Jonathan Clements's Blog, page 246
December 7, 2021
Paying the Price
I STARTED DOING the family grocery shopping when I was 12 years old. I also married a woman who doesn���t like to cook or grocery shop. That means I���ve been buying the groceries now for more than 50 years. Fortunately, I enjoy it most of the time, but only recently have I noticed some behavior that I wish I���d used more frequently in my early investing life.
I find it hard to buy anything unless it���s on sale. At times in my life, I spent the weekend clipping coupons. Today, I find them online. Being a huge fan of Costco helps, as does being a member of several grocery stores that are happy to send me the latest and greatest deals at least once a week. The truth is, when it comes to chili beans, pickles and potato chips, as well as just about everything else, I���m driven far more by the lowest cost and greatest discount than by brand loyalty or quality.
This sales mindset extends to other parts of my life. Over the years, I���ve learned most of the tricks for how to get good deals on everything from cars to clothes to credit cards. Some of my friends ask me for counsel before they book a trip or make a large purchase. Thanks to consumer advocate Clark Howard and others, I���ve learned a lot over the years.
Unfortunately, I haven���t always brought this same obsession to my financial life. In my younger days, I chased past performance and the hottest stocks or mutual funds. What���s 1% more in fees if I get back an additional 3% in annual return? Too often, I bought high and eventually sold low, or I worried when something went up too fast and sold it way before I should have. Mistakes at the grocery store cost a few dollars. Mistakes when investing can cost us five more years in the workforce.
I���ve been thinking lately that investing right now is like shopping in a store where nothing is on sale. By most measures, stocks are selling at close to all-time record highs. Even with the recent declines, most investments aren���t cheap enough for a bargain-basement shopper. I would never buy my food, clothes or trips at full cost. Yet sometimes I���ve bought my investments that way.
But not now. Fees and discounts matter���whether buying taco shells or technology stocks or Treasury bonds.
The post Paying the Price appeared first on HumbleDollar.
Spin the Wheel
I RECENTLY SPOKE with a colleague. I’d expected him to be retired by now. He told me that he’d planned to retire last spring, but his employer offered him a three-day-a-week part-time schedule with full benefits. He discussed it with his financial planner.
The planner told him that, if he retired, he had an 85% chance of meeting his retirement goals. By working part-time for two more years, his chances of meeting his goals went up to 95%. My colleague enjoyed his work and figured he’d still be able to schedule four-day weekends. He decided to continue working part-time.
If you work with a financial planner, you may have heard assessments similar to my friend’s. The higher the percent chance of success, the better you’re supposed to feel. But what do these numbers really mean?
There are two common methods that planners use to assess your portfolio’s probability of success—historical averages and Monte Carlo simulations. Using historical averages is more straightforward. You take historical market returns for each asset class and compute a weighted average annual return based on your portfolio’s asset allocation.
Let’s say you have a classic 60% stock-40% bond mix. The stock portion is in an S&P 500 index fund, which has an historical annual return of 9.6%. The bond return is calculated using a long-term U.S. bond fund, which has an historical annual return of 5.6%. Their weighted average is (0.6 x 9.6%) + (0.4 x 5.6%), which comes to 8%.
Starting with this assumption, a retirement income projection is built for each year of retirement. It compares all sources of income—pension, Social Security, portfolio growth, withdrawals—against all anticipated expenses. The analysis can incorporate other variables, such as inflation, required minimum distributions and taxes.
If your total spending is less than total income, your portfolio continues to grow. If you have money left over at the end of your whole retirement period, your retirement plan is considered a success.
What if your spending is greater than your income? The analysis assumes you make up the difference by taking larger withdrawals from your portfolio. Your portfolio will shrink each year and may eventually be depleted. If your savings are projected to run dry before the assumed end of your retirement, your retirement plan is—needless to say—considered a failure.
The weakness of this analysis: The model uses the same investment return for each year of the analysis. Your retirement success will hinge on how much your actual investment results differ from the assumed average return.
A Monte Carlo simulation attempts to avoid the shortcomings of the “historical averages” method by varying the returns of each asset class in each time period, often focusing on annual results. Once again, you start with the historical averages for each asset class. But a Monte Carlo simulation throws in historical volatility and a random number generator, thereby calculating a distinct asset return for each time period in the retirement projection.
The Monte Carlo method repeats the whole process hundreds or even thousands of times, each with a different set of returns for each asset class and each time period. The total number of iterations that produce a positive portfolio value at death is computed. This number is then compared to the total number of iterations attempted.
Say the Monte Carlo software ran 1,000 iterations of a retirement projection. If 950 of those cases showed a positive portfolio value at the end of the projection, the probability of success for that retirement plan would be 95%. In other words, each of the 1,000 scenarios considered a different stock and bond market performance and, in 95% of those random cases, your portfolio carried you all the way through your retirement.
The math is more complex than my explanation here. You can also use the statistical methods to randomize more than asset returns. For example, you could vary inflation randomly as well. But varying asset returns suffices for many of my friends and colleagues who aren’t math aficionados.
What if this analysis shows a lower probability of success than you’re comfortable with? You can often adjust your plan to reach an acceptable level. For example, you could reduce retirement spending. Alternatively, you might adjust your asset allocation, increasing risk until you meet your success objective. Just don’t overdo that extra risk.
Michael Kitces has written a paper that challenges the need for a 95% probability of success. The paper brings up several good points that can help us better understand the results of these experiments.
Let’s say you only achieve a 50% probability of success. Small adjustments may translate into a dramatic improvement. For instance, if you have ongoing sources of income, like pension and Social Security, that cover the great majority of your spending, cutting your spending just a bit could significantly improve the odds of success.
The bottom line: If you’re working with a financial planner and she says your probability of success is 50%, don’t panic. It’s likely not a bad starting point as you approach retirement. The key is to understand the source and magnitude of the failure, and what can be done to overcome it. Consider my friend at the start of this article: A few years of part-time work put him squarely in the 95% success range.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.
The planner told him that, if he retired, he had an 85% chance of meeting his retirement goals. By working part-time for two more years, his chances of meeting his goals went up to 95%. My colleague enjoyed his work and figured he’d still be able to schedule four-day weekends. He decided to continue working part-time.
If you work with a financial planner, you may have heard assessments similar to my friend’s. The higher the percent chance of success, the better you’re supposed to feel. But what do these numbers really mean?
There are two common methods that planners use to assess your portfolio’s probability of success—historical averages and Monte Carlo simulations. Using historical averages is more straightforward. You take historical market returns for each asset class and compute a weighted average annual return based on your portfolio’s asset allocation.
Let’s say you have a classic 60% stock-40% bond mix. The stock portion is in an S&P 500 index fund, which has an historical annual return of 9.6%. The bond return is calculated using a long-term U.S. bond fund, which has an historical annual return of 5.6%. Their weighted average is (0.6 x 9.6%) + (0.4 x 5.6%), which comes to 8%.
Starting with this assumption, a retirement income projection is built for each year of retirement. It compares all sources of income—pension, Social Security, portfolio growth, withdrawals—against all anticipated expenses. The analysis can incorporate other variables, such as inflation, required minimum distributions and taxes.
If your total spending is less than total income, your portfolio continues to grow. If you have money left over at the end of your whole retirement period, your retirement plan is considered a success.
What if your spending is greater than your income? The analysis assumes you make up the difference by taking larger withdrawals from your portfolio. Your portfolio will shrink each year and may eventually be depleted. If your savings are projected to run dry before the assumed end of your retirement, your retirement plan is—needless to say—considered a failure.
The weakness of this analysis: The model uses the same investment return for each year of the analysis. Your retirement success will hinge on how much your actual investment results differ from the assumed average return.
A Monte Carlo simulation attempts to avoid the shortcomings of the “historical averages” method by varying the returns of each asset class in each time period, often focusing on annual results. Once again, you start with the historical averages for each asset class. But a Monte Carlo simulation throws in historical volatility and a random number generator, thereby calculating a distinct asset return for each time period in the retirement projection.
The Monte Carlo method repeats the whole process hundreds or even thousands of times, each with a different set of returns for each asset class and each time period. The total number of iterations that produce a positive portfolio value at death is computed. This number is then compared to the total number of iterations attempted.
Say the Monte Carlo software ran 1,000 iterations of a retirement projection. If 950 of those cases showed a positive portfolio value at the end of the projection, the probability of success for that retirement plan would be 95%. In other words, each of the 1,000 scenarios considered a different stock and bond market performance and, in 95% of those random cases, your portfolio carried you all the way through your retirement.
The math is more complex than my explanation here. You can also use the statistical methods to randomize more than asset returns. For example, you could vary inflation randomly as well. But varying asset returns suffices for many of my friends and colleagues who aren’t math aficionados.
What if this analysis shows a lower probability of success than you’re comfortable with? You can often adjust your plan to reach an acceptable level. For example, you could reduce retirement spending. Alternatively, you might adjust your asset allocation, increasing risk until you meet your success objective. Just don’t overdo that extra risk.
Michael Kitces has written a paper that challenges the need for a 95% probability of success. The paper brings up several good points that can help us better understand the results of these experiments.
Let’s say you only achieve a 50% probability of success. Small adjustments may translate into a dramatic improvement. For instance, if you have ongoing sources of income, like pension and Social Security, that cover the great majority of your spending, cutting your spending just a bit could significantly improve the odds of success.
The bottom line: If you’re working with a financial planner and she says your probability of success is 50%, don’t panic. It’s likely not a bad starting point as you approach retirement. The key is to understand the source and magnitude of the failure, and what can be done to overcome it. Consider my friend at the start of this article: A few years of part-time work put him squarely in the 95% success range.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.The post Spin the Wheel appeared first on HumbleDollar.
December 6, 2021
Takes Courage
I DROVE BY the condominium I sold last year. It was bought by a young lady in her early 20s. I noticed a for-sale sign hanging near the front entrance of the building.
Out of curiosity, I looked up the unit for sale online. It had the same floor plan as the condo I’d sold, but was located on the first floor in the back of the building. The condo I owned was located on the top floor facing the street—a much better location.
The asking price for this condo was $466,000. I sold my unit in June 2020 for $380,000. At the time, COVID-19 was wreaking havoc with our lives. I received two offers, both below my asking price. I made the same counteroffer to both parties. But only the young lady responded to my offer. The other party told my agent they were no longer interested, because they thought real estate prices were going to drop.
We all know real estate prices didn’t go down. On the contrary, they went through the roof. It’s yet another example of how difficult it is to predict what real estate—as well stocks and interest rates—will do in the short term.
Back then, even CEOs of major companies didn’t get it right about the economy. Automakers in 2020 thought there’d be a deep recession, so they cut back production and cancelled orders for supplies, such as semiconductors. Meanwhile, car rental companies sold off their inventory.
What seemed like a reasonable decision at the time proved to be a huge mistake. The economy turned out to be entirely different from the one they planned for. Demand for automobiles is actually higher today than before the pandemic.
I told my wife about the asking price for the condo. She said, “The young lady bought before real estate prices took off. It took courage when the market was rattled. Good for her.” Indeed, it sometimes takes courage to invest our money—and the more courage that’s required, often the better the opportunity.
Out of curiosity, I looked up the unit for sale online. It had the same floor plan as the condo I’d sold, but was located on the first floor in the back of the building. The condo I owned was located on the top floor facing the street—a much better location.
The asking price for this condo was $466,000. I sold my unit in June 2020 for $380,000. At the time, COVID-19 was wreaking havoc with our lives. I received two offers, both below my asking price. I made the same counteroffer to both parties. But only the young lady responded to my offer. The other party told my agent they were no longer interested, because they thought real estate prices were going to drop.
We all know real estate prices didn’t go down. On the contrary, they went through the roof. It’s yet another example of how difficult it is to predict what real estate—as well stocks and interest rates—will do in the short term.
Back then, even CEOs of major companies didn’t get it right about the economy. Automakers in 2020 thought there’d be a deep recession, so they cut back production and cancelled orders for supplies, such as semiconductors. Meanwhile, car rental companies sold off their inventory.
What seemed like a reasonable decision at the time proved to be a huge mistake. The economy turned out to be entirely different from the one they planned for. Demand for automobiles is actually higher today than before the pandemic.
I told my wife about the asking price for the condo. She said, “The young lady bought before real estate prices took off. It took courage when the market was rattled. Good for her.” Indeed, it sometimes takes courage to invest our money—and the more courage that’s required, often the better the opportunity.
The post Takes Courage appeared first on HumbleDollar.
Starting Early
ONE WAY TO MAXIMIZE long-term family wealth is through a teenager’s summer or after-school job. How do these small paychecks add up to serious money? Probably the best investment we can make for our children and grandchildren: Stash their earnings in a Roth IRA.
A teenager’s Roth has three things going for it: little or zero taxes owed on the small bits of income earned, 70 or 80 years of investment compounding, and zero taxes owed when those gains are withdrawn.
As Warren Buffett said, “My wealth has come from a combination of living in America, some lucky genes, and compound interest.” Parents or grandparents who help children make Roth contributions can set up these kids to capture the third part of Buffett’s wealth equation—compound interest—on a tax-free basis.
To get started, a child must have earned income, such as wages or tips, to contribute to a Roth. I know some folks with family businesses who set their kids up to “earn” a paycheck. They might manage inventory, work the website, or help with marketing and shipping activities.
The maximum IRA contribution in 2021 and 2022 is $6,000 for those under age 50. Unlike a traditional IRA, Roth contributions are made with after-tax dollars. But Roth withdrawals are tax-free, providing the account is held for at least five years and the account holder reaches age 59½.
Some people might be scared away by the requirement to lock up their kids’ money for such a long time. They shouldn’t be. Roth owners can withdraw their contributions at any time. No taxes or penalties are owed, provided the account’s investment earnings aren’t withdrawn.
Since the account has decades to grow, I’d suggest a 100% allocation to low-cost stock index funds. Our daughter’s initial Roth contributions have generated about a 250% gain. She’s in her late 20s—with decades of additional compounding ahead of her.
A teenager’s Roth has three things going for it: little or zero taxes owed on the small bits of income earned, 70 or 80 years of investment compounding, and zero taxes owed when those gains are withdrawn.
As Warren Buffett said, “My wealth has come from a combination of living in America, some lucky genes, and compound interest.” Parents or grandparents who help children make Roth contributions can set up these kids to capture the third part of Buffett’s wealth equation—compound interest—on a tax-free basis.
To get started, a child must have earned income, such as wages or tips, to contribute to a Roth. I know some folks with family businesses who set their kids up to “earn” a paycheck. They might manage inventory, work the website, or help with marketing and shipping activities.
The maximum IRA contribution in 2021 and 2022 is $6,000 for those under age 50. Unlike a traditional IRA, Roth contributions are made with after-tax dollars. But Roth withdrawals are tax-free, providing the account is held for at least five years and the account holder reaches age 59½.
Some people might be scared away by the requirement to lock up their kids’ money for such a long time. They shouldn’t be. Roth owners can withdraw their contributions at any time. No taxes or penalties are owed, provided the account’s investment earnings aren’t withdrawn.
Since the account has decades to grow, I’d suggest a 100% allocation to low-cost stock index funds. Our daughter’s initial Roth contributions have generated about a 250% gain. She’s in her late 20s—with decades of additional compounding ahead of her.
The post Starting Early appeared first on HumbleDollar.
Fill ’Er Up
I OWN JUST TWO individual stocks. One is Wells Fargo, which I’ve discussed before. The other is Total, recently renamed TotalEnergies, a major oil company headquartered in France.
I was initially attracted to Total by its generous dividend and enormous underperformance in 2020. Yes, great underperformance—not outperformance—often piques my interest. Of course, declining stock prices and generous dividend yields go hand in hand. As the price of oil stocks cratered in 2020, their dividend yields soared.
How bad was the carnage? The energy sector performed so poorly that it shrank last year to become the S&P 500’s smallest component. Here’s another bit of market trivia: In 2020, the market cap of tech upstart Zoom Video Communications briefly eclipsed that of Exxon Mobil. Update: Exxon’s market cap is now more than quadruple that of Zoom. So much for the efficient market hypothesis.
Both Exxon and Total sported dividend yields well north of 10% in 2020. In fact, Total’s dividend yield briefly topped 12%. While unusually rich dividend yields can be a red flag, I decided that the world would need oil for a while longer, so I made an investment in the energy patch. I went with the oil major that had the cleanest balance sheet and one of the highest dividend yields—Total.
While it’s been a good investment thus far, I realize it’s too early to declare victory. Still, here are five reasons I’ll likely be a long-term investor in Total:
1. Still-generous dividends. Even after a rebound in its stock price (symbol: TTE), Total has a dividend yield of 6.5%. That’s almost five times the yield of the 10-year Treasury note. Put another way, the price-to-dividend ratio is 15 for Total, versus 74 for the 10-year note. And unlike Treasury coupons, Total’s cash dividend payments are likely to increase over time.
2. Hedging my energy costs. Every time I fill my SUV with gas, it’s a win-win psychologically. If energy prices rise—as they have lately and are projected to this winter—I’m pretty confident my energy bill will be offset by my investment in Total. On the other hand, if gas prices are down, I’m happy to walk away from the pump with more cash in my wallet.
3. Hedging against inflation. Oil stocks can act as an inflation hedge for an investment portfolio. Lately, I’ve written extensively about inflation. I believe resurgent inflation is one of the most important investing themes to come along in years, maybe decades.
Investing in commodities is one way we can protect our portfolios against inflation. Still, I don’t know about you, but I’m not ready to purchase pork belly futures or store crude oil in my backyard. Investing directly in commodities is too volatile for my taste. But being a shareholder in an energy company that pays a generous dividend fits the bill, at least for me.
Speaking of commodities, the next time you feel like trading oil futures, read this piece first. Then ask yourself: Do I really want to enter the ring against such seasoned pros?
4. Taking the other side of the ESG trade. As environmental, social and governance (ESG) investing grows more popular, I believe it creates opportunities for “shunned assets,” such as oil stocks. Not only are oil stocks anti-ESG, everyone knows that renewable energy is set to replace natural resources in the not-too-distant future. For proof, witness the meteoric rise of Tesla’s stock.
As investors’ appetite for energy shares wanes, their stock prices have come under pressure. Ironically, this may set the stage for outsized returns in the energy complex.
If this sounds crazy, consider the history of tobacco companies. Tobacco stocks have been untouchable from an ESG standpoint for decades. They’ve been banned from advertising. Litigation threatened to put them out of business. Smoking rates in the U.S. have been falling for half a century.
Result? One of the best-performing stocks in modern history is Altria, the cigarette company formerly called Philip Morris. The reason is simple. The total return from stocks is largely driven by dividends—the starting dividend yield, plus the growth in dividend payments. Oil stocks certainly have high dividend yields. Time will tell if they can sustain them.
5. Avoiding the cardinal sin. As I’ve written recently, the cardinal investment sin is taking profits too soon. It’s always tempting to claim victory and sell a stock for a gain. That’s especially true when that gain comes quickly, as it did with my investment in Total.
But the research is clear: Investors, even professionals, often err by selling their winners too soon. I’ve resolved to become a better investor by avoiding this mistake. As long as Total is paying a fair dividend, count me as a shareholder.
John Lim is a physician and author of "How to Raise Your Child's Financial IQ," which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles.
I was initially attracted to Total by its generous dividend and enormous underperformance in 2020. Yes, great underperformance—not outperformance—often piques my interest. Of course, declining stock prices and generous dividend yields go hand in hand. As the price of oil stocks cratered in 2020, their dividend yields soared.
How bad was the carnage? The energy sector performed so poorly that it shrank last year to become the S&P 500’s smallest component. Here’s another bit of market trivia: In 2020, the market cap of tech upstart Zoom Video Communications briefly eclipsed that of Exxon Mobil. Update: Exxon’s market cap is now more than quadruple that of Zoom. So much for the efficient market hypothesis.
Both Exxon and Total sported dividend yields well north of 10% in 2020. In fact, Total’s dividend yield briefly topped 12%. While unusually rich dividend yields can be a red flag, I decided that the world would need oil for a while longer, so I made an investment in the energy patch. I went with the oil major that had the cleanest balance sheet and one of the highest dividend yields—Total.
While it’s been a good investment thus far, I realize it’s too early to declare victory. Still, here are five reasons I’ll likely be a long-term investor in Total:
1. Still-generous dividends. Even after a rebound in its stock price (symbol: TTE), Total has a dividend yield of 6.5%. That’s almost five times the yield of the 10-year Treasury note. Put another way, the price-to-dividend ratio is 15 for Total, versus 74 for the 10-year note. And unlike Treasury coupons, Total’s cash dividend payments are likely to increase over time.
2. Hedging my energy costs. Every time I fill my SUV with gas, it’s a win-win psychologically. If energy prices rise—as they have lately and are projected to this winter—I’m pretty confident my energy bill will be offset by my investment in Total. On the other hand, if gas prices are down, I’m happy to walk away from the pump with more cash in my wallet.
3. Hedging against inflation. Oil stocks can act as an inflation hedge for an investment portfolio. Lately, I’ve written extensively about inflation. I believe resurgent inflation is one of the most important investing themes to come along in years, maybe decades.
Investing in commodities is one way we can protect our portfolios against inflation. Still, I don’t know about you, but I’m not ready to purchase pork belly futures or store crude oil in my backyard. Investing directly in commodities is too volatile for my taste. But being a shareholder in an energy company that pays a generous dividend fits the bill, at least for me.
Speaking of commodities, the next time you feel like trading oil futures, read this piece first. Then ask yourself: Do I really want to enter the ring against such seasoned pros?
4. Taking the other side of the ESG trade. As environmental, social and governance (ESG) investing grows more popular, I believe it creates opportunities for “shunned assets,” such as oil stocks. Not only are oil stocks anti-ESG, everyone knows that renewable energy is set to replace natural resources in the not-too-distant future. For proof, witness the meteoric rise of Tesla’s stock.
As investors’ appetite for energy shares wanes, their stock prices have come under pressure. Ironically, this may set the stage for outsized returns in the energy complex.
If this sounds crazy, consider the history of tobacco companies. Tobacco stocks have been untouchable from an ESG standpoint for decades. They’ve been banned from advertising. Litigation threatened to put them out of business. Smoking rates in the U.S. have been falling for half a century.
Result? One of the best-performing stocks in modern history is Altria, the cigarette company formerly called Philip Morris. The reason is simple. The total return from stocks is largely driven by dividends—the starting dividend yield, plus the growth in dividend payments. Oil stocks certainly have high dividend yields. Time will tell if they can sustain them.
5. Avoiding the cardinal sin. As I’ve written recently, the cardinal investment sin is taking profits too soon. It’s always tempting to claim victory and sell a stock for a gain. That’s especially true when that gain comes quickly, as it did with my investment in Total.
But the research is clear: Investors, even professionals, often err by selling their winners too soon. I’ve resolved to become a better investor by avoiding this mistake. As long as Total is paying a fair dividend, count me as a shareholder.
John Lim is a physician and author of "How to Raise Your Child's Financial IQ," which is available as both a free PDF and a Kindle edition. Follow John on Twitter @JohnTLim and check out his earlier articles.The post Fill ’Er Up appeared first on HumbleDollar.
Fill ���Er Up
I OWN JUST TWO individual stocks. One is Wells Fargo, which I���ve discussed before. The other is Total, recently renamed TotalEnergies, a major oil company headquartered in France.
I was initially attracted to Total by its generous dividend and enormous underperformance in 2020. Yes, great underperformance���not outperformance���often piques my interest. Of course, declining stock prices and generous dividend yields go hand in hand. As the price of oil stocks cratered in 2020, their dividend yields soared.
How bad was the carnage? The energy sector performed so poorly that it shrank last year to become the S&P 500���s smallest component. Here���s another bit of market trivia: In 2020, the market cap of tech upstart Zoom Video Communications briefly eclipsed that of Exxon Mobil. Update: Exxon���s market cap is now more than quadruple that of Zoom. So much for the efficient market hypothesis.
Both Exxon and Total sported dividend yields well north of 10% in 2020. In fact, Total���s dividend yield briefly topped 12%. While unusually rich dividend yields can be a red flag, I decided that the world would need oil for a while longer, so I made an investment in the energy patch. I went with the oil major that had the cleanest balance sheet and one of the highest dividend yields���Total.
While it���s been a good investment thus far, I realize it���s too early to declare victory. Still, here are five reasons I���ll likely be a long-term investor in Total:
1. Still-generous dividends. Even after a rebound in its stock price (symbol: TTE), Total has a dividend yield of 6.5%. That���s almost five times the yield of the 10-year Treasury note. Put another way, the price-to-dividend ratio is 15 for Total, versus 74 for the 10-year note. And unlike Treasury coupons, Total���s cash dividend payments are likely to increase over time.
2. Hedging my energy costs. Every time I fill my SUV with gas, it���s a win-win psychologically. If energy prices rise���as they have lately and are projected to this winter���I���m pretty confident my energy bill will be offset by my investment in Total. On the other hand, if gas prices are down, I���m happy to walk away from the pump with more cash in my wallet.
3. Hedging against inflation. Oil stocks can act as an inflation hedge for an investment portfolio. Lately, I���ve written extensively about inflation. I believe resurgent inflation is one of the most important investing themes to come along in years, maybe decades.
Investing in commodities is one way we can protect our portfolios against inflation. Still, I don���t know about you, but I���m not ready to purchase pork belly futures or store crude oil in my backyard. Investing directly in commodities is too volatile for my taste. But being a shareholder in an energy company that pays a generous dividend fits the bill, at least for me.
Speaking of commodities, the next time you feel like trading oil futures, read this piece first. Then ask yourself: Do I really want to enter the ring against such seasoned pros?
4. Taking the other side of the ESG trade. As environmental, social and governance (ESG) investing grows more popular, I believe it creates opportunities for ���shunned assets,��� such as oil stocks. Not only are oil stocks anti-ESG, everyone knows that renewable energy is set to replace natural resources in the not-too-distant future. For proof, witness the meteoric rise of Tesla���s stock.
As investors��� appetite for energy shares wanes, their stock prices have come under pressure. Ironically, this may set the stage for outsized returns in the energy complex.
If this sounds crazy, consider the history of tobacco companies. Tobacco stocks have been untouchable from an ESG standpoint for decades. They���ve been banned from advertising. Litigation threatened to put them out of business. Smoking rates in the U.S. have been falling for half a century.
Result? One of the best-performing stocks in modern history is Altria, the cigarette company formerly called Philip Morris. The reason is simple. The total return from stocks is largely driven by dividends���the starting dividend yield, plus the growth in dividend payments. Oil stocks certainly have high dividend yields. Time will tell if they can sustain them.
5. Avoiding the cardinal sin. As I���ve written recently, the cardinal investment sin is taking profits too soon. It���s always tempting to claim victory and sell a stock for a gain. That���s especially true when that gain comes quickly, as it did with my investment in Total.
But the research is clear: Investors, even professionals, often err by selling their winners too soon. I���ve resolved to become a better investor by avoiding this mistake. As long as Total is paying a fair dividend, count me as a shareholder.
John Lim is a physician and author of "How to Raise Your Child's Financial IQ," which is available as both a free PDF and a Kindle edition.��Follow John on Twitter @JohnTLim��and check out his earlier articles.
I was initially attracted to Total by its generous dividend and enormous underperformance in 2020. Yes, great underperformance���not outperformance���often piques my interest. Of course, declining stock prices and generous dividend yields go hand in hand. As the price of oil stocks cratered in 2020, their dividend yields soared.
How bad was the carnage? The energy sector performed so poorly that it shrank last year to become the S&P 500���s smallest component. Here���s another bit of market trivia: In 2020, the market cap of tech upstart Zoom Video Communications briefly eclipsed that of Exxon Mobil. Update: Exxon���s market cap is now more than quadruple that of Zoom. So much for the efficient market hypothesis.
Both Exxon and Total sported dividend yields well north of 10% in 2020. In fact, Total���s dividend yield briefly topped 12%. While unusually rich dividend yields can be a red flag, I decided that the world would need oil for a while longer, so I made an investment in the energy patch. I went with the oil major that had the cleanest balance sheet and one of the highest dividend yields���Total.
While it���s been a good investment thus far, I realize it���s too early to declare victory. Still, here are five reasons I���ll likely be a long-term investor in Total:
1. Still-generous dividends. Even after a rebound in its stock price (symbol: TTE), Total has a dividend yield of 6.5%. That���s almost five times the yield of the 10-year Treasury note. Put another way, the price-to-dividend ratio is 15 for Total, versus 74 for the 10-year note. And unlike Treasury coupons, Total���s cash dividend payments are likely to increase over time.
2. Hedging my energy costs. Every time I fill my SUV with gas, it���s a win-win psychologically. If energy prices rise���as they have lately and are projected to this winter���I���m pretty confident my energy bill will be offset by my investment in Total. On the other hand, if gas prices are down, I���m happy to walk away from the pump with more cash in my wallet.
3. Hedging against inflation. Oil stocks can act as an inflation hedge for an investment portfolio. Lately, I���ve written extensively about inflation. I believe resurgent inflation is one of the most important investing themes to come along in years, maybe decades.
Investing in commodities is one way we can protect our portfolios against inflation. Still, I don���t know about you, but I���m not ready to purchase pork belly futures or store crude oil in my backyard. Investing directly in commodities is too volatile for my taste. But being a shareholder in an energy company that pays a generous dividend fits the bill, at least for me.
Speaking of commodities, the next time you feel like trading oil futures, read this piece first. Then ask yourself: Do I really want to enter the ring against such seasoned pros?
4. Taking the other side of the ESG trade. As environmental, social and governance (ESG) investing grows more popular, I believe it creates opportunities for ���shunned assets,��� such as oil stocks. Not only are oil stocks anti-ESG, everyone knows that renewable energy is set to replace natural resources in the not-too-distant future. For proof, witness the meteoric rise of Tesla���s stock.
As investors��� appetite for energy shares wanes, their stock prices have come under pressure. Ironically, this may set the stage for outsized returns in the energy complex.
If this sounds crazy, consider the history of tobacco companies. Tobacco stocks have been untouchable from an ESG standpoint for decades. They���ve been banned from advertising. Litigation threatened to put them out of business. Smoking rates in the U.S. have been falling for half a century.
Result? One of the best-performing stocks in modern history is Altria, the cigarette company formerly called Philip Morris. The reason is simple. The total return from stocks is largely driven by dividends���the starting dividend yield, plus the growth in dividend payments. Oil stocks certainly have high dividend yields. Time will tell if they can sustain them.
5. Avoiding the cardinal sin. As I���ve written recently, the cardinal investment sin is taking profits too soon. It���s always tempting to claim victory and sell a stock for a gain. That���s especially true when that gain comes quickly, as it did with my investment in Total.
But the research is clear: Investors, even professionals, often err by selling their winners too soon. I���ve resolved to become a better investor by avoiding this mistake. As long as Total is paying a fair dividend, count me as a shareholder.
John Lim is a physician and author of "How to Raise Your Child's Financial IQ," which is available as both a free PDF and a Kindle edition.��Follow John on Twitter @JohnTLim��and check out his earlier articles.The post Fill ���Er Up appeared first on HumbleDollar.
December 5, 2021
Driving Me Happy
MY CAR EMAILED ME to say its tire pressure was low. Perhaps it���s more accurate to say it this way: An email from Subaru was triggered by data uploaded from my 2020 Forester, all part of the automatic safety and maintenance technology built into the vehicle. The email confirmed the dashboard light indicating the same problem.
My frugal friends and I have had friendly debates about car buying. Is it better to buy a used car and avoid the instant depreciation when you drive off the dealer���s lot? Or should we pay more to purchase a new car, with a plan to drive it for many years?
This same debate was featured in the book The Millionaire Next Door by Thomas J. Stanley and William D. Danko. Their research for the 2010 edition found that the millionaires surveyed were split on the issue, just as my friends and I are. The book said 63.4% of millionaires were buying new, versus 36.6% choosing used.
Historically, I���ve bought new vehicles. The Subaru replaced a 2008 Mercury. Our second car is a 2010 Honda. Like the Subaru, we purchased both the Mercury and Honda new. I dislike the car-buying experience, so I want our vehicles to last. I buy new and keep up with routine maintenance to delay the need to replace them.
My push to shop for a new car in 2020 was because of the new safety technology now available. Many studies have shown that 80% to 90% of Americans feel they���re ���above average��� drivers���a statistical impossibility. Based on my wife���s reactions in the passenger seat, I���ve concluded that I must be average at best. When Consumer Reports began touting the many safety improvements available today, I couldn���t ignore the opportunity to improve our safety.
After buying the Forester, I became an instant fan of adaptive cruise control, which automatically adjusts a car���s speed to keep a safe following distance. There have also been a few occasions when my car���s automatic braking system reacted faster than my reflexes. Lane change assist, blind spot sensors and a backup camera with collision warnings all combine to reduce my accident risk.
My reasons for buying new cars in the past were threefold: to maximize the time between purchases, to reduce the chance of buying a hidden problem and to control the vehicle maintenance from the outset. To these, I now add a fourth���the peace of mind that comes with the latest safety technology.
And, yes, there was a leak in my car���s front left tire valve stem. I���ve now had it repaired.
My frugal friends and I have had friendly debates about car buying. Is it better to buy a used car and avoid the instant depreciation when you drive off the dealer���s lot? Or should we pay more to purchase a new car, with a plan to drive it for many years?
This same debate was featured in the book The Millionaire Next Door by Thomas J. Stanley and William D. Danko. Their research for the 2010 edition found that the millionaires surveyed were split on the issue, just as my friends and I are. The book said 63.4% of millionaires were buying new, versus 36.6% choosing used.
Historically, I���ve bought new vehicles. The Subaru replaced a 2008 Mercury. Our second car is a 2010 Honda. Like the Subaru, we purchased both the Mercury and Honda new. I dislike the car-buying experience, so I want our vehicles to last. I buy new and keep up with routine maintenance to delay the need to replace them.
My push to shop for a new car in 2020 was because of the new safety technology now available. Many studies have shown that 80% to 90% of Americans feel they���re ���above average��� drivers���a statistical impossibility. Based on my wife���s reactions in the passenger seat, I���ve concluded that I must be average at best. When Consumer Reports began touting the many safety improvements available today, I couldn���t ignore the opportunity to improve our safety.
After buying the Forester, I became an instant fan of adaptive cruise control, which automatically adjusts a car���s speed to keep a safe following distance. There have also been a few occasions when my car���s automatic braking system reacted faster than my reflexes. Lane change assist, blind spot sensors and a backup camera with collision warnings all combine to reduce my accident risk.
My reasons for buying new cars in the past were threefold: to maximize the time between purchases, to reduce the chance of buying a hidden problem and to control the vehicle maintenance from the outset. To these, I now add a fourth���the peace of mind that comes with the latest safety technology.
And, yes, there was a leak in my car���s front left tire valve stem. I���ve now had it repaired.
The post Driving Me Happy appeared first on HumbleDollar.
Sentiment Sours
FINANCIAL MARKETS had a lot to digest in recent days: Retail analysts are keeping a close eye on holiday spending, economists got their latest dose of employment data���and traders are coming to grips with the current bout of volatility.
The VIX, the S&P 500 Volatility Index or ���fear gauge,��� surged above 30 on Friday. That was the highest end-of-week close since January. For perspective, the VIX climbed to 80 during 2020's COVID-19 stock market crash. It was as low as 15 during periods of relative calm earlier this year.
What���s driving the uncertainty? It���s hard to pin it on one narrative. The Omicron variant wasn���t the sole culprit. After all, both travel and stay-at-home stocks were hit hard last week. Instead, it might just be stock market investors taking a little money off the table.
Market analysts at Bespoke Investments point out that the average stock in the S&P 1500 is now 19.1% below its 52-week high. There���s been a stealth correction taking place beneath the market���s surface since February���all while the broad market kept within a few percentage points of its all-time high.
Small-caps, value stocks and foreign shares have all endured notable drawdowns��this year after impressive rallies off the March 2020 lows. Since March 2021, however, those niches of the stock market have turned very choppy.
The last few weeks shouldn���t come as a surprise to long-term investors. Dips happen. Quite often they occur when folks are overly optimistic about the near-term direction of the stock market. Back on Nov. 10, 48% of those surveyed for the weekly AAII (American Association of Individual Investors) Sentiment Survey were bullish, well above the long-term average. Stocks then dropped, and suddenly less than 27% are bullish, according to last Thursday���s survey. Maybe investor sentiment is finally catching up with the rough 2021 suffered by many stocks.
The VIX, the S&P 500 Volatility Index or ���fear gauge,��� surged above 30 on Friday. That was the highest end-of-week close since January. For perspective, the VIX climbed to 80 during 2020's COVID-19 stock market crash. It was as low as 15 during periods of relative calm earlier this year.
What���s driving the uncertainty? It���s hard to pin it on one narrative. The Omicron variant wasn���t the sole culprit. After all, both travel and stay-at-home stocks were hit hard last week. Instead, it might just be stock market investors taking a little money off the table.
Market analysts at Bespoke Investments point out that the average stock in the S&P 1500 is now 19.1% below its 52-week high. There���s been a stealth correction taking place beneath the market���s surface since February���all while the broad market kept within a few percentage points of its all-time high.
Small-caps, value stocks and foreign shares have all endured notable drawdowns��this year after impressive rallies off the March 2020 lows. Since March 2021, however, those niches of the stock market have turned very choppy.
The last few weeks shouldn���t come as a surprise to long-term investors. Dips happen. Quite often they occur when folks are overly optimistic about the near-term direction of the stock market. Back on Nov. 10, 48% of those surveyed for the weekly AAII (American Association of Individual Investors) Sentiment Survey were bullish, well above the long-term average. Stocks then dropped, and suddenly less than 27% are bullish, according to last Thursday���s survey. Maybe investor sentiment is finally catching up with the rough 2021 suffered by many stocks.
The post Sentiment Sours appeared first on HumbleDollar.
The Price Is Right
DOLLAR STORES ARE currently booming in popularity, but I���ve patronized them for many years. It never made sense to me to pay more for household goods elsewhere. Yes, the quality isn���t always great���but you can���t complain about the price.
I never buy food at Dollar General on my weekly visits. That���s partly because I go on to ALDI and Trader Joe���s immediately afterwards. I also wouldn���t want anything to spoil in the Florida heat.
The canned goods would likely be fine. Yet I hesitate, fearing they���re inferior products. That might be an unfair bias on my part.
My shopping list frequently includes toilet paper, paper towels, tissues, dish soap, Drano, baking soda, bathroom cleaner, sponges, air spray, candles, plastic wrap, foil, sandwich bags, trash bags, toothbrushes, toothpaste and mouthwash.
For a few years, I had a roommate who hated the paper goods I purchased. He supplied the house with his preferred toilet paper and paper towels. I���m simply not fussy about such items.
One of the greatest finds, for those of us who have had cataracts removed, is their reading glasses. I���ve worn glasses since I was 13, and then bifocals since my 40s. With the cataracts gone, I can now see distances but not up close.
My eye doctor suggested that I could probably correct my near vision with over-the-counter reading glasses. After spending literally thousands of dollars for prescription glasses over the decades, this sounded like a good idea.
It takes a bit of trial and error to find the right strength, and Dollar Tree provides a variety���for just $1. A few pairs of glasses have broken easily. But the ones I bought elsewhere for $10 didn���t hold up, either.
I don���t like the idea of more disposable plastic. But I���m even less eager to spend hundreds of dollars for a prescription pair of reading glasses.
I also like the idea of uniform pricing. Too often, items are priced wrong in other stores, including leading supermarkets. There���s a simplicity to shopping when you know everything is $1���though that, alas, is changing because of the supply chain problems.
Dollar stores benefit many lower-income people, including retirees like me. They���re often located in poorer parts of cities and remote rural areas. That means they meet at least some needs in so-called food deserts. I���m happy to keep patronizing them.
I never buy food at Dollar General on my weekly visits. That���s partly because I go on to ALDI and Trader Joe���s immediately afterwards. I also wouldn���t want anything to spoil in the Florida heat.
The canned goods would likely be fine. Yet I hesitate, fearing they���re inferior products. That might be an unfair bias on my part.
My shopping list frequently includes toilet paper, paper towels, tissues, dish soap, Drano, baking soda, bathroom cleaner, sponges, air spray, candles, plastic wrap, foil, sandwich bags, trash bags, toothbrushes, toothpaste and mouthwash.
For a few years, I had a roommate who hated the paper goods I purchased. He supplied the house with his preferred toilet paper and paper towels. I���m simply not fussy about such items.
One of the greatest finds, for those of us who have had cataracts removed, is their reading glasses. I���ve worn glasses since I was 13, and then bifocals since my 40s. With the cataracts gone, I can now see distances but not up close.
My eye doctor suggested that I could probably correct my near vision with over-the-counter reading glasses. After spending literally thousands of dollars for prescription glasses over the decades, this sounded like a good idea.
It takes a bit of trial and error to find the right strength, and Dollar Tree provides a variety���for just $1. A few pairs of glasses have broken easily. But the ones I bought elsewhere for $10 didn���t hold up, either.
I don���t like the idea of more disposable plastic. But I���m even less eager to spend hundreds of dollars for a prescription pair of reading glasses.
I also like the idea of uniform pricing. Too often, items are priced wrong in other stores, including leading supermarkets. There���s a simplicity to shopping when you know everything is $1���though that, alas, is changing because of the supply chain problems.
Dollar stores benefit many lower-income people, including retirees like me. They���re often located in poorer parts of cities and remote rural areas. That means they meet at least some needs in so-called food deserts. I���m happy to keep patronizing them.
The post The Price Is Right appeared first on HumbleDollar.
Not So Efficient
THE STOCK MARKET���S recent wrenching price swings offer a valuable investment lesson. Let���s start by reviewing the facts:
On the day after Thanksgiving, the S&P 500 suffered its worst day in months and the Dow had its worst day in more than a year. The proximate cause: news about Omicron, a new coronavirus variant. Overnight, investors seemed to revive their playbook from the early 2020 recession. Airline stocks dropped precipitously. Oil plunged 13%. Meanwhile, bond prices rose, along with the stocks of vaccine makers, such as Moderna, which gained 20%.
The following Monday, most everything seemed to reverse. The market staged a rebound, with the S&P gaining and bonds dropping back. Why the sudden reversal? Reporters at��The Wall Street Journal��tried to��piece it��together. They quoted the president, who��said Omicron was ���not a cause for panic.��� They also quoted a Wall Street analyst, who offered this explanation: ���Friday was a panic selloff. Traders have had time to sit back and breathe a bit.���
The market took another steep dive on Tuesday. Why the reversal? Here���s some of the commentary the��Journal offered��this time: ���We really don���t know in regards to the new variant what we���re dealing with,��� said one Wall Street strategist. The CEO of a fund company suggested this explanation: ���People are trying to protect what they have.���
On Wednesday, the market rebounded again in the morning. The proximate cause this time: the release of some positive��employment��data. But by the afternoon it gave up those gains and ended up in negative territory. What happened? A report that someone in the U.S. had been infected with the Omicron variant.
Finally, on Thursday, the market bounced back yet again, despite news that three more people in the U.S.���all vaccinated���had been infected with the Omicron variant.
What conclusions can you draw from this snapshot of five days in the stock market? In the world of investment theory, there���s a school of thought that believes in ���the wisdom of crowds������the idea that groups of people, in aggregate, are smarter and will make better decisions than any one individual. A related concept, the efficient markets hypothesis (EMH), takes this a step further.
EMH argues that investors, collectively, are always monitoring the news and are quick on their feet. As a result, when new information becomes available, not only do they understand it, but they also jump into action. EMH postulates that these quick-thinking investors will buy or sell stocks in response to the latest news. This causes the prices of those investments to quickly adjust to the new information. In this way, they are said to keep the market efficient.
Intuitively, this makes sense. People do generally make better decisions when they collaborate on a question or problem. By extension, it seems like we ought to put faith in the wisdom of crowds. There are certainly cases in which the market has exhibited remarkable efficiency. One notable example occurred almost 36 years ago.
On Jan. 28, 1986, the Space Shuttle Challenger exploded shortly after liftoff. While there were four publicly traded companies that were contractors to the Shuttle program, a government panel found that just one was ultimately responsible: Morton Thiokol. It took the panel five months to reach that conclusion. But if you look at how the stock market��reacted��on the day of the crash, you���ll see the market seemed to figure this out much more quickly���almost immediately, in fact. Within minutes of the news hitting wire services, the shares of all four companies dropped. But the drop in Thiokol shares was far more pronounced. Its stock ended the day down 13%, while the stocks of the other three companies lost just 2% or 3%.
Supporters of the efficient markets hypothesis often cite this case. In my opinion, though, this is more the exception than the rule. If you contrast the Challenger case with the five-day microcosm described above, you���ll see two significant differences.
First, the facts are rarely as clear as they were in the Challenger case. That was a single tragic episode, and there were just four possible culprits. Even among them, Thiokol was a reasonable guess because concerns had been��raised��before���by Thiokol itself���about the safety of its rocket boosters in cold weather conditions. It was an unseasonably cold 36 degrees at Cape Canaveral at the time of the launch.
By contrast, COVID-19 is a moving target. It is literally evolving. As we���ve seen recently, it���s hard for anyone to know when there will be further variants. And when there are, no one knows what they���ll look like or what their impact will be.
One theory floated last week was the idea that Omicron will be more contagious but less lethal than Delta. If that were the case, the thinking goes, Omicron might crowd out Delta. Then more people would become infected, but with a more benign virus. If that were the result, Omicron might actually be a welcome development. But that���s just a theory. No one knows for sure if anything like this will occur.
In contrast to the complexity and lack of clarity surrounding COVID, the Challenger case was more like a controlled scientific experiment, with a very straightforward set of facts. But that rarely happens in the stock market. It���s why, in my opinion, the Challenger case is the one that EMH enthusiasts always seem to cite. It���s one of the only cases that perfectly supports their hypothesis.
The other difference between the Challenger case and the stock market���s normal function is that stocks are usually subject to a mix of countervailing forces. Over the past week, for example, the Omicron news���which was itself inconclusive���was clouded by several other factors. Notable among them: Federal Reserve Chair Jerome Powell was in front of Congress providing testimony on Tuesday and Wednesday. Powell weighed in on the potential impact of Omicron, as did the��World Health Organization��and the��CEO��of Moderna, among others. Mixed in with all that was new economic data, like the employment report that came out Wednesday.
The result: As the saying goes, things were clear as mud. That���s why we saw the stock market seesawing the way it did���and why the investors that the��Journal��interviewed seemed to be grasping at straws in trying to explain the stock market's movements.
Bottom line: The market always reacts to news. Sometimes its lightning-fast reactions make it��seem��efficient. But whether the market���s reactions ultimately make sense is a different question. In rare cases, perhaps the market is truly efficient. But most of the time, information is incomplete, inconclusive or clouded by other factors. As a result, it���s hard to argue that it���s truly efficient on a day-to-day basis.
Where does this leave you as an individual investor? I���d turn, as I often do, to Benjamin Graham, the father of modern investment analysis. His view: In the short term, the stock market is like a ���voting machine.��� It���s a popularity contest and not necessarily logical. But in the long term, Graham said, the market is a ���weighing machine.��� In other words, if you can make it through the day-to-day noise, the market is, in fact, logical over time and generally a good investment.
The key, then, is to try hard to tune out the noise. As Warren Buffett once��said, ���If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.���
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.
On the day after Thanksgiving, the S&P 500 suffered its worst day in months and the Dow had its worst day in more than a year. The proximate cause: news about Omicron, a new coronavirus variant. Overnight, investors seemed to revive their playbook from the early 2020 recession. Airline stocks dropped precipitously. Oil plunged 13%. Meanwhile, bond prices rose, along with the stocks of vaccine makers, such as Moderna, which gained 20%.
The following Monday, most everything seemed to reverse. The market staged a rebound, with the S&P gaining and bonds dropping back. Why the sudden reversal? Reporters at��The Wall Street Journal��tried to��piece it��together. They quoted the president, who��said Omicron was ���not a cause for panic.��� They also quoted a Wall Street analyst, who offered this explanation: ���Friday was a panic selloff. Traders have had time to sit back and breathe a bit.���
The market took another steep dive on Tuesday. Why the reversal? Here���s some of the commentary the��Journal offered��this time: ���We really don���t know in regards to the new variant what we���re dealing with,��� said one Wall Street strategist. The CEO of a fund company suggested this explanation: ���People are trying to protect what they have.���
On Wednesday, the market rebounded again in the morning. The proximate cause this time: the release of some positive��employment��data. But by the afternoon it gave up those gains and ended up in negative territory. What happened? A report that someone in the U.S. had been infected with the Omicron variant.
Finally, on Thursday, the market bounced back yet again, despite news that three more people in the U.S.���all vaccinated���had been infected with the Omicron variant.
What conclusions can you draw from this snapshot of five days in the stock market? In the world of investment theory, there���s a school of thought that believes in ���the wisdom of crowds������the idea that groups of people, in aggregate, are smarter and will make better decisions than any one individual. A related concept, the efficient markets hypothesis (EMH), takes this a step further.
EMH argues that investors, collectively, are always monitoring the news and are quick on their feet. As a result, when new information becomes available, not only do they understand it, but they also jump into action. EMH postulates that these quick-thinking investors will buy or sell stocks in response to the latest news. This causes the prices of those investments to quickly adjust to the new information. In this way, they are said to keep the market efficient.
Intuitively, this makes sense. People do generally make better decisions when they collaborate on a question or problem. By extension, it seems like we ought to put faith in the wisdom of crowds. There are certainly cases in which the market has exhibited remarkable efficiency. One notable example occurred almost 36 years ago.
On Jan. 28, 1986, the Space Shuttle Challenger exploded shortly after liftoff. While there were four publicly traded companies that were contractors to the Shuttle program, a government panel found that just one was ultimately responsible: Morton Thiokol. It took the panel five months to reach that conclusion. But if you look at how the stock market��reacted��on the day of the crash, you���ll see the market seemed to figure this out much more quickly���almost immediately, in fact. Within minutes of the news hitting wire services, the shares of all four companies dropped. But the drop in Thiokol shares was far more pronounced. Its stock ended the day down 13%, while the stocks of the other three companies lost just 2% or 3%.
Supporters of the efficient markets hypothesis often cite this case. In my opinion, though, this is more the exception than the rule. If you contrast the Challenger case with the five-day microcosm described above, you���ll see two significant differences.
First, the facts are rarely as clear as they were in the Challenger case. That was a single tragic episode, and there were just four possible culprits. Even among them, Thiokol was a reasonable guess because concerns had been��raised��before���by Thiokol itself���about the safety of its rocket boosters in cold weather conditions. It was an unseasonably cold 36 degrees at Cape Canaveral at the time of the launch.
By contrast, COVID-19 is a moving target. It is literally evolving. As we���ve seen recently, it���s hard for anyone to know when there will be further variants. And when there are, no one knows what they���ll look like or what their impact will be.
One theory floated last week was the idea that Omicron will be more contagious but less lethal than Delta. If that were the case, the thinking goes, Omicron might crowd out Delta. Then more people would become infected, but with a more benign virus. If that were the result, Omicron might actually be a welcome development. But that���s just a theory. No one knows for sure if anything like this will occur.
In contrast to the complexity and lack of clarity surrounding COVID, the Challenger case was more like a controlled scientific experiment, with a very straightforward set of facts. But that rarely happens in the stock market. It���s why, in my opinion, the Challenger case is the one that EMH enthusiasts always seem to cite. It���s one of the only cases that perfectly supports their hypothesis.
The other difference between the Challenger case and the stock market���s normal function is that stocks are usually subject to a mix of countervailing forces. Over the past week, for example, the Omicron news���which was itself inconclusive���was clouded by several other factors. Notable among them: Federal Reserve Chair Jerome Powell was in front of Congress providing testimony on Tuesday and Wednesday. Powell weighed in on the potential impact of Omicron, as did the��World Health Organization��and the��CEO��of Moderna, among others. Mixed in with all that was new economic data, like the employment report that came out Wednesday.
The result: As the saying goes, things were clear as mud. That���s why we saw the stock market seesawing the way it did���and why the investors that the��Journal��interviewed seemed to be grasping at straws in trying to explain the stock market's movements.
Bottom line: The market always reacts to news. Sometimes its lightning-fast reactions make it��seem��efficient. But whether the market���s reactions ultimately make sense is a different question. In rare cases, perhaps the market is truly efficient. But most of the time, information is incomplete, inconclusive or clouded by other factors. As a result, it���s hard to argue that it���s truly efficient on a day-to-day basis.
Where does this leave you as an individual investor? I���d turn, as I often do, to Benjamin Graham, the father of modern investment analysis. His view: In the short term, the stock market is like a ���voting machine.��� It���s a popularity contest and not necessarily logical. But in the long term, Graham said, the market is a ���weighing machine.��� In other words, if you can make it through the day-to-day noise, the market is, in fact, logical over time and generally a good investment.
The key, then, is to try hard to tune out the noise. As Warren Buffett once��said, ���If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.���
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 Not So Efficient appeared first on HumbleDollar.
