.��� If you can do that, you���ll sleep soundly, your stocks will eventually recover and, when they do, you just might sell some and fatten your safe portfolio a bit. Remember, your portfolio���s prime directive is to survive, and there���s no better portfolio longevity tonic than a nice pile of ���sleeping money.���
The implications of this strategy are manifold, and apply differently at different ages. The young person might say, ���Wait a minute. My portfolio is tiny. My safe assets won���t even last me three months.��� While that���s literally true, she still owns a large amount of bond-like assets in the form of her human capital, which dwarfs her retirement portfolio. What does it matter if her portfolio craters today? Three or four decades from now, it���ll be fine, and the money added to it at today���s low prices will likely be some of the best investments she���ll ever make.
The retiree, because she has no human capital left, is in a completely different place, and she had better have a nice pile of safe assets to see her through the hard times. How big should that pile be? Consider the graph below, which shows the 10-year after-inflation (or ���real���) total return of the S&P 500 in periods when there are losses:
What this graph tells us is that, if you had owned stocks, the spending power of your stocks fell significantly over 10 years on three separate occasions���by about 25% in the 1930s, 35% in the 1970s to 1980s, and by 45% during the 2007-09 global financial crisis. Further, notice that, despite the fact that overall long-term U.S. stock returns have held up well over the past century, the inflation-adjusted drawdowns seem to be getting worse.
Why is this? At the beginning of the 20th century, each dollar invested in stocks yielded about five cents in annual dividends. Even if stock prices fell, that 5% yield nicely cushioned the loss in share prices. Over the decades, that yield has fallen to well below two cents, which is a much thinner cushion.
Almost a century ago, economist John Maynard Keynes said this about owning stocks: ���It is from time to time the duty of the serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself.��� (Italics added.) Think you can time the market and avoid these drawdowns? Guess again. There is now almost a century of academic research demonstrating that no one has consistently done so, and the boneyard of Wall Street is littered with the remains of those who gained fame with one lucky call and then made spectacularly lousy forecasts for decades thereafter.
Now, let���s see what this all means for the young investor and for the retiree.
Theoretically, even if the young investor puts 100% of his savings into stocks, those savings are so small relative to his bond-like human capital that his overall stock allocation is still quite small. Even knowing all that, our young investor with 100% stocks in his 401(k) plan may not be able to emotionally handle half of it disappearing for some years. Our young investor, then, needs to discover his real-world risk tolerance. Start with, say, a 50% stock-50% bond retirement portfolio, and see how you respond during a bear market. Were you able to buy more and up your stock allocation to, say, 75% stocks-25% bonds? If so, then great. Wait until the next time, rinse and repeat. Did you just barely hang on? Then 50-50 is probably about right. Did you panic and sell? Then even 50-50 is too aggressive.
For older investors like me, things are a bit more complex. Let���s start with the simplest, and most felicitous, case. There are likely millions of retirees who have won the retirement trifecta with income from Social Security and an old-style corporate pension whose monthly payments meet or even exceed their living expenses and taxes. Their investment portfolio, then, really doesn���t belong to them. Rather, it���s destined for their heirs, charities and maybe even Uncle Sam. (Which applies, as well, to the essence of estate planning: You can piss the money away, your heirs can piss the money away or the government can piss the money away. Your job is to pick the pisser.) The stock allocation of these fortunate individuals really doesn���t matter at all to them and, by the time they���re retired, they should have a good idea of their risk tolerance. If they���ve hung on in the past with 100% in stocks, then God bless.
The same is also true of retirees who need, say, less than 2% of their portfolio to meet living expenses. Since the dividend flow on their stocks should provide this, and since dividends do not decline very much for very long even in severe bear markets, then even a nearly 100% stock allocation with a small sliver of cash for emergencies, if tolerated emotionally, is fine, too.
Below that level of assets, things are a little dicier. For the retiree, holding 10 years of living expenses in safe assets is barely acceptable, 15 years is better and 20 years��� worth is optimal. Once you���ve filled your retirement safe-asset bucket, you can begin filling and growing your risk-and-aspirational bucket. Never forget, if you���re going to survive retirement, your portfolio first has to survive. If you play portfolio Russian Roulette, by taking more risk than you can handle during a frightening economic and investment crunch, you���ll inevitably pay the price.
Thirty-five years after my 1987 baptism by fire, this is how I���ve come to view the great lifetime financial endeavor of amassing and then spending money. I often tell people that, when you���ve won the game, stop playing with the money you really need. Perhaps all would be fine if I kept 100% in stocks. But I���m now in my 70s and more interested in financial survival, which is why today I keep at least 20 years of living expenses in bonds and cash investments. That won���t make me rich. But there���s little chance I���ll end up poor.
Latest Posts
HERE ARE THE SIX other articles published by HumbleDollar this week:
If big tech stocks fall from favor, active managers may suddenly look like market-beaters. Don't count on that outperformance continuing for long, says Charley Ellis.
"If you choose to age in place, take a realistic look around and decide what needs to change," advises Rick Connor. "With minor��modifications, you can often remain at home for many years."
Bill Ehart thought he'd squandered $4,000 on a trip to Ukraine intended to launch a new career. Seven years later, the journey is still paying dividends.
"I confronted my brother and was shocked by his attitude," recounts Jiab Wasserman. "He admitted no wrongdoing. He claimed that he just meant to borrow the money temporarily."
Want to avoid family fights and large, unnecessary medical bills? Howard Rohleder's advice: Draw up a living will and health care power of attorney.
"The top 10 companies in the S&P 500 account for more than 30% of its overall value," notes Adam Grossman. "That 30% level has only been eclipsed twice in the past 50 years."
Also be sure to check out the past week's��blog posts, including Mike Zaccardi on covered calls, Sanjib Saha on returning to learning, Ron Wayne on getting organized, Mike Flack on the cost of internet service, Kyle McIntosh on fixing his finances and John Lim on the Federal Reserve.
Bill Bernstein is a recovering neurologist, author and co-founder of Efficient Frontier Advisors. He���s contributed to peer-reviewed finance journals and has written for national publications, including Money magazine and The Wall Street Journal. Bill has produced several finance books, including The Four Pillars of Investing, and also four volumes of history, the latest of which is The Delusions of Crowds. His life's goal is to convey a suitcase full of books and a laptop to Provence for six months���and call it ���work.��� Bill's previous article was When Cash Is King.
As a young practicing physician, I was just finishing up the day���s charting when I took a call from one of my colleagues: ���Did the Dow fall enough for you today?��� Indeed it had, by 508 points, or nearly 23%, and 36% off its peak of some weeks before.
Gulp. My net worth had plunged nearly six figures in just a few hours. In my unhappy state, though, it occurred to me that if I was comfortable owning stocks at Dow 2700, shouldn���t I be even more comfy owning them at Dow 1800?
And so I held my breath and increased my stock exposure. This one salutary move, though, did not exactly herald a full flowering of financial wisdom. I continued to make mistakes: reading market-timing newsletters, trying to pick both stocks and active fund managers and time the market, and allowing my spirits to rise and fall on a daily basis with share prices. I even got taken in by 1989���s spurious cold fusion excitement and went long palladium futures.
Fortunately, my financial journey got better from there. Not long after, I came across the books of Burton Malkiel and Jack Bogle, and began to immerse myself in the world of academic finance, particularly Eugene Fama and Kenneth French���s work on market efficiency and factor investing. I taught myself to spreadsheet, which was far less ubiquitous back then than it is now. My portfolio, whose stock exposure now consisted entirely of low-cost passively managed funds, prospered. Perhaps most fortuitously, in the early 1990s, I came across Charles Mackay���s Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, which immunized me from the dot-com bubble that blew up a few years later.Even so, I could have done things better. Here are two lessons that took me decades more to learn���and which could have made my financial journey far smoother:
First, a suboptimal portfolio you can execute is better than an optimal one you can���t.
Yes, it���s true that, over most long periods, the more stock-heavy a portfolio, the higher its returns will be. The problem is that we humans are overconfident about most things, and none is more deadly to financial success than overestimating our risk tolerance. It���s one thing to fire up a spreadsheet and simulate losing a large chunk of assets, but quite another when it happens in real-time. A good analogy is how experiencing a plane crash in a simulator compares with the real thing.
Never forget humorist and financial journalist Fred Schwed���s famous injunction: ���There are certain things that cannot be adequately explained to a virgin either by words or pictures. Nor can any description I might offer here even approximate what it feels like to lose a real chunk of money that you used to own.���
Over the past four decades, I���ve learned that the prime prerequisite for a successful portfolio is that it survives. One occasionally comes across newspaper articles about a recently deceased janitor, secretary or kindergarten teacher���s estate that surprises a charity with a multi-million-dollar bequest. Such stories always feature two common elements: first, the departed���s frugality (anecdotes involving bus and subway transport are mandatory journalistic elements); and, second, that they invested over periods of around half a century.
By the same token, it���s not uncommon to read about star money managers who flame out after a few years of shooting the lights out. The difference between these two narratives? The first group made sure their portfolios survived long enough for compound interest to work its magic. The best way of ensuring that is to have a portfolio that can be held through the inevitable episodes of economic and financial excrement hitting the ventilating system.
To wrap this first lesson up, I���ll risk one more analogy. The financial markets are a car that conveys your assets across town from your present self to your future self. The roads are slick with ice and studded with giant potholes. If you drive fast, you might indeed get to your destination a lot quicker. But it���s usually a bad idea.
Second, mentally compartmentalize your portfolio.
For decades, whether it was my money or that of clients, I hewed to the conventional academic and financial practitioner wisdom of designing a single overall portfolio encompassing all assets. I still go through that exercise, and it still drives the security purchases and sales I make for myself and for my clients.
But here���s what I���m doing behind the scenes: I���m mentally dividing a given portfolio into two completely separate pools, the safe assets necessary to sustain body and soul���more on that in a bit���and the risky assets aimed at consumption decades hence. This mental shortcut is commonly called the ���two bucket��� approach to asset allocation. You have a retirement bucket for your basic needs, along with a risk bucket earmarked for your aspirational desires���think BMW or first-class travel���and for future generations.
Investment guru and writer Charles Ellis observes that you can win the investment game in one of three ways: by being smarter, working harder or being more emotionally disciplined than the other participants.
The first two are clearly impossible. Wall Street is packed with folks with 175 IQs working 90 hours per week. But winning the emotional game is doable. The secret is to be able to say to yourself after share prices have halved, ���I don���t need to tap my stocks for decades. In fact, if I manage my portfolio well enough, in the long run that money will be going to my heirs and charities.��� If you can do that, you���ll sleep soundly, your stocks will eventually recover and, when they do, you just might sell some and fatten your safe portfolio a bit. Remember, your portfolio���s prime directive is to survive, and there���s no better portfolio longevity tonic than a nice pile of ���sleeping money.���
The implications of this strategy are manifold, and apply differently at different ages. The young person might say, ���Wait a minute. My portfolio is tiny. My safe assets won���t even last me three months.��� While that���s literally true, she still owns a large amount of bond-like assets in the form of her human capital, which dwarfs her retirement portfolio. What does it matter if her portfolio craters today? Three or four decades from now, it���ll be fine, and the money added to it at today���s low prices will likely be some of the best investments she���ll ever make.
The retiree, because she has no human capital left, is in a completely different place, and she had better have a nice pile of safe assets to see her through the hard times. How big should that pile be? Consider the graph below, which shows the 10-year after-inflation (or ���real���) total return of the S&P 500 in periods when there are losses:
What this graph tells us is that, if you had owned stocks, the spending power of your stocks fell significantly over 10 years on three separate occasions���by about 25% in the 1930s, 35% in the 1970s to 1980s, and by 45% during the 2007-09 global financial crisis. Further, notice that, despite the fact that overall long-term U.S. stock returns have held up well over the past century, the inflation-adjusted drawdowns seem to be getting worse.
Why is this? At the beginning of the 20th century, each dollar invested in stocks yielded about five cents in annual dividends. Even if stock prices fell, that 5% yield nicely cushioned the loss in share prices. Over the decades, that yield has fallen to well below two cents, which is a much thinner cushion.
Almost a century ago, economist John Maynard Keynes said this about owning stocks: ���It is from time to time the duty of the serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself.��� (Italics added.) Think you can time the market and avoid these drawdowns? Guess again. There is now almost a century of academic research demonstrating that no one has consistently done so, and the boneyard of Wall Street is littered with the remains of those who gained fame with one lucky call and then made spectacularly lousy forecasts for decades thereafter.
Now, let���s see what this all means for the young investor and for the retiree.
Theoretically, even if the young investor puts 100% of his savings into stocks, those savings are so small relative to his bond-like human capital that his overall stock allocation is still quite small. Even knowing all that, our young investor with 100% stocks in his 401(k) plan may not be able to emotionally handle half of it disappearing for some years. Our young investor, then, needs to discover his real-world risk tolerance. Start with, say, a 50% stock-50% bond retirement portfolio, and see how you respond during a bear market. Were you able to buy more and up your stock allocation to, say, 75% stocks-25% bonds? If so, then great. Wait until the next time, rinse and repeat. Did you just barely hang on? Then 50-50 is probably about right. Did you panic and sell? Then even 50-50 is too aggressive.
For older investors like me, things are a bit more complex. Let���s start with the simplest, and most felicitous, case. There are likely millions of retirees who have won the retirement trifecta with income from Social Security and an old-style corporate pension whose monthly payments meet or even exceed their living expenses and taxes. Their investment portfolio, then, really doesn���t belong to them. Rather, it���s destined for their heirs, charities and maybe even Uncle Sam. (Which applies, as well, to the essence of estate planning: You can piss the money away, your heirs can piss the money away or the government can piss the money away. Your job is to pick the pisser.) The stock allocation of these fortunate individuals really doesn���t matter at all to them and, by the time they���re retired, they should have a good idea of their risk tolerance. If they���ve hung on in the past with 100% in stocks, then God bless.
The same is also true of retirees who need, say, less than 2% of their portfolio to meet living expenses. Since the dividend flow on their stocks should provide this, and since dividends do not decline very much for very long even in severe bear markets, then even a nearly 100% stock allocation with a small sliver of cash for emergencies, if tolerated emotionally, is fine, too.
Below that level of assets, things are a little dicier. For the retiree, holding 10 years of living expenses in safe assets is barely acceptable, 15 years is better and 20 years��� worth is optimal. Once you���ve filled your retirement safe-asset bucket, you can begin filling and growing your risk-and-aspirational bucket. Never forget, if you���re going to survive retirement, your portfolio first has to survive. If you play portfolio Russian Roulette, by taking more risk than you can handle during a frightening economic and investment crunch, you���ll inevitably pay the price.
Thirty-five years after my 1987 baptism by fire, this is how I���ve come to view the great lifetime financial endeavor of amassing and then spending money. I often tell people that, when you���ve won the game, stop playing with the money you really need. Perhaps all would be fine if I kept 100% in stocks. But I���m now in my 70s and more interested in financial survival, which is why today I keep at least 20 years of living expenses in bonds and cash investments. That won���t make me rich. But there���s little chance I���ll end up poor.
Latest Posts
HERE ARE THE SIX other articles published by HumbleDollar this week:
If big tech stocks fall from favor, active managers may suddenly look like market-beaters. Don't count on that outperformance continuing for long, says Charley Ellis.
"If you choose to age in place, take a realistic look around and decide what needs to change," advises Rick Connor. "With minor��modifications, you can often remain at home for many years."
Bill Ehart thought he'd squandered $4,000 on a trip to Ukraine intended to launch a new career. Seven years later, the journey is still paying dividends.
"I confronted my brother and was shocked by his attitude," recounts Jiab Wasserman. "He admitted no wrongdoing. He claimed that he just meant to borrow the money temporarily."
Want to avoid family fights and large, unnecessary medical bills? Howard Rohleder's advice: Draw up a living will and health care power of attorney.
"The top 10 companies in the S&P 500 account for more than 30% of its overall value," notes Adam Grossman. "That 30% level has only been eclipsed twice in the past 50 years."
Also be sure to check out the past week's��blog posts, including Mike Zaccardi on covered calls, Sanjib Saha on returning to learning, Ron Wayne on getting organized, Mike Flack on the cost of internet service, Kyle McIntosh on fixing his finances and John Lim on the Federal Reserve.
Bill Bernstein is a recovering neurologist, author and co-founder of Efficient Frontier Advisors. He���s contributed to peer-reviewed finance journals and has written for national publications, including Money magazine and The Wall Street Journal. Bill has produced several finance books, including The Four Pillars of Investing, and also four volumes of history, the latest of which is The Delusions of Crowds. His life's goal is to convey a suitcase full of books and a laptop to Provence for six months���and call it ���work.��� Bill's previous article was When Cash Is King.The post A Day to Remember appeared first on HumbleDollar.
Off the Spectrum
LET���S START WITH TWO definitions:
Spec��trum, n. a trade name of Charter Communications used to market avaricious cable television,��internet,��telephone and wireless services. ��
Vig���or���ish, n.[via Yid., from R. v��igry��,��lit.,���gain, winnings.] interest owed a��loan shark��in consideration for credit. Abbrev: vig.
I bought a home a few months back and, besides trying to meet the��neighbors, I had the pleasure of trying to arrange internet service. "Just go with Google Fiber," you say. Well, sorry, I���m not going to bow down before the overlord of the digital age and assimilate. Well, that, plus Spectrum internet is $40 cheaper.
I signed up for $29.99 a month and promptly went to the nearby Spectrum store to pick up my free gear. I was given a modem and a wi-fi router. It was all quite seamless���as it turns out, too seamless. I hooked up everything at home and, of course, despite what I was informed over the phone repeatedly, I needed to schedule a tech to come out to the house. A few days later, after the tech did his magic, my house was filled with wi-fi.
Everything was copacetic until I noticed Spectrum was suddenly charging me $5 a month for "wi-fi service." After a 30-minute "chat" with customer service, I learned that the "free" wi-fi router I���d received was deemed a mistake and I now had two options: pay the monthly $5 "wi-fi service" fee and keep the Spectrum wi-fi router or break the insidious cycle and buy my own router.
It all reminded me of an old episode of The Rockford Files titled "Dirty Money, Black Light" where the eponymous private investigator is warned by Electric Larry, his loan shark, that, "As long as I get the vig, you keep the nut."
After a little research, I realized that the wi-fi router that Spectrum had loaned me cost around $50, which made the vig on this nut 10% per month. Which seemed, well, a little usurious, as the usury law in my state is 10% a year. I thought about just not paying it, but was worried that someone named Lawrence might break my legs���or worse, for my wife at least, cancel our internet service.
I decided instead to buy my own wi-fi router on eBay for $44.99, return the offending one and have the accumulated vig refunded to me by writing the CEO of Spectrum a very vigorous letter.
Spec��trum, n. a trade name of Charter Communications used to market avaricious cable television,��internet,��telephone and wireless services. ��
Vig���or���ish, n.[via Yid., from R. v��igry��,��lit.,���gain, winnings.] interest owed a��loan shark��in consideration for credit. Abbrev: vig.
I bought a home a few months back and, besides trying to meet the��neighbors, I had the pleasure of trying to arrange internet service. "Just go with Google Fiber," you say. Well, sorry, I���m not going to bow down before the overlord of the digital age and assimilate. Well, that, plus Spectrum internet is $40 cheaper.
I signed up for $29.99 a month and promptly went to the nearby Spectrum store to pick up my free gear. I was given a modem and a wi-fi router. It was all quite seamless���as it turns out, too seamless. I hooked up everything at home and, of course, despite what I was informed over the phone repeatedly, I needed to schedule a tech to come out to the house. A few days later, after the tech did his magic, my house was filled with wi-fi.
Everything was copacetic until I noticed Spectrum was suddenly charging me $5 a month for "wi-fi service." After a 30-minute "chat" with customer service, I learned that the "free" wi-fi router I���d received was deemed a mistake and I now had two options: pay the monthly $5 "wi-fi service" fee and keep the Spectrum wi-fi router or break the insidious cycle and buy my own router.
It all reminded me of an old episode of The Rockford Files titled "Dirty Money, Black Light" where the eponymous private investigator is warned by Electric Larry, his loan shark, that, "As long as I get the vig, you keep the nut."
After a little research, I realized that the wi-fi router that Spectrum had loaned me cost around $50, which made the vig on this nut 10% per month. Which seemed, well, a little usurious, as the usury law in my state is 10% a year. I thought about just not paying it, but was worried that someone named Lawrence might break my legs���or worse, for my wife at least, cancel our internet service.
I decided instead to buy my own wi-fi router on eBay for $44.99, return the offending one and have the accumulated vig refunded to me by writing the CEO of Spectrum a very vigorous letter.
The post Off the Spectrum appeared first on HumbleDollar.
Wasted Journey?
WE OFTEN WRITE at HumbleDollar that saving and investing aren���t everything. Spending money on the right things���such as fulfilling experiences���can also be a great investment, especially if the dollars bring ample happiness.
Nearly seven years ago, I thought I���d wasted $4,000 on a foreign trip. But the law of unintended consequences has since worked in my favor.
The 2015 trip was supposed to be an investment in my career. I thought I could make a difference in the world and become a freelance foreign correspondent. I failed. I couldn���t interest any major publication in a story. At least The Christian Science Monitor gave me the courtesy of a polite response.
What was meant to be an investment became an expenditure that I never would have made at that time in my life, just for the sake of traveling. Yet I now properly view the money ���spent��� as an investment that will pay dividends to my son and me for the rest of our lives.
We didn���t travel to a touristy locale. We went to Kyiv, the capital of Ukraine, a post-Soviet republic where reformed-minded citizens had risen up successfully against an extravagantly corrupt pro-Russia leader in 2014.
Our hotel overlooked the main site of the uprising. Ukraine was then���and still is���under siege by a jealous neighbor. All the talk now is of a potential large-scale Russian invasion. But the fact is, Vladimir Putin invaded Ukraine immediately after the uprising, seizing Crimea and slipping troops and heavy equipment into parts of eastern Ukraine, ostensibly to support pro-Russia separatists.
I have no family ties to that part of the world. But I was grandiose enough to think I could help rally public support for a free and independent Ukraine. I didn���t pretend to be a war correspondent, and have never been a foreign correspondent. But I felt that, far from the frontlines, I could write compelling stories about victims of the war. I���ve been a journalist most of my working life, with personal profiles and emotive writing among my strengths.
I took my then 16-year-old son with me. I wanted to get his mind out of Harry Potter books and ground him in reality. It doesn���t get much more real than interviewing horribly wounded soldiers, with the help of a translator, in Kyiv���s woefully underequipped Central Military Hospital.
In that, I succeeded. My son has always been fascinated by exotic languages. He later furthered his interest in Eastern Europe and took many Russian courses while majoring in linguistics at the University of Pennsylvania. Recently, he received a conditional��offer for an important job in which his Russian skills will be crucial.
��
My son wowed my friend Nadiya and her husband Yevgeniy last year with his Russian conversation skills. They turned to me and began speaking in Russian. I said, ���Don���t look at me, he���s the genius.��� Both Ukrainian and Russian are widely spoken in Ukraine.
What about me? I���ve formed relationships with many of the Ukrainian-American activists in the Washington, D.C., area. They met and formed charitable organizations while protesting Russia���s actions. They���ve raised money to help war victims and advocated that U.S. arms, particularly antitank missiles, be provided to Ukraine. The Trump administration did so in 2018.
I���ve written online articles stemming from the trip, for which I received no pay. I also donate modestly to two charities��that help war victims, and I do a little pro-bono PR work for one of them. I frequent Ukrainian festivals, where I am greeted warmly and buy items���like a traditional shirt with vyshyvanka embroidery for my son���to support Ukrainian causes.
As often happens when personal ties are formed, business relationships are forged as well. I���ve rented my family���s beach condo to two of the friends I���ve made. And I frequent Nadiya���s jewelry business, much to my daughter���s delight.
Have I swayed public opinion on Ukraine���s behalf? Have I become a globe-trotting author? No. I have seen the faces of the wounded��veterans, war widows��and orphans, however, who have been helped by my online articles, donations and PR work.
I have made a small difference in their lives, and a big one in my own. And I may have helped my son launch his career and a lifelong passion. That���s one heck of a father-son trip.
William Ehart is a journalist in the Washington, D.C., area. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart��and check out his earlier articles.
The post Wasted Journey? appeared first on HumbleDollar.
January 13, 2022
Resolved: Less Stuff
CLUTTER IS DEFINED as ���things lying in heaps or crowded confusion.��� Its origin as a word dates to the 1570s. More than four centuries later, you might imagine we would have got the problem under control, but it seems not.
I had a friend in high school who lived like a monk. He had nothing on his bedroom dressers except lamps and a record player. I wish I could achieve such a pristine state in my condo. Instead, I have too many books, magazines and notebooks. They usually end up wherever I last used them, whether it be my desk, the bed, the couch or the dining table.
One drastic solution: Remove the places where clutter grows. But that would mean getting rid of part of my already minimal kitchen counter space, the top of my desk, the dining table, the front passenger seat of my car and so on. Obviously, that���s not the answer.
Experts say too much clutter can hurt in many ways, including our finances if we don���t keep bills and important records organized. Fortunately, many of these tasks���such as doing the taxes and paying bills���have moved online, where it can be easier to stay organized. I���m trying to convert all my regular bills to emails, but for some reason I cling to the habit of receiving a paper reminder. Still, I have one good habit: I immediately tackle the mail upon receiving it. I open up the legitimate mail and place it in folders or on my desk. I tear up and shred the rest.
Clutter can also cause stress, and that affects our judgment when it comes to financial and other important decisions. I live alone in a small condo without an attic, basement or garage. That���s where many people hide their clutter. I���ve gone to estate sales for recently deceased elderly people and been astounded at just how much stuff they owned.
So what���s my plan for eliminating clutter in 2022? I���m going to convert my remaining monthly snail mail bills to email. I plan to start using a basket or bin for all those items that seem to have no home. And I intend to buy an iPad so I have a mobile device for writing down thoughts, notes and lists.
If you also need help, try searching online. You���ll find numerous suggestions on ways to conquer your clutter, including here, here (I really like idea No. 3) and here.
I had a friend in high school who lived like a monk. He had nothing on his bedroom dressers except lamps and a record player. I wish I could achieve such a pristine state in my condo. Instead, I have too many books, magazines and notebooks. They usually end up wherever I last used them, whether it be my desk, the bed, the couch or the dining table.
One drastic solution: Remove the places where clutter grows. But that would mean getting rid of part of my already minimal kitchen counter space, the top of my desk, the dining table, the front passenger seat of my car and so on. Obviously, that���s not the answer.
Experts say too much clutter can hurt in many ways, including our finances if we don���t keep bills and important records organized. Fortunately, many of these tasks���such as doing the taxes and paying bills���have moved online, where it can be easier to stay organized. I���m trying to convert all my regular bills to emails, but for some reason I cling to the habit of receiving a paper reminder. Still, I have one good habit: I immediately tackle the mail upon receiving it. I open up the legitimate mail and place it in folders or on my desk. I tear up and shred the rest.
Clutter can also cause stress, and that affects our judgment when it comes to financial and other important decisions. I live alone in a small condo without an attic, basement or garage. That���s where many people hide their clutter. I���ve gone to estate sales for recently deceased elderly people and been astounded at just how much stuff they owned.
So what���s my plan for eliminating clutter in 2022? I���m going to convert my remaining monthly snail mail bills to email. I plan to start using a basket or bin for all those items that seem to have no home. And I intend to buy an iPad so I have a mobile device for writing down thoughts, notes and lists.
If you also need help, try searching online. You���ll find numerous suggestions on ways to conquer your clutter, including here, here (I really like idea No. 3) and here.
The post Resolved: Less Stuff appeared first on HumbleDollar.
Resolved: Learn Again
I DEVOTE A GOOD amount of time to learning, not because I worry about cognitive decline—though that’s a worthy reason—but because I enjoy sampling a host of subjects, everything from meditation to music theories.
Before online courses became popular, my self-directed learning involved watching lecture DVDs. I later discovered many free online offerings from reputed universities, including Stanford, Harvard, Yale, MIT and Princeton.
When the pandemic forced me to spend more time at home, I signed up for a five-course series on modern finance. It was a comprehensive program for folks pursuing a career in finance. Paid enrollees could earn college credits toward a master’s degree in finance. I didn’t need another degree, nor was I ready to cough up a few hundred dollars per course, so I was happy to choose the free option.
The program started in the fall of 2020, with one course each for the next five quarters. The first two quarters covered the foundations of modern finance and the third covered financial accounting. New lectures were released each week, with assignments due the week after. I was thoroughly enjoying the rigorous curriculum. The pressure was manageable. I was happy with my progress—until the fourth course, the one on quantitative finance.
Within a week or so, I realized that I should’ve taken the course prerequisites more seriously and brushed up on my undergraduate math. Unprepared and stressed out, I fell behind, struggled to catch up and finally threw in the towel.
Dropping out felt like a shameful intellectual defeat. Fearing a repeat disappointment, I stopped taking online courses altogether. My learning paused for 2021’s entire second half, and I felt awful about it.
Even before the new year began, I resolved to get past my embarrassment and resume learning. A quarterly course on the adaptive market hypothesis caught my eye. The class has started—and I’m loving it.
Before online courses became popular, my self-directed learning involved watching lecture DVDs. I later discovered many free online offerings from reputed universities, including Stanford, Harvard, Yale, MIT and Princeton.
When the pandemic forced me to spend more time at home, I signed up for a five-course series on modern finance. It was a comprehensive program for folks pursuing a career in finance. Paid enrollees could earn college credits toward a master’s degree in finance. I didn’t need another degree, nor was I ready to cough up a few hundred dollars per course, so I was happy to choose the free option.
The program started in the fall of 2020, with one course each for the next five quarters. The first two quarters covered the foundations of modern finance and the third covered financial accounting. New lectures were released each week, with assignments due the week after. I was thoroughly enjoying the rigorous curriculum. The pressure was manageable. I was happy with my progress—until the fourth course, the one on quantitative finance.
Within a week or so, I realized that I should’ve taken the course prerequisites more seriously and brushed up on my undergraduate math. Unprepared and stressed out, I fell behind, struggled to catch up and finally threw in the towel.
Dropping out felt like a shameful intellectual defeat. Fearing a repeat disappointment, I stopped taking online courses altogether. My learning paused for 2021’s entire second half, and I felt awful about it.
Even before the new year began, I resolved to get past my embarrassment and resume learning. A quarterly course on the adaptive market hypothesis caught my eye. The class has started—and I’m loving it.
The post Resolved: Learn Again appeared first on HumbleDollar.
Anomaly Ahead
COULD I BE WRONG about indexing?
Every investor soon learns that being wrong is a frequent malady, particularly on the day-to-day decisions of when to buy. Those minor errors are, as we also learn, part of the “game” of investing and are best ignored. But what if there’s evidence that conflicts with your longer-term thinking and expectations? What if evidence conflicts with your central beliefs?
I suspect it could happen to me.
After 60 years of experience and study of investing, and extensive dealings with many of the world’s outstanding professional investors, I came to a central conclusion many years ago. Smart as they are, hard-working as they are, superbly armed with the best equipment that technology can offer, and marvelously informed as they are, most expert investors are doomed to underperform the market for two simple reasons.
First, everybody still in the game is superb in every way, so experts can only buy from or sell to other experts, all of whom have the same access to superb and voluminous information at the same time. Second, the cost of trading, plus fees and taxes, are high enough to be virtually impossible to overcome long term by outperforming the collective expertise of hyper-competitive competitors who now dominate the market. (The stock markets of China, so far, continue to be the exception because they are still dominated by individual price-trend followers, sometimes called “willing losers.”)
As a serious student-observer of both the markets and investment managers for decades, I’ve been convinced that, over the long term, the best way to achieve the Holy Grail of top-quartile performance was simple: index. Most active managers would, due to fees and costs, underperform.
Now, I’m not so sure.
Here’s why: Among the 500 stocks in that most popular S&P index are a group of technology stocks with very high price-earnings multiples. They’re still called the “FAANG” stocks—for Facebook, Amazon, Apple, Netflix and Google—even though Facebook and Google have changed their names to Meta and Alphabet, respectively.
It wouldn’t be surprising if these stocks, despite continuing business growth by the companies, were to have a pause or even a decline in their share prices. Since these stocks are under-owned by most active managers, the statistical result would be evidence that active management is back. We can be sure that this suggestion of a comeback would be widely celebrated by active managers. Well, they would, wouldn’t they?
So, what should I do now?
When heavy snows fell in late spring in Washington, D.C., climate-change skeptics celebrated the “hard evidence” against global warming. But climatologists cautioned that the unusual snowfall was a predictable part of their expected data, and actually confirmed global warming models.
As every statistician understands, long-term trends are chock full of short-term, out-of-pattern anomalies. In my view, the long-term reality continues to hold: Most active managers won’t be able to overcome the fees and costs of their operations by outperforming their competitors. That’s why I’m sticking with indexing and recommend all long-term investors do the same. I’m confident that I’ll be wrong again and again in the short run—but proven right over the long haul.
Charles D. Ellis is the author of 18 books, including Winning the Loser’s Game, which is now in its 8th edition, with 600,000 copies sold. Charley has taught investing courses at both Yale and Harvard business schools, and he served for 17 years on Yale’s investment committee. Check out his earlier articles.
Every investor soon learns that being wrong is a frequent malady, particularly on the day-to-day decisions of when to buy. Those minor errors are, as we also learn, part of the “game” of investing and are best ignored. But what if there’s evidence that conflicts with your longer-term thinking and expectations? What if evidence conflicts with your central beliefs?
I suspect it could happen to me.
After 60 years of experience and study of investing, and extensive dealings with many of the world’s outstanding professional investors, I came to a central conclusion many years ago. Smart as they are, hard-working as they are, superbly armed with the best equipment that technology can offer, and marvelously informed as they are, most expert investors are doomed to underperform the market for two simple reasons.
First, everybody still in the game is superb in every way, so experts can only buy from or sell to other experts, all of whom have the same access to superb and voluminous information at the same time. Second, the cost of trading, plus fees and taxes, are high enough to be virtually impossible to overcome long term by outperforming the collective expertise of hyper-competitive competitors who now dominate the market. (The stock markets of China, so far, continue to be the exception because they are still dominated by individual price-trend followers, sometimes called “willing losers.”)
As a serious student-observer of both the markets and investment managers for decades, I’ve been convinced that, over the long term, the best way to achieve the Holy Grail of top-quartile performance was simple: index. Most active managers would, due to fees and costs, underperform.
Now, I’m not so sure.
Here’s why: Among the 500 stocks in that most popular S&P index are a group of technology stocks with very high price-earnings multiples. They’re still called the “FAANG” stocks—for Facebook, Amazon, Apple, Netflix and Google—even though Facebook and Google have changed their names to Meta and Alphabet, respectively.
It wouldn’t be surprising if these stocks, despite continuing business growth by the companies, were to have a pause or even a decline in their share prices. Since these stocks are under-owned by most active managers, the statistical result would be evidence that active management is back. We can be sure that this suggestion of a comeback would be widely celebrated by active managers. Well, they would, wouldn’t they?
So, what should I do now?
When heavy snows fell in late spring in Washington, D.C., climate-change skeptics celebrated the “hard evidence” against global warming. But climatologists cautioned that the unusual snowfall was a predictable part of their expected data, and actually confirmed global warming models.
As every statistician understands, long-term trends are chock full of short-term, out-of-pattern anomalies. In my view, the long-term reality continues to hold: Most active managers won’t be able to overcome the fees and costs of their operations by outperforming their competitors. That’s why I’m sticking with indexing and recommend all long-term investors do the same. I’m confident that I’ll be wrong again and again in the short run—but proven right over the long haul.
Charles D. Ellis is the author of 18 books, including Winning the Loser’s Game, which is now in its 8th edition, with 600,000 copies sold. Charley has taught investing courses at both Yale and Harvard business schools, and he served for 17 years on Yale’s investment committee. Check out his earlier articles.The post Anomaly Ahead appeared first on HumbleDollar.
January 12, 2022
Goodbye Upside
SELLING COVERED calls can sound like a winning investment strategy, especially to yield-hungry investors frustrated by today���s low interest rates. Wouldn���t you know it? There are exchange-traded funds (ETFs) designed to mimic the strategy.
For background, covered calls are a yield-enhancement play that involve selling call options against stocks that you own. The call option gives you extra income, but���during the life of the option���your gains are capped at the call option���s strike price. Essentially, you give up the possibility of scoring big gains but receive extra income in return. If the stock goes nowhere���or even if it rises slightly���you get the call premium while still hanging on to the stock.
I was shocked when I saw the 2021 performance of Global X Nasdaq 100 Covered Call ETF (symbol: QYLD) compared to that of the Invesco QQQ Trust (QQQ), which tracks the Nasdaq 100. The Global X fund was up a paltry 10% last year, while the Invesco ETF soared 27%.
To be fair, selling covered calls is a fine endeavor so long as you fully understand the wager you���re making. During periods of sharply rising stock prices, selling away your upside potential is a losing strategy. But when a sideways or bear market strikes, collecting premiums by writing calls should outperform simply owning the shares outright.
Tempted to write covered calls? Keep in mind that trading options will likely be a wash over the long run, since options are a zero-sum game. It might even cost you because of the money lost to bid-ask spreads and to any commissions you pay. Perhaps more important, your best-performing stocks will likely be ���called away������and history tells us that a small number of huge winners account for much of the stock market���s gains.
For background, covered calls are a yield-enhancement play that involve selling call options against stocks that you own. The call option gives you extra income, but���during the life of the option���your gains are capped at the call option���s strike price. Essentially, you give up the possibility of scoring big gains but receive extra income in return. If the stock goes nowhere���or even if it rises slightly���you get the call premium while still hanging on to the stock.
I was shocked when I saw the 2021 performance of Global X Nasdaq 100 Covered Call ETF (symbol: QYLD) compared to that of the Invesco QQQ Trust (QQQ), which tracks the Nasdaq 100. The Global X fund was up a paltry 10% last year, while the Invesco ETF soared 27%.
To be fair, selling covered calls is a fine endeavor so long as you fully understand the wager you���re making. During periods of sharply rising stock prices, selling away your upside potential is a losing strategy. But when a sideways or bear market strikes, collecting premiums by writing calls should outperform simply owning the shares outright.
Tempted to write covered calls? Keep in mind that trading options will likely be a wash over the long run, since options are a zero-sum game. It might even cost you because of the money lost to bid-ask spreads and to any commissions you pay. Perhaps more important, your best-performing stocks will likely be ���called away������and history tells us that a small number of huge winners account for much of the stock market���s gains.
The post Goodbye Upside appeared first on HumbleDollar.
Giving Directions
IF YOU FIND YOURSELF with a loved one in hospital who can���t make medical decisions, it can be overwhelming, intimidating and emotionally charged. Decisions are needed and each family member is conflicted: What would I want? What would the patient want? What do I want for the patient? The result can be sharp family disagreements.
Death, the prospect of death or even thinking about death is so loaded with emotion that it can hinder our willingness to prepare. Yet, as with estate planning, there are steps every adult should consider. And as with estate planning, failure to plan can not only be frustrating and emotionally taxing for your family, but also lead to undue suffering���and large, unnecessary medical bills.
Two key ���advanced directives��� can help. First, a health care proxy, also known as a durable power of attorney for health care, appoints someone to speak on your behalf when you can���t speak for yourself. Second, a living will lays out what specific types of advanced, or ���heroic,��� treatment you want in the event you���re terminally ill or injured and can���t express your wishes.
As a hospital CEO, I spoke with clinicians who had to help families navigate such situations every day. They observed some common problems. For starters, the durable power of attorney for health care is sometimes confused with a financial power of attorney. Despite similar names, they���re completely different documents. The first can make your wishes known during illness. The second can act for you in financial matters���but not with medical issues.
The clinicians also pointed out a second problem they see: More living wills are completed than powers of attorney. A living will details the patient���s medical wishes. But without a corresponding health care power of attorney, no one is designated to see those wishes carried out.
Lacking these two advanced directives, many families find themselves needing to make health care decisions without guidance on how to act. This could be due to a patient who is unconscious from an accident, or a slow decline in mental acuity that renders the patient no longer able to give consent. If the patient doesn���t have the mental competence to give consent for treatment, he or she also can no longer sign a document turning over that decision to someone else.
Medical professionals are taught to diagnose a problem and solve it. Their bias will be to act and, in fact, the law requires it. We now live in an age where technology has the tremendous ability to cure, but also the unfortunate ability to prolong suffering, even when no cure is in sight. The doctors can employ the technology. The patient, or their proxy, has to say when it���s time for nature to take its course.
Selecting someone to act in your place���your proxy���shouldn���t be taken lightly. A spouse is an obvious choice, assuming he or she is capable of fulfilling the role, which may include making difficult decisions. If not the spouse, it could be an adult child. Maybe it���s a trusted friend. Seniors with no family must take extra care to find someone who will make sure their wishes are followed.
There should be two main considerations. First, can the person selected accept and understand my wishes? Second, will my proxy carry out my wishes at the most difficult of times? Note that the person you select doesn���t have to agree with your wishes or feel that he or she would make the same choices. You should consider appointing at least one backup proxy in case the primary proxy can���t fulfill the role.
With your proxy designated, communicating your wishes through a living will is next. The most important thing to understand about a living will is that it isn���t ���one size fits all.��� It���s not an automatic license to ���pull the plug.��� Rather, it���s your opportunity to lay out your wishes in as much detail as you want. If your wish is for everything to be done to keep you alive, no matter what your condition or the chances of success, then the living will can convey that. Interestingly, a hospital chaplain told me that about 40% of the time resistance to completing a living will came from families, not the patient. Often, this comes from a misunderstanding of the purpose or a distrust of ���the system.���
There can be misunderstandings based on cultural or religious grounds. A living will doesn���t promote or allow euthanasia. It only allows you to say what you want. If in doubt about the religious implications, you can consult a cleric.
Once completed, both documents should be scanned into your electronic record at your physician���s office and into the hospital electronic record during your next admission. If you have special family or medical considerations, you should consider a supplemental conversation with your family doctor about your concerns. This is a situation where more is better. Make lots of copies and be prepared to hand a copy to each new health care provider. Ideally, a transfer from one facility to another will include the paperwork. Don���t depend on it, though���provide your own copy.
Your proxy should also have copies of your advanced directives and should have an understanding of your expectations. My wife and I carry a card in our wallets stating that we have advanced directives and the phone numbers of our proxies. Consider carrying copies when you travel, especially if you���re a snowbird who lives in another state for weeks at a time.
The bigger the family, the more likely that fear, guilt, hard feelings or tender feelings will splinter the group. The proxy���s job will be easier if you communicate to your family that you have a living will, what it states and that you expect it to be followed. This can head off family disagreements if your proxy has to act on your behalf.
What if your family member didn���t have the foresight to prepare advanced directives? State law designates who clinicians must approach as a surrogate, typically starting with a spouse or adult children. If multiple family members are weighing in with conflicting opinions, there are resources available in every hospital to navigate this situation. Start with the immediate team of doctors and nurses. They can give the best picture of the patient���s condition and likely prognosis. Supporting them and the family are social workers and hospital chaplains, who are trained to guide families through decision making.
The living will and durable power of attorney for health care are documents governed by state law. You can undertake to create them yourself by accessing the correct forms for your state through AARP. Hospitals and doctors��� offices may also stock the forms. Observe the requirements for witnessing each document. For example, family members may not be allowed to witness or your state may require a notary. If you want, an attorney can draw up the documents. The attorney can also keep a copy as the ultimate backup.
As your health or feelings about medical decisions change, each of these documents can be revoked or replaced with an updated version. Old copies should be retrieved and destroyed. Make sure to track down any electronic copies.
Howard Rohleder, a former chief executive of a community hospital, retired early after more than 30 years in hospital administration. In retirement, he enjoys serving on several nonprofit boards, exploring walking paths with his wife Susan, and visiting their six grandchildren. A little-known fact: In May 1994, Howard was featured���along with five others���on the cover of Kiplinger���s Personal Finance for an article titled ���Secrets of My Investment Success.��� Check out his previous��articles.
Death, the prospect of death or even thinking about death is so loaded with emotion that it can hinder our willingness to prepare. Yet, as with estate planning, there are steps every adult should consider. And as with estate planning, failure to plan can not only be frustrating and emotionally taxing for your family, but also lead to undue suffering���and large, unnecessary medical bills.
Two key ���advanced directives��� can help. First, a health care proxy, also known as a durable power of attorney for health care, appoints someone to speak on your behalf when you can���t speak for yourself. Second, a living will lays out what specific types of advanced, or ���heroic,��� treatment you want in the event you���re terminally ill or injured and can���t express your wishes.
As a hospital CEO, I spoke with clinicians who had to help families navigate such situations every day. They observed some common problems. For starters, the durable power of attorney for health care is sometimes confused with a financial power of attorney. Despite similar names, they���re completely different documents. The first can make your wishes known during illness. The second can act for you in financial matters���but not with medical issues.
The clinicians also pointed out a second problem they see: More living wills are completed than powers of attorney. A living will details the patient���s medical wishes. But without a corresponding health care power of attorney, no one is designated to see those wishes carried out.
Lacking these two advanced directives, many families find themselves needing to make health care decisions without guidance on how to act. This could be due to a patient who is unconscious from an accident, or a slow decline in mental acuity that renders the patient no longer able to give consent. If the patient doesn���t have the mental competence to give consent for treatment, he or she also can no longer sign a document turning over that decision to someone else.
Medical professionals are taught to diagnose a problem and solve it. Their bias will be to act and, in fact, the law requires it. We now live in an age where technology has the tremendous ability to cure, but also the unfortunate ability to prolong suffering, even when no cure is in sight. The doctors can employ the technology. The patient, or their proxy, has to say when it���s time for nature to take its course.
Selecting someone to act in your place���your proxy���shouldn���t be taken lightly. A spouse is an obvious choice, assuming he or she is capable of fulfilling the role, which may include making difficult decisions. If not the spouse, it could be an adult child. Maybe it���s a trusted friend. Seniors with no family must take extra care to find someone who will make sure their wishes are followed.
There should be two main considerations. First, can the person selected accept and understand my wishes? Second, will my proxy carry out my wishes at the most difficult of times? Note that the person you select doesn���t have to agree with your wishes or feel that he or she would make the same choices. You should consider appointing at least one backup proxy in case the primary proxy can���t fulfill the role.
With your proxy designated, communicating your wishes through a living will is next. The most important thing to understand about a living will is that it isn���t ���one size fits all.��� It���s not an automatic license to ���pull the plug.��� Rather, it���s your opportunity to lay out your wishes in as much detail as you want. If your wish is for everything to be done to keep you alive, no matter what your condition or the chances of success, then the living will can convey that. Interestingly, a hospital chaplain told me that about 40% of the time resistance to completing a living will came from families, not the patient. Often, this comes from a misunderstanding of the purpose or a distrust of ���the system.���
There can be misunderstandings based on cultural or religious grounds. A living will doesn���t promote or allow euthanasia. It only allows you to say what you want. If in doubt about the religious implications, you can consult a cleric.
Once completed, both documents should be scanned into your electronic record at your physician���s office and into the hospital electronic record during your next admission. If you have special family or medical considerations, you should consider a supplemental conversation with your family doctor about your concerns. This is a situation where more is better. Make lots of copies and be prepared to hand a copy to each new health care provider. Ideally, a transfer from one facility to another will include the paperwork. Don���t depend on it, though���provide your own copy.
Your proxy should also have copies of your advanced directives and should have an understanding of your expectations. My wife and I carry a card in our wallets stating that we have advanced directives and the phone numbers of our proxies. Consider carrying copies when you travel, especially if you���re a snowbird who lives in another state for weeks at a time.
The bigger the family, the more likely that fear, guilt, hard feelings or tender feelings will splinter the group. The proxy���s job will be easier if you communicate to your family that you have a living will, what it states and that you expect it to be followed. This can head off family disagreements if your proxy has to act on your behalf.
What if your family member didn���t have the foresight to prepare advanced directives? State law designates who clinicians must approach as a surrogate, typically starting with a spouse or adult children. If multiple family members are weighing in with conflicting opinions, there are resources available in every hospital to navigate this situation. Start with the immediate team of doctors and nurses. They can give the best picture of the patient���s condition and likely prognosis. Supporting them and the family are social workers and hospital chaplains, who are trained to guide families through decision making.
The living will and durable power of attorney for health care are documents governed by state law. You can undertake to create them yourself by accessing the correct forms for your state through AARP. Hospitals and doctors��� offices may also stock the forms. Observe the requirements for witnessing each document. For example, family members may not be allowed to witness or your state may require a notary. If you want, an attorney can draw up the documents. The attorney can also keep a copy as the ultimate backup.
As your health or feelings about medical decisions change, each of these documents can be revoked or replaced with an updated version. Old copies should be retrieved and destroyed. Make sure to track down any electronic copies.
Howard Rohleder, a former chief executive of a community hospital, retired early after more than 30 years in hospital administration. In retirement, he enjoys serving on several nonprofit boards, exploring walking paths with his wife Susan, and visiting their six grandchildren. A little-known fact: In May 1994, Howard was featured���along with five others���on the cover of Kiplinger���s Personal Finance for an article titled ���Secrets of My Investment Success.��� Check out his previous��articles.The post Giving Directions appeared first on HumbleDollar.
