Jonathan Clements's Blog, page 244
December 15, 2021
Deluding Ourselves
INVESTMENT RESEARCH has overwhelmingly shown that active stock strategies perform poorly over long periods compared to buying index funds and simply collecting the market���s return.
There���s still some debate about whether the best active managers are a smart bet���and whether we can count on them continuing to perform well. But there���s no question that active stock management, on average, has destroyed value for clients.
Yet active strategies remain popular with both individual investors and their wealth managers. Why? A cynical explanation might place the blame solely on the investment industry. After all, it tends to receive much more revenue from active management than index investments.
Indeed, wealth advisors who choose active managers may be trying to dodge a dreaded question from clients: ���If you can���t pick managers that���ll beat the market, and instead recommend a stock portfolio that���s entirely indexed, why should I pay you so much in fees?���
While the investment industry may try to avoid the hard truth about active management, the blame for its continued popularity must be shared. In particular, two other groups deserve to be recognized.
First, clients contribute through their own biases, which are well documented in the behavioral finance literature. Investors who hire active wealth managers fall into two traps: the illusion of control and overconfidence.
Behavioral data show that many investors presume they can control outcomes that are, in fact, random. Unfortunately for our portfolios, our brains just aren���t wired for sound probabilistic thinking. Instead, we crave the excitement and satisfaction of trying to outperform the market, much the same way we might crave sweet or fatty foods.
Those survival instincts that encouraged us to eat rich foods might have kept us alive in prehistoric times. But they aren���t well suited to the developed world we inhabit today. Overabundance is now a bigger problem than scarcity. Similarly, we tend to harm our portfolios when we reach for outperformance, even though it feels natural to want to outrun the rest of the pack.
We also harm ourselves when we surrender to an urge to tweak our asset allocation. For example, we may feel compelled to sell in the middle of a bear market. We���re overconfident that we can beat the odds���despite all evidence that, on average, we cannot. As Benjamin Graham wrote in 1949, ���The investor���s chief problem���and even his worst enemy���is likely to be himself.���
The second siren song drawing us to active management is financial journalism, be it newspapers, magazines, blogs or podcasts. Media sources, both paid and purportedly free, make money by rewarding our worst habits as consumers.
Exciting stories of successful investors or star managers are far more likely to attract attention than the boring advice to buy and hold index funds no matter what. A recommendation to do nothing���providing you have a good asset allocation with index investments���garners little attention, no matter how solidly studies support this approach.
If nearly all the media coverage highlights the rare successes of active strategies, it's no wonder that uninformed consumers might presume that beating the market is a lot more likely than the data show.
It���s valid to criticize the industry for recommending active management. As consumers and readers, however, we also need to look in the mirror to assess our own culpability. Unfortunately, we���re hard-wired through evolution to avoid that discipline of introspection. It���s so much more gratifying to blame others for our bad fortune.
Patrick Geddes was the co-founder and CEO of Aperio Group until his retirement in 2021. His book Transparent Investing, available for sale Jan. 25, 2022, helps investors avoid biases in their own behavior, as well as those perpetuated by the frequently self-serving investment industry.
There���s still some debate about whether the best active managers are a smart bet���and whether we can count on them continuing to perform well. But there���s no question that active stock management, on average, has destroyed value for clients.
Yet active strategies remain popular with both individual investors and their wealth managers. Why? A cynical explanation might place the blame solely on the investment industry. After all, it tends to receive much more revenue from active management than index investments.
Indeed, wealth advisors who choose active managers may be trying to dodge a dreaded question from clients: ���If you can���t pick managers that���ll beat the market, and instead recommend a stock portfolio that���s entirely indexed, why should I pay you so much in fees?���
While the investment industry may try to avoid the hard truth about active management, the blame for its continued popularity must be shared. In particular, two other groups deserve to be recognized.
First, clients contribute through their own biases, which are well documented in the behavioral finance literature. Investors who hire active wealth managers fall into two traps: the illusion of control and overconfidence.
Behavioral data show that many investors presume they can control outcomes that are, in fact, random. Unfortunately for our portfolios, our brains just aren���t wired for sound probabilistic thinking. Instead, we crave the excitement and satisfaction of trying to outperform the market, much the same way we might crave sweet or fatty foods.
Those survival instincts that encouraged us to eat rich foods might have kept us alive in prehistoric times. But they aren���t well suited to the developed world we inhabit today. Overabundance is now a bigger problem than scarcity. Similarly, we tend to harm our portfolios when we reach for outperformance, even though it feels natural to want to outrun the rest of the pack.
We also harm ourselves when we surrender to an urge to tweak our asset allocation. For example, we may feel compelled to sell in the middle of a bear market. We���re overconfident that we can beat the odds���despite all evidence that, on average, we cannot. As Benjamin Graham wrote in 1949, ���The investor���s chief problem���and even his worst enemy���is likely to be himself.���
The second siren song drawing us to active management is financial journalism, be it newspapers, magazines, blogs or podcasts. Media sources, both paid and purportedly free, make money by rewarding our worst habits as consumers.
Exciting stories of successful investors or star managers are far more likely to attract attention than the boring advice to buy and hold index funds no matter what. A recommendation to do nothing���providing you have a good asset allocation with index investments���garners little attention, no matter how solidly studies support this approach.
If nearly all the media coverage highlights the rare successes of active strategies, it's no wonder that uninformed consumers might presume that beating the market is a lot more likely than the data show.
It���s valid to criticize the industry for recommending active management. As consumers and readers, however, we also need to look in the mirror to assess our own culpability. Unfortunately, we���re hard-wired through evolution to avoid that discipline of introspection. It���s so much more gratifying to blame others for our bad fortune.
Patrick Geddes was the co-founder and CEO of Aperio Group until his retirement in 2021. His book Transparent Investing, available for sale Jan. 25, 2022, helps investors avoid biases in their own behavior, as well as those perpetuated by the frequently self-serving investment industry.The post Deluding Ourselves appeared first on HumbleDollar.
December 14, 2021
Time Is Running Out
INFLATION CONTINUES to sizzle. November���s Producer Price Index (PPI) rose 9.6% from a year earlier. Even after removing food and energy, PPI was up 7.7%. Both figures are the highest since 2010, when such data were first compiled.
This follows last week���s Consumer Price Index report, which showed inflation climbing 6.8% over the past 12 months. Since consumer prices lag producer prices, we can expect little relief from inflation in 2022.
All this must be foremost on the minds of Federal Reserve members as they meet this week. Price stability is one of its two mandates, so it���s widely expected that the Fed will accelerate the tapering of its bond purchases. This will position the Fed to raise interest rates sooner as it seeks to quell inflation.
Unfortunately, time is running out. A number of factors conspire to make the job of Federal Reserve Chair Jerome Powell a lot more difficult:
1. Inflation expectations are climbing. According to the Federal Reserve Bank of New York, inflation expectations one year out are 6%. This number has doubled since the beginning of the year. This is concerning because, once entrenched, inflation expectations can become a self-fulfilling prophecy.
2. Wages are on the rise. Wages are companies��� largest expense and hence a major determinant of prices. Wages also tend to be sticky, meaning workers are loath to accept cuts in wages. According to a recent survey by the Conference Board, companies plan to raise salaries by 3.9% in 2022. That���s the fastest pace since 2008.
3. The yield curve is flattening. The difference in yield between five-year and 30-year Treasurys was just 0.54 percentage point as of last week. The last time the spread was so small was during the depths of the COVID-19 pandemic in March 2020. A flattening yield curve has many people worried that a recession may be looming. Could we really have a recession when inflation is on a tear? Yes, it���s called stagflation.
4. The Fed must now walk a tightrope. Over the weekend, economist Mohamed El-Erian, a former deputy director of the International Monetary Fund, had some blunt words for Jerome Powell: ���The characterization of inflation as transitory���it���s probably the worst inflation call in the history of the Federal Reserve.���
Alas, hindsight is 20-20. I give credit to Powell for pivoting on inflation. Instead of digging in his heels, he reversed course as the facts changed���although arguably he ought to have tightened monetary policy sooner. Now, Powell���s greatest challenge awaits him. Will he tighten the monetary spigots too fast and throw the economy into recession? Or will he drag his feet and allow inflation to spiral out of control? This is the��question facing markets in 2022.
This follows last week���s Consumer Price Index report, which showed inflation climbing 6.8% over the past 12 months. Since consumer prices lag producer prices, we can expect little relief from inflation in 2022.
All this must be foremost on the minds of Federal Reserve members as they meet this week. Price stability is one of its two mandates, so it���s widely expected that the Fed will accelerate the tapering of its bond purchases. This will position the Fed to raise interest rates sooner as it seeks to quell inflation.
Unfortunately, time is running out. A number of factors conspire to make the job of Federal Reserve Chair Jerome Powell a lot more difficult:
1. Inflation expectations are climbing. According to the Federal Reserve Bank of New York, inflation expectations one year out are 6%. This number has doubled since the beginning of the year. This is concerning because, once entrenched, inflation expectations can become a self-fulfilling prophecy.
2. Wages are on the rise. Wages are companies��� largest expense and hence a major determinant of prices. Wages also tend to be sticky, meaning workers are loath to accept cuts in wages. According to a recent survey by the Conference Board, companies plan to raise salaries by 3.9% in 2022. That���s the fastest pace since 2008.
3. The yield curve is flattening. The difference in yield between five-year and 30-year Treasurys was just 0.54 percentage point as of last week. The last time the spread was so small was during the depths of the COVID-19 pandemic in March 2020. A flattening yield curve has many people worried that a recession may be looming. Could we really have a recession when inflation is on a tear? Yes, it���s called stagflation.
4. The Fed must now walk a tightrope. Over the weekend, economist Mohamed El-Erian, a former deputy director of the International Monetary Fund, had some blunt words for Jerome Powell: ���The characterization of inflation as transitory���it���s probably the worst inflation call in the history of the Federal Reserve.���
Alas, hindsight is 20-20. I give credit to Powell for pivoting on inflation. Instead of digging in his heels, he reversed course as the facts changed���although arguably he ought to have tightened monetary policy sooner. Now, Powell���s greatest challenge awaits him. Will he tighten the monetary spigots too fast and throw the economy into recession? Or will he drag his feet and allow inflation to spiral out of control? This is the��question facing markets in 2022.
The post Time Is Running Out appeared first on HumbleDollar.
Heading Abroad
NATIXIS INVESTMENT Managers just released its 2022 institutional investors��� outlook. The firm surveyed 500 portfolio managers, asking their thoughts on what the next year might look like in the financial markets. The managers���who oversee $13.2 trillion of assets���were generally optimistic, but didn���t expect the recent torrid pace of stock market gains to continue.
The survey found that 35% of institutions plan to decrease exposure to U.S. stocks, allocating more to developed European and Asian markets, as well as emerging markets. Those findings aren���t surprising given the lofty valuations on U.S. large-cap stocks. What sort of returns can we expect? Vanguard Group recently published its latest 10-year asset class outlook. Spoiler alert: Most of the return projections are well below long-term averages.
Back to Natixis���s data: 62% of portfolio managers expect pent-up consumer demand for big-ticket items to be a significant driver of growth in 2022. A December survey from Bank of America Global Research concurred. It seems the onus is on you and me to keep swiping our credit cards.
���Cautious optimism��� from survey respondents was another key theme. The majority of institutional investors expect higher volatility from stocks and bonds. They also expect economic ���reopening��� stocks to outperform ���stay-at-home" plays.
In a not-so-rosy twist, the results show a whopping 68% of money managers predict the bull market will end once central banks���including the Federal Reserve���stop printing money. The Fed has already begun tapering its bond-buying program. Traders expect perhaps three interest rate��increases next year.
Still, we should take such stock market survey data with a grain���or boulder���of salt. As famed trader Jesse Livermore once quipped, ���The stock market is never obvious. It is designed to fool most of the people, most of the time.���
The survey found that 35% of institutions plan to decrease exposure to U.S. stocks, allocating more to developed European and Asian markets, as well as emerging markets. Those findings aren���t surprising given the lofty valuations on U.S. large-cap stocks. What sort of returns can we expect? Vanguard Group recently published its latest 10-year asset class outlook. Spoiler alert: Most of the return projections are well below long-term averages.
Back to Natixis���s data: 62% of portfolio managers expect pent-up consumer demand for big-ticket items to be a significant driver of growth in 2022. A December survey from Bank of America Global Research concurred. It seems the onus is on you and me to keep swiping our credit cards.
���Cautious optimism��� from survey respondents was another key theme. The majority of institutional investors expect higher volatility from stocks and bonds. They also expect economic ���reopening��� stocks to outperform ���stay-at-home" plays.
In a not-so-rosy twist, the results show a whopping 68% of money managers predict the bull market will end once central banks���including the Federal Reserve���stop printing money. The Fed has already begun tapering its bond-buying program. Traders expect perhaps three interest rate��increases next year.
Still, we should take such stock market survey data with a grain���or boulder���of salt. As famed trader Jesse Livermore once quipped, ���The stock market is never obvious. It is designed to fool most of the people, most of the time.���
The post Heading Abroad appeared first on HumbleDollar.
Pocketing Premiums
INTEREST RATES HAVE been low for years, with 10-year Treasury notes now yielding some 1.4%. How about dividend-paying stocks instead? Many pay twice what Treasurys currently yield, though obviously with more risk. My strategy: Instead of a classic 60% stock-40% bond mix, I���ve landed at roughly 70% stocks, with another 15% to 25% in individual stocks against which I���ve written call options.
By selling call options, I give the buyers the right to purchase the underlying stock from me at a specified price���the so-called strike price���at any time between now and when the options expire. Today, on my dividend stocks, traders might pay a 3% to 5% call premium for an ���at-the-money��� call option expiring in as little as 60 to 90 days. An at-the-money call option is one that���s sold with a strike price near the current share price, so both the option seller and buyer know there���s a decent chance the option won���t expire worthless.
That 3% to 5% premium strikes me as generous for such a short period. Put another way, I���m getting paid a 3% to 5% return to provide traders with the chance to purchase my shares at the current stock price for perhaps the next three months. In the meantime, I should also collect a dividend, increasing my return by another 0.5% to 0.8%.
If the stock price is above the strike price on the exercise date, the option���s buyer exercises the option, calling away my shares and paying me the strike price. Since the market has generally been rising, the majority of my call options have been exercised and the stocks called away. Still, I earned the call premium, plus one dividend payment, providing a 4%-plus return over three months or less���not bad on an annualized basis. If a stock rises only slightly above the exercise price, I generally repurchase the same company���s shares and then sell new call options at the marginally higher price.
When the share price is below the strike price on the exercise date, the options expire without being exercised. That means I���m left holding the lower priced shares. But the companies involved still pay solid dividends, plus I already pocketed the 4%-plus return. In these cases, I generally sell a new call option, either at the old strike price, which earns me a somewhat lower premium, or at the new lower share price. I���ve sold call options on the same shares up to three times during a year. In all but a very few cases, the option premium combined with the dividends have far outweighed any decline in the stock���s price.
I���ve written call options against stocks from a host of market sectors, including insurance (Prudential Financial, MetLife), health care (Pfizer, AbbVie, CVS Health), banking (Bank of America, JP Morgan Chase, Truist Financial), retail (Target, Home Depot), industrial (Nucor, General Dynamics, Automatic Data Processing, Archer Daniels Midland) and even some technology stocks (Qualcomm, Seagate Technology, Texas Instruments, Cisco Systems, NetApp). Some of these companies are ���dividend aristocrats��� that have increased their dividends for decades.
The obvious question: Why don���t I simply increase my portfolio���s stock exposure to capture the market���s gain, while accepting low bond yields on the balance? The partial downside protection offered by covered calls, coupled with the healthy dividend yields, have given me the comfort to keep more of my money in the stock market. Simply put, I prefer the risk-return tradeoff of these covered calls over low-yielding bonds, plus bond prices could get hit hard if interest rates rise.
Writing covered calls isn���t a get-rich-quick scheme, plus it takes work to keep resetting the covered calls. Moreover, in selling call options, I limit my portfolio���s upside potential, while still suffering any price declines. But such price declines are a risk that all stock investors face���and mine are at least partly offset by the option premiums I collect.
John��Yeigh��is an author, speaker, coach, youth sports advocate and businessman with more than 30 years of publishing experience in the sports, finance and scientific fields. His book "Win the Youth Sports Game" was published in 2021. John retired in 2017 from the oil industry, where he negotiated financial details for multi-billion-dollar international projects. Check out his earlier articles.
By selling call options, I give the buyers the right to purchase the underlying stock from me at a specified price���the so-called strike price���at any time between now and when the options expire. Today, on my dividend stocks, traders might pay a 3% to 5% call premium for an ���at-the-money��� call option expiring in as little as 60 to 90 days. An at-the-money call option is one that���s sold with a strike price near the current share price, so both the option seller and buyer know there���s a decent chance the option won���t expire worthless.
That 3% to 5% premium strikes me as generous for such a short period. Put another way, I���m getting paid a 3% to 5% return to provide traders with the chance to purchase my shares at the current stock price for perhaps the next three months. In the meantime, I should also collect a dividend, increasing my return by another 0.5% to 0.8%.
If the stock price is above the strike price on the exercise date, the option���s buyer exercises the option, calling away my shares and paying me the strike price. Since the market has generally been rising, the majority of my call options have been exercised and the stocks called away. Still, I earned the call premium, plus one dividend payment, providing a 4%-plus return over three months or less���not bad on an annualized basis. If a stock rises only slightly above the exercise price, I generally repurchase the same company���s shares and then sell new call options at the marginally higher price.
When the share price is below the strike price on the exercise date, the options expire without being exercised. That means I���m left holding the lower priced shares. But the companies involved still pay solid dividends, plus I already pocketed the 4%-plus return. In these cases, I generally sell a new call option, either at the old strike price, which earns me a somewhat lower premium, or at the new lower share price. I���ve sold call options on the same shares up to three times during a year. In all but a very few cases, the option premium combined with the dividends have far outweighed any decline in the stock���s price.
I���ve written call options against stocks from a host of market sectors, including insurance (Prudential Financial, MetLife), health care (Pfizer, AbbVie, CVS Health), banking (Bank of America, JP Morgan Chase, Truist Financial), retail (Target, Home Depot), industrial (Nucor, General Dynamics, Automatic Data Processing, Archer Daniels Midland) and even some technology stocks (Qualcomm, Seagate Technology, Texas Instruments, Cisco Systems, NetApp). Some of these companies are ���dividend aristocrats��� that have increased their dividends for decades.
The obvious question: Why don���t I simply increase my portfolio���s stock exposure to capture the market���s gain, while accepting low bond yields on the balance? The partial downside protection offered by covered calls, coupled with the healthy dividend yields, have given me the comfort to keep more of my money in the stock market. Simply put, I prefer the risk-return tradeoff of these covered calls over low-yielding bonds, plus bond prices could get hit hard if interest rates rise.
Writing covered calls isn���t a get-rich-quick scheme, plus it takes work to keep resetting the covered calls. Moreover, in selling call options, I limit my portfolio���s upside potential, while still suffering any price declines. But such price declines are a risk that all stock investors face���and mine are at least partly offset by the option premiums I collect.
John��Yeigh��is an author, speaker, coach, youth sports advocate and businessman with more than 30 years of publishing experience in the sports, finance and scientific fields. His book "Win the Youth Sports Game" was published in 2021. John retired in 2017 from the oil industry, where he negotiated financial details for multi-billion-dollar international projects. Check out his earlier articles.The post Pocketing Premiums appeared first on HumbleDollar.
December 13, 2021
Looking Long
TIME IS IMPORTANT in investing���far more important than most of us seem to appreciate when we structure our portfolio���s asset mix.
Regular readers may remember that I believe we tend to focus too much on one part of our total portfolio, the securities we own. We often ignore other important parts of our total portfolio, such as Social Security, any pension plan, our homes and���particularly for the young���the present value of our future earning power.
We also focus way too much on the short term and not nearly enough on the long run. At age 40, how many of us say to ourselves, ���If our life expectancy is 85 to 90, that means we���ll be investing for 45 to 50 years, so that should always be the main way we frame our thinking about investing���? Not many of us, I���d imagine.
If length of time is crucial to getting investing right, we would be wise to take full advantage of time realities in our policies and practices. In the very short run, the daily prices of securities fluctuate significantly. But as we add more and more time, those daily price moves tend to offset one another. They become less and less significant, while the long-term price trend looms more and more important.
In a plot of prices over, say, 20 to 30 years, the day-to-day ups and downs tend to disappear. Over 50 years, they lose all significance. All we see is the long-term trend. The long term is���and always will be���significant for serious decisions on investing.
We tend to focus on ���how the market did today.��� We would be wiser to focus on much, much longer time periods because we���re going to be investing not for days, but for decades. Since decades are the more relevant unit of time for most investors, we would improve our results if we'd focus our thinking and our feelings on what���s best for us over the very long run.
This is not easy.
Most of us have learned���or taught ourselves���to live by the ���longer term��� when eating to avoid gaining weight. Those with teenage children have learned not to overreact to the kids��� reactions to ���stuff.���
All long-term investors know how hard it is not to react to Mr. Market���s short-run gyrations. He tries to trick us into taking action���any action at any time���with his clever ruses designed to grab our attention. That���s why successful investors appreciate the value of benign neglect, otherwise known as patience.
Target-date retirement funds get a lot right, but then make mistakes. One mistake���unavoidable in a portfolio that isn���t customized for each individual���is to focus only on the securities part of an investor���s total portfolio. Another is to anchor the biggest asset mix decisions around age 65, presumably because so many of us think of retiring at around 65.
Since we���ll likely live another 20 years or so, is age 65 the right date to target? After all, that leaves out those important last 20 years of our life.
While all investors would be wise to have a cash cushion to meet unexpected spending needs, this amount should be determined by careful analysis. Many investors will also want to have a layer of bonds for ���peace of mind.���
One way to determine this bond amount is to see whether spending exceeds income and, if so, by how much. If our spending doesn���t exceed our income, then the bond layer can be small, probably zero. What if our spending is greater than our income, such as the spending needs for retirees after taking into account Social Security and any pension income? We might multiply that spending need by three years or so to determine the gap that needs to be filled with bonds, so we���re ready for a stock market downturn.
Once that gap filled, the investor can then focus on longer-term investing. Since the long-term return on stocks is greater than the long-term return on bonds, the bulk of the informed investor���s portfolio can be invested in stocks���ideally low-cost index funds.
As a double check on this decision, the wise investor will determine the historical difference in rates of return between stocks and bonds over, say, 10 years or more. She will multiply that figure by the value of her bond holdings to see what those bonds will probably cost her in returns forgone. If that cost seems low as an ���insurance premium,��� the bond layer can be increased. If it seems high, the bond layer can be reduced.
We are emotional people. The big mistake we should avoid is thinking we���re more capable of maintaining calm rationality than we really are. That said, chances are high that many investors are being overly protective of themselves. They are paying too high a price, particularly over the long term, to feel secure���free from worries about daily, monthly or even annual stock market fluctuations.
Every investor is unique. No other investor has the same age, the same years to live, the same assets, the same attitude toward market risk, the same financial responsibilities, the same rate of savings, the same understanding of the markets, the same interest in investing, the same views on philanthropy, and so on. Since each of us is unique, our optimal investment portfolio should be uniquely tailored to suit ourselves.
Because this takes relatively little time���and produces great value���why not break away from conventional wisdom and design the investment program that���s best suited to yourself? The work is interesting and the benefits can be great. It could well be our best investment ever.
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.
Regular readers may remember that I believe we tend to focus too much on one part of our total portfolio, the securities we own. We often ignore other important parts of our total portfolio, such as Social Security, any pension plan, our homes and���particularly for the young���the present value of our future earning power.
We also focus way too much on the short term and not nearly enough on the long run. At age 40, how many of us say to ourselves, ���If our life expectancy is 85 to 90, that means we���ll be investing for 45 to 50 years, so that should always be the main way we frame our thinking about investing���? Not many of us, I���d imagine.
If length of time is crucial to getting investing right, we would be wise to take full advantage of time realities in our policies and practices. In the very short run, the daily prices of securities fluctuate significantly. But as we add more and more time, those daily price moves tend to offset one another. They become less and less significant, while the long-term price trend looms more and more important.
In a plot of prices over, say, 20 to 30 years, the day-to-day ups and downs tend to disappear. Over 50 years, they lose all significance. All we see is the long-term trend. The long term is���and always will be���significant for serious decisions on investing.
We tend to focus on ���how the market did today.��� We would be wiser to focus on much, much longer time periods because we���re going to be investing not for days, but for decades. Since decades are the more relevant unit of time for most investors, we would improve our results if we'd focus our thinking and our feelings on what���s best for us over the very long run.
This is not easy.
Most of us have learned���or taught ourselves���to live by the ���longer term��� when eating to avoid gaining weight. Those with teenage children have learned not to overreact to the kids��� reactions to ���stuff.���
All long-term investors know how hard it is not to react to Mr. Market���s short-run gyrations. He tries to trick us into taking action���any action at any time���with his clever ruses designed to grab our attention. That���s why successful investors appreciate the value of benign neglect, otherwise known as patience.
Target-date retirement funds get a lot right, but then make mistakes. One mistake���unavoidable in a portfolio that isn���t customized for each individual���is to focus only on the securities part of an investor���s total portfolio. Another is to anchor the biggest asset mix decisions around age 65, presumably because so many of us think of retiring at around 65.
Since we���ll likely live another 20 years or so, is age 65 the right date to target? After all, that leaves out those important last 20 years of our life.
While all investors would be wise to have a cash cushion to meet unexpected spending needs, this amount should be determined by careful analysis. Many investors will also want to have a layer of bonds for ���peace of mind.���
One way to determine this bond amount is to see whether spending exceeds income and, if so, by how much. If our spending doesn���t exceed our income, then the bond layer can be small, probably zero. What if our spending is greater than our income, such as the spending needs for retirees after taking into account Social Security and any pension income? We might multiply that spending need by three years or so to determine the gap that needs to be filled with bonds, so we���re ready for a stock market downturn.
Once that gap filled, the investor can then focus on longer-term investing. Since the long-term return on stocks is greater than the long-term return on bonds, the bulk of the informed investor���s portfolio can be invested in stocks���ideally low-cost index funds.
As a double check on this decision, the wise investor will determine the historical difference in rates of return between stocks and bonds over, say, 10 years or more. She will multiply that figure by the value of her bond holdings to see what those bonds will probably cost her in returns forgone. If that cost seems low as an ���insurance premium,��� the bond layer can be increased. If it seems high, the bond layer can be reduced.
We are emotional people. The big mistake we should avoid is thinking we���re more capable of maintaining calm rationality than we really are. That said, chances are high that many investors are being overly protective of themselves. They are paying too high a price, particularly over the long term, to feel secure���free from worries about daily, monthly or even annual stock market fluctuations.
Every investor is unique. No other investor has the same age, the same years to live, the same assets, the same attitude toward market risk, the same financial responsibilities, the same rate of savings, the same understanding of the markets, the same interest in investing, the same views on philanthropy, and so on. Since each of us is unique, our optimal investment portfolio should be uniquely tailored to suit ourselves.
Because this takes relatively little time���and produces great value���why not break away from conventional wisdom and design the investment program that���s best suited to yourself? The work is interesting and the benefits can be great. It could well be our best investment ever.
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 Looking Long appeared first on HumbleDollar.
December 12, 2021
The un-COLA
SENIORS RECEIVING Social Security celebrated the recent announcement that their benefits will increase 5.9% this January. It���s the largest cost-of-living adjustment (COLA) in 40 years, and it���s based on a measure of inflation called the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
As the name implies, CPI-W is a ���monthly measure of the average change over time in the prices paid by urban wage earners and clerical workers for a market basket of consumer goods and services.��� The index jumped 5.9% between the third quarters of 2020 and 2021.
There have been arguments for years that this index doesn���t accurately reflect spending by the elderly. Accordingly, in 1987, Congress directed the Bureau of Labor Statistics to develop a price index that better reflected elderly spending. This experimental inflation index for the elderly is known as CPI-E.
CPI-E uses existing data, but changes its weightings to better represent modern elderly spending. For example, the elderly spend about twice as much on medical care as the rest of the population.
Boston College���s Center for Retirement Research recently published an intriguing paper comparing the two indexes from 1983 to 2021. The elderly index has risen faster than CPI-W, consistent with the thought that seniors must grapple with higher inflation. But more recently, the gap has narrowed.
In the first 20 years, CPI-E was 0.38 percentage point higher per year, on average, than CPI-W. For the period 2002-21, however, the elderly index was only 0.05 percentage point greater per year than the general inflation measure.
The authors identify two main reasons for this���trends in medical and transportation costs. Medical inflation has slowed in the last 20 years, and the pandemic lowered medical inflation still further. As people avoided routine visits to the doctor, medical costs actually declined 0.4% in 2020.
Meanwhile, transportation costs have risen fairly rapidly over the past two decades. In this case, however, seniors have been less hurt���because they use less transportation than the general public. In other words, transportation price increases have hit the general population harder than the elderly.
Do you still favor linking Social Security to CPI-E? If it had been used to calculate the 2022 Social Security COLA, the result would have been a 4.8% rise in benefits, lower than the 5.9% increase that was recently announced.
As the name implies, CPI-W is a ���monthly measure of the average change over time in the prices paid by urban wage earners and clerical workers for a market basket of consumer goods and services.��� The index jumped 5.9% between the third quarters of 2020 and 2021.
There have been arguments for years that this index doesn���t accurately reflect spending by the elderly. Accordingly, in 1987, Congress directed the Bureau of Labor Statistics to develop a price index that better reflected elderly spending. This experimental inflation index for the elderly is known as CPI-E.
CPI-E uses existing data, but changes its weightings to better represent modern elderly spending. For example, the elderly spend about twice as much on medical care as the rest of the population.
Boston College���s Center for Retirement Research recently published an intriguing paper comparing the two indexes from 1983 to 2021. The elderly index has risen faster than CPI-W, consistent with the thought that seniors must grapple with higher inflation. But more recently, the gap has narrowed.
In the first 20 years, CPI-E was 0.38 percentage point higher per year, on average, than CPI-W. For the period 2002-21, however, the elderly index was only 0.05 percentage point greater per year than the general inflation measure.
The authors identify two main reasons for this���trends in medical and transportation costs. Medical inflation has slowed in the last 20 years, and the pandemic lowered medical inflation still further. As people avoided routine visits to the doctor, medical costs actually declined 0.4% in 2020.
Meanwhile, transportation costs have risen fairly rapidly over the past two decades. In this case, however, seniors have been less hurt���because they use less transportation than the general public. In other words, transportation price increases have hit the general population harder than the elderly.
Do you still favor linking Social Security to CPI-E? If it had been used to calculate the 2022 Social Security COLA, the result would have been a 4.8% rise in benefits, lower than the 5.9% increase that was recently announced.
The post The un-COLA appeared first on HumbleDollar.
Reading Rates
THE MARKET SEEMS to have found its footing when it comes to inflation. Friday���s Consumer Price Index report was roughly in line with expectations. Recently, there haven���t been any major shifts in the experts��� inflation forecasts. The bond market has also calmed down. Just a few weeks ago, the 10-year Treasury yield neared 1.7%. It settled at 1.49% on Friday.
Volatility could reemerge later this week, however. Data on producer prices post on Tuesday, retail sales hit Wednesday morning and the Federal Open Market Committee issues its rate decision Wednesday afternoon.
More key data arrive on Thursday with housing starts, industrial production figures and the Purchasing Managers' Index. These readings on U.S. economic strength will all impact the bond market.
Some pundits are growing uneasy about the yield curve���the level of interest rates at various maturities. Normally, short-term yields are low relative to long-term yields. But recently, the short end of the curve has climbed, while the long end remains historically low. The dreaded ���inverted yield curve��� might be talked about more in the months ahead.
An inverted yield curve is thought to portend an economic recession. The last inversion, when the two-year Treasury yield climbed above the 10-year Treasury rate, occurred in August 2019. The GDP growth rate then turned negative in early 2020. Of course, nobody predicted a pandemic would strike, least of all the bond market.
In the months ahead, the yield curve could invert if traders believe the Fed will raise short-term interest rates. Higher short-term rates mean a tighter credit market, possibly leading to less business activity and reduced consumer spending. That, in turn, might cause long-term interest rates to dip, as investors bet that long-run economic growth could be slightly weaker and inflation somewhat lower.
Volatility could reemerge later this week, however. Data on producer prices post on Tuesday, retail sales hit Wednesday morning and the Federal Open Market Committee issues its rate decision Wednesday afternoon.
More key data arrive on Thursday with housing starts, industrial production figures and the Purchasing Managers' Index. These readings on U.S. economic strength will all impact the bond market.
Some pundits are growing uneasy about the yield curve���the level of interest rates at various maturities. Normally, short-term yields are low relative to long-term yields. But recently, the short end of the curve has climbed, while the long end remains historically low. The dreaded ���inverted yield curve��� might be talked about more in the months ahead.
An inverted yield curve is thought to portend an economic recession. The last inversion, when the two-year Treasury yield climbed above the 10-year Treasury rate, occurred in August 2019. The GDP growth rate then turned negative in early 2020. Of course, nobody predicted a pandemic would strike, least of all the bond market.
In the months ahead, the yield curve could invert if traders believe the Fed will raise short-term interest rates. Higher short-term rates mean a tighter credit market, possibly leading to less business activity and reduced consumer spending. That, in turn, might cause long-term interest rates to dip, as investors bet that long-run economic growth could be slightly weaker and inflation somewhat lower.
The post Reading Rates appeared first on HumbleDollar.
Me Fighting Me
PSYCHOLOGISTS and biologists call it a supernormal��stimulus response. Basically, organisms evolve in the direction of what���s good for them. There doesn���t seem to be an off switch to this instinct, however, so organisms can pursue these ���good things��� even to their detriment.
For instance, field researchers have shown that birds instinctually drawn to colorful eggs will roost on more colorful fake eggs���and ignore their own. And, no, humans aren���t immune to such mistakes. Sunlight is good for us, but many know the pain of sunning to the point of sunburn. Advertisers know we have basic urges for sugar, salt and sex. They use these urges to nudge us to consume, say, sugary foods and salty snacks.
Instinct can push us to crave more abstract things, too, that are higher on Maslow's��hierarchy of needs. Financially, we can be nudged to go further than a healthy budget would allow. Our rush for a secure home can cause us to overspend. Biology and aesthetics say we desire a fit, attractive partner. But many cried ���too far��� at Peloton's sexist��Christmas��advertisement a couple of years ago.
There���s also that strong desire to be viewed as ���successful.��� How that looks is ever-changing, but in a material world it almost always comes down to money and goods. We go into debt to be alpha peacocks, taking out huge mortgages so we can show the world an ever-bigger nest. On the road to success, we���re all accelerator and no brake. Even those who don���t crash aren���t ���winners��� because there is no finish line to this race, just the next urge to spend.
If we don���t seem to have a natural off switch to our instinctual desires for more, can we create artificial ones? Even if we can't train ourselves to stop throwing good money��after bad, could we at least stop ourselves from throwing away too much good money?
Some people can simply say ���enough stuff,��� which just happens to be the name of a book I wrote, and walk away. On their daily calendar, many make notes to ���do��� or ���don���t do��� some things. Others need more tangible visual reminders���such as a sign in front of their computer that asks if the time, fees and frustration of all their portfolio manipulation is really worth the possible extra return. One friend has a small yin-yang symbol tattooed on his wrist to remind him to pause before acting.
It���s a long story, but two weeks ago was a really bad time for our family. My stimulus response in such circumstances is to jump into action. I was doing everything���and nothing���all at once to try to fix the situation. This usually works, but this time it was like spinning the wheels of a car trapped in mud. My escape strategy was just digging a bigger hole, especially mentally.
As luck would have it, I had to immediately travel to Thailand for in-law matters. Separated by time differences���and an unreliable internet connection���I was forced to quell my instinct to do things and just, well, ruminate. I thought, I mourned, I reflected. I was less active in trying to make things better, and that was a better resolution for me.
For instance, field researchers have shown that birds instinctually drawn to colorful eggs will roost on more colorful fake eggs���and ignore their own. And, no, humans aren���t immune to such mistakes. Sunlight is good for us, but many know the pain of sunning to the point of sunburn. Advertisers know we have basic urges for sugar, salt and sex. They use these urges to nudge us to consume, say, sugary foods and salty snacks.
Instinct can push us to crave more abstract things, too, that are higher on Maslow's��hierarchy of needs. Financially, we can be nudged to go further than a healthy budget would allow. Our rush for a secure home can cause us to overspend. Biology and aesthetics say we desire a fit, attractive partner. But many cried ���too far��� at Peloton's sexist��Christmas��advertisement a couple of years ago.
There���s also that strong desire to be viewed as ���successful.��� How that looks is ever-changing, but in a material world it almost always comes down to money and goods. We go into debt to be alpha peacocks, taking out huge mortgages so we can show the world an ever-bigger nest. On the road to success, we���re all accelerator and no brake. Even those who don���t crash aren���t ���winners��� because there is no finish line to this race, just the next urge to spend.
If we don���t seem to have a natural off switch to our instinctual desires for more, can we create artificial ones? Even if we can't train ourselves to stop throwing good money��after bad, could we at least stop ourselves from throwing away too much good money?
Some people can simply say ���enough stuff,��� which just happens to be the name of a book I wrote, and walk away. On their daily calendar, many make notes to ���do��� or ���don���t do��� some things. Others need more tangible visual reminders���such as a sign in front of their computer that asks if the time, fees and frustration of all their portfolio manipulation is really worth the possible extra return. One friend has a small yin-yang symbol tattooed on his wrist to remind him to pause before acting.
It���s a long story, but two weeks ago was a really bad time for our family. My stimulus response in such circumstances is to jump into action. I was doing everything���and nothing���all at once to try to fix the situation. This usually works, but this time it was like spinning the wheels of a car trapped in mud. My escape strategy was just digging a bigger hole, especially mentally.
As luck would have it, I had to immediately travel to Thailand for in-law matters. Separated by time differences���and an unreliable internet connection���I was forced to quell my instinct to do things and just, well, ruminate. I thought, I mourned, I reflected. I was less active in trying to make things better, and that was a better resolution for me.
The post Me Fighting Me appeared first on HumbleDollar.
Giving Advice
GOT CHARITABLE giving on your mind? Join the crowd. Many folks donate at this time of year, with their charitable giving driven by the charities themselves.
As solicitations arrive, people decide on a case-by-case basis whether to pull out their checkbooks. But some folks follow a more structured process, and that���s the approach I favor. It includes asking these three questions:
1. How much��ideally��would you like to give?��As a starting point, I suggest totaling up the gifts that you���ve made, on average, over the past few years. If you���ve been making gifts on the larger side, those figures will be on your tax return. If you use a donor-advised fund, most fund websites provide annual giving summaries. That���s what I would call the dollar-based approach to thinking about giving.
An alternative is to take a percentage-based approach. As the label suggests, some folks target a specific percentage of their pay for charitable giving. If your income varies significantly from year to year, this approach may be more appealing. I am, of course, not prescribing���or proscribing���any particular amount or percentage. I���m just suggesting that your first step should be to quantify your goals.
2. How much can you afford to give?��To answer this question, I'd start with the pay-yourself-first framework. If you aren���t familiar with it, here���s how this strategy works: Assuming you have a sense of your long-term financial goals, you���d work backward to calculate the minimum you need to save each year to be on track for those goals.
For example, suppose you currently have $500,000 saved and your goal is to have $1.25 million for retirement in 15 years. In that case, assuming 5% returns, you'd have to save about $10,000 per year to hit that $1.25 million goal. If you take the pay-yourself-first approach, you���d just need to make sure you're adding that amount to your savings each year. Then you can choose to allocate what's left in any way you see fit, including charitable giving.
3. What are the tax considerations?��On the surface, this seems like a simple question. If you're in the 32% tax bracket, every dollar you give ought to save you 32 cents in taxes. Unfortunately, the IRS doesn't make it that easy.
The wrinkle that affects the most people: the standard deduction. In 2021, an individual taxpayer is entitled to a $12,550 standard deduction and a married couple is entitled to $25,100. But under current rules, there���s a $10,000 cap on the deduction that can be taken for state and local taxes. That makes it more difficult than in the past to muster enough deductions to exceed the standard deduction. The result: If you don���t have any other significant deductions, charitable contributions may not provide any incremental benefit.
One solution to this challenge, as I���ve��noted��before, is to use a donor-advised fund. Then you can group several years of contributions together into one year, thereby exceeding the standard deduction and realizing a bigger tax benefit. You could repeat this process periodically���every two or three years, for example. Another benefit of donor-advised funds: They allow you to donate appreciated assets, thus sidestepping capital gains taxes. Some even accept cryptocurrencies.
Donor-advised funds are terrific, but keep a few caveats in mind. If you���re donating appreciated stock, annual deductible contributions are limited to 30% of adjusted gross income. But if you���re donating cash, the limit is typically 60%. The IRS imposes other contribution limits, which are also important to keep in mind. For most people, these limits are very generous, but it's nonetheless important to be aware of them.
Another tax consideration applies to investors who are contending with required minimum distributions. Beginning at age 70��, taxpayers are eligible to make contributions directly from their tax-deferred retirement accounts. This is called a qualified charitable distribution (QCD).
What���s the benefit? While contributions made this way aren���t eligible for a deduction, they carry a potentially more valuable benefit. They count toward required minimum distributions, up to a maximum of $100,000 per person. Not only can this lower your income tax bill, but it can also lower other costs which are tied to adjusted gross income. These include Medicare premium��surcharges and the degree to which Social Security is taxed. If you���re in this age range, you���ll want to compare the relative tax benefits of a standard contribution to a QCD.
What about potential tax law changes? While Congress is never��very popular, it���s certainly not winning new friends this year. For months, politicians have been debating potential rule changes, some of which would be retroactive to earlier periods in 2021. As an investor trying to make planning decisions, this makes things even more difficult. According to the latest version of the bill, there would be no changes to the income tax brackets next year.
The 3.8% net investment income tax, however, would apply to distributions from S corporations. If you own an S corporation and take sizable distributions on top of your salary, that would represent a tax increase in 2022. All things being equal, that would be a reason to delay tax deductions, including charitable contributions, until 2022. It���s important to note, though, that negotiations are ongoing. This change might or might not make it into the final rules.
Planning to make a very large donation? As noted above, in most years, deductions on cash contributions are limited to 60% of adjusted gross income. But for 2021, as part of the CARES Act, you���re permitted to deduct��up to 100%��if you contribute directly to a charity. The upshot: If you were so inclined, you could zero out your tax bill this year.
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.
As solicitations arrive, people decide on a case-by-case basis whether to pull out their checkbooks. But some folks follow a more structured process, and that���s the approach I favor. It includes asking these three questions:
1. How much��ideally��would you like to give?��As a starting point, I suggest totaling up the gifts that you���ve made, on average, over the past few years. If you���ve been making gifts on the larger side, those figures will be on your tax return. If you use a donor-advised fund, most fund websites provide annual giving summaries. That���s what I would call the dollar-based approach to thinking about giving.
An alternative is to take a percentage-based approach. As the label suggests, some folks target a specific percentage of their pay for charitable giving. If your income varies significantly from year to year, this approach may be more appealing. I am, of course, not prescribing���or proscribing���any particular amount or percentage. I���m just suggesting that your first step should be to quantify your goals.
2. How much can you afford to give?��To answer this question, I'd start with the pay-yourself-first framework. If you aren���t familiar with it, here���s how this strategy works: Assuming you have a sense of your long-term financial goals, you���d work backward to calculate the minimum you need to save each year to be on track for those goals.
For example, suppose you currently have $500,000 saved and your goal is to have $1.25 million for retirement in 15 years. In that case, assuming 5% returns, you'd have to save about $10,000 per year to hit that $1.25 million goal. If you take the pay-yourself-first approach, you���d just need to make sure you're adding that amount to your savings each year. Then you can choose to allocate what's left in any way you see fit, including charitable giving.
3. What are the tax considerations?��On the surface, this seems like a simple question. If you're in the 32% tax bracket, every dollar you give ought to save you 32 cents in taxes. Unfortunately, the IRS doesn't make it that easy.
The wrinkle that affects the most people: the standard deduction. In 2021, an individual taxpayer is entitled to a $12,550 standard deduction and a married couple is entitled to $25,100. But under current rules, there���s a $10,000 cap on the deduction that can be taken for state and local taxes. That makes it more difficult than in the past to muster enough deductions to exceed the standard deduction. The result: If you don���t have any other significant deductions, charitable contributions may not provide any incremental benefit.
One solution to this challenge, as I���ve��noted��before, is to use a donor-advised fund. Then you can group several years of contributions together into one year, thereby exceeding the standard deduction and realizing a bigger tax benefit. You could repeat this process periodically���every two or three years, for example. Another benefit of donor-advised funds: They allow you to donate appreciated assets, thus sidestepping capital gains taxes. Some even accept cryptocurrencies.
Donor-advised funds are terrific, but keep a few caveats in mind. If you���re donating appreciated stock, annual deductible contributions are limited to 30% of adjusted gross income. But if you���re donating cash, the limit is typically 60%. The IRS imposes other contribution limits, which are also important to keep in mind. For most people, these limits are very generous, but it's nonetheless important to be aware of them.
Another tax consideration applies to investors who are contending with required minimum distributions. Beginning at age 70��, taxpayers are eligible to make contributions directly from their tax-deferred retirement accounts. This is called a qualified charitable distribution (QCD).
What���s the benefit? While contributions made this way aren���t eligible for a deduction, they carry a potentially more valuable benefit. They count toward required minimum distributions, up to a maximum of $100,000 per person. Not only can this lower your income tax bill, but it can also lower other costs which are tied to adjusted gross income. These include Medicare premium��surcharges and the degree to which Social Security is taxed. If you���re in this age range, you���ll want to compare the relative tax benefits of a standard contribution to a QCD.
What about potential tax law changes? While Congress is never��very popular, it���s certainly not winning new friends this year. For months, politicians have been debating potential rule changes, some of which would be retroactive to earlier periods in 2021. As an investor trying to make planning decisions, this makes things even more difficult. According to the latest version of the bill, there would be no changes to the income tax brackets next year.
The 3.8% net investment income tax, however, would apply to distributions from S corporations. If you own an S corporation and take sizable distributions on top of your salary, that would represent a tax increase in 2022. All things being equal, that would be a reason to delay tax deductions, including charitable contributions, until 2022. It���s important to note, though, that negotiations are ongoing. This change might or might not make it into the final rules.
Planning to make a very large donation? As noted above, in most years, deductions on cash contributions are limited to 60% of adjusted gross income. But for 2021, as part of the CARES Act, you���re permitted to deduct��up to 100%��if you contribute directly to a charity. The upshot: If you were so inclined, you could zero out your tax bill this year.
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 Giving Advice appeared first on HumbleDollar.
December 11, 2021
Less Funds More Gain
READERS MAY RECALL Laura, my acquaintance who didn���t need life insurance but was sold a policy��anyway. Alarmed by her ignorance, she vowed to manage her own money. As a first step, she parted ways with her financial advisor.
The advisor had her invested in 35 funds. She never fully understood what these funds owned or why she needed them. She had previously thought that investing had to be complicated and was best left to the professionals. She wasn���t so sure anymore.
After spending days researching her funds and still getting nowhere, Laura figured that there must be simpler ways to invest. She broached the idea with me.
What struck me about her investments wasn���t just the complexity, but also her overall asset allocation. More than half of her long-term savings was in cash and bonds. Why would someone in her 40s invest so conservatively?
Apparently, Laura���s former advisor had recommended a moderately��aggressive asset allocation. Indeed, 70% of her managed investments were in various stock funds. But she also had a pile of cash in her bank account. Did her advisor overlook this uninvested savings?
Nope. It turns out that she was repeatedly asked to add the remaining cash to her investment accounts, but she declined. She didn���t want to pay yet more management fees. More important, she didn���t want to see her stable cash disappear into the mysterious jungle of managed accounts.
There was an alternative. Laura could���ve left her cash in the bank, while shifting the allocation in her investment accounts away from bonds and more toward stocks. Her overall stock exposure would then have been closer to her desired asset allocation. Laura couldn���t tell why this wasn���t done by her old advisor, but she saw no problem in doing it now.
Undeterred by the tax consequences, Laura sold all her previous holdings and replaced them with a few index funds. Between lower fund expenses and no more advisory fees, her annual investment��costs fell almost two percentage points. The best part: She now understands her investments.
The advisor had her invested in 35 funds. She never fully understood what these funds owned or why she needed them. She had previously thought that investing had to be complicated and was best left to the professionals. She wasn���t so sure anymore.
After spending days researching her funds and still getting nowhere, Laura figured that there must be simpler ways to invest. She broached the idea with me.
What struck me about her investments wasn���t just the complexity, but also her overall asset allocation. More than half of her long-term savings was in cash and bonds. Why would someone in her 40s invest so conservatively?
Apparently, Laura���s former advisor had recommended a moderately��aggressive asset allocation. Indeed, 70% of her managed investments were in various stock funds. But she also had a pile of cash in her bank account. Did her advisor overlook this uninvested savings?
Nope. It turns out that she was repeatedly asked to add the remaining cash to her investment accounts, but she declined. She didn���t want to pay yet more management fees. More important, she didn���t want to see her stable cash disappear into the mysterious jungle of managed accounts.
There was an alternative. Laura could���ve left her cash in the bank, while shifting the allocation in her investment accounts away from bonds and more toward stocks. Her overall stock exposure would then have been closer to her desired asset allocation. Laura couldn���t tell why this wasn���t done by her old advisor, but she saw no problem in doing it now.
Undeterred by the tax consequences, Laura sold all her previous holdings and replaced them with a few index funds. Between lower fund expenses and no more advisory fees, her annual investment��costs fell almost two percentage points. The best part: She now understands her investments.
The post Less Funds More Gain appeared first on HumbleDollar.
