Jonathan Clements's Blog, page 313

High Times

READERS KNOW I love my baseball. There’s an old unwritten rule that, when a pitcher is working a perfect game, nobody talks to him. The position players leave the hurler alone since he needs to be “in the zone.” Fans grow more nervous as the game progresses and the ninth inning draws near. With each passing out, the prized perfect game comes closer into view.

I’m getting the same antsy feeling when it comes to highflying tech stocks. Their valuations are through the roof based on most metrics. We’ve seen the Nasdaq commit a few “errors” this month, after seeming to pitching a perfect game from the March 23 market low through August, and folks are now wondering whether the great tech bull market is over.

To judge whether a stock is expensive or cheap, market analysts look to price-to-earnings and price-to-sales ratios. More in-depth valuation metrics include price-to-free cash flow and enterprise value-to-EBITDA, or earnings before interest, taxes, depreciation and amortization. Let’s take a moment to explore some of these gauges of market frothiness.

What’s a price-earnings (P/E) ratio? This is Finance 101 stuff. At the University of North Florida, here in Jacksonville, I teach P/Es during the first week of my security analysis class. It’s simply the price of the stock (or the level of a market index) divided by the company’s earnings per share (or the index’s aggregate earnings per share).

Today, the S&P 500 trades at a whopping 37 times the past 12 months’ reported earnings. The 100-year average trailing P/E ratio for the S&P 500 is just 17, so we’re at more than double the historical average. Meanwhile, the P/E ratio based on expected earnings for the next 12 months is 26, also high by historical standards.

Why have P/Es increased? The S&P 500 is up 3% this year, while corporate earnings per share are down 29% from their peak, according to data from S&P Global. You don’t need a PhD in finance to realize that when prices go up and earnings collapse, P/Es go to the moon. Still, other measures of market valuation also indicate that the stock market is expensive:

Price-to-sales. With this market gauge, instead of using earnings as the denominator, we use the past 12 months’ sales. The S&P 500 had sales per share of $1,372 over the 12 months through 2020’s second quarter. With the index at 3341, that means the price-to-sales ratio is around 2.4, a 60% premium to the 20-year average of 1.5.

Shiller P/E. Standard P/E ratios are criticized as being too sensitive to short-term fluctuations in corporate profits. The Shiller P/E avoids that pitfall by using average inflation-adjusted earnings for the past 10 years. This measure is also called the CAPE (cyclically adjusted price earnings) ratio or simply PE 10. It currently stands at 31, a 70% premium to the 100-year average of 18. The 30-year average is 26, which puts the current valuation premium at “just” 20%.

Price-to-book value. For this measure, analysts use stockholders’ equity, which is the value of a company’s assets—as carried on its books—minus all liabilities. Book value is stockholders’ equity figured on a per-share basis. The S&P 500 currently trades at around 3.8 times book value, or some 35% above the 20-year average of 2.8.

Tobin’s Q. This one is a little more obscure. It compares the stock market’s total value to the value of corporate assets—with those assets valued at replacement cost, rather than at how much companies paid for their assets. Today, stock prices are at 1.86 times corporate assets, versus a 120-year average of 0.78. For perspective, Tobin’s Q peaked at 2.14 in March 2000 and at 2.1 just before the COVID-19 crash. At the March 2009 market low, it touched 0.65, just below the long-term average.

The bottom line: By almost any measure, U.S. large-cap valuations are high. But keep in mind that this year’s first six months had a severe negative impact on sales and earnings. We may not get back to “normal” earnings until July and August of next year, when companies report 2021’s second quarter earnings. That means valuation measures will be somewhat distorted for at least the next year or so.

What should investors do? If you’re scared by the S&P 500’s valuation, look to beaten-down areas like small-cap shares, value stocks and foreign markets, where valuations are far more reasonable. Amazon, Apple, Facebook, Google (a.k.a. Alphabet) and Microsoft—the so-called FAAMG stocks—make up more than a fifth of the S&P 500’s market cap, so their sky-high valuations have a big impact on the index.

Is this March 2000 all over again? Are we in the ninth inning? Who knows? But it’s reasonable to think that returns might be weak over the next five or 10 years for mega-cap tech stocks, at least relative to other areas of the stock market. It’s been a hall-of-fame-worthy run for FAAMG. Maybe it’s time to make sure you have plenty of exposure to other areas of the global market.

Mike Zaccardi is a portfolio manager at an energy trading firm and a finance instructor at the University of North Florida. He also works as a consultant to financial advisors on an hourly basis, helping with portfolio analysis and financial planning. Mike is a Chartered Financial Analyst and Chartered Market Technician, and has passed the coursework for the Certified Financial Planner program. His previous articles include Ripple Effects, Raw Deal and Cooking Up a Story. Follow Mike on Twitter @MikeZaccardi, connect with him via LinkedIn and email him at MikeCZaccardi@gmail.com.

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Just Say No

DOES WEALTH bring advantages? Yes—but it can also invite some unique challenges. Consider country music singer Kane Brown.

Shortly after moving into a new home, he went for a walk. He told his wife he’d be back in half an hour. But seven hours later, after getting lost, he ended up calling for help. What was unique about this episode is that, the entire time he was lost, Brown was on his own property. His backyard, if you can call it that, covers some 30 acres.

It seems wealth can make life more complicated. Another example: As your net worth grows, invitations arrive to participate in more complex investments. These might include hedge funds, private equity, startup companies and other seemingly attractive alternatives to stocks and bonds.

In recent months, with both the stock and bond markets in the U.S. near all-time highs, interest in private-company investments appears to have grown. In the past, to protect everyday investors, private investments were limited to those who met certain net worth or income thresholds and, indeed, such investments were most common among university endowments and pension funds.

But now, thanks to industry lobbying, the government is broadening access. In a recent ruling, the Department of Labor threw open the doors to private equity. Employers now have the green light to include private equity among the funds offered to their 401(k) plan participants.

A private equity fund, if you aren’t familiar with it, is a fund that invests in private companies. This is in contrast to traditional mutual funds, which invest almost exclusively in publicly traded companies. As enticing as private equity funds may seem, I see at least five reasons to steer clear of them:

1. Cost. Private equity funds typically carry fees that are orders of magnitude higher than simple mutual funds. The standard has long been 2% of assets under management per year plus 20% of profits. By contrast, a simple index mutual fund might charge 0.02% of assets under management and not take any of the profits. Sound bad? It gets worse.

According to research conducted by The New York Times, private equity firms often deduct additional expenses from clients’ accounts without disclosing the costs. In 2015, private equity giant Blackstone paid $39 million to settle a case along these lines. Even when there is disclosure, it can be buried in the fine print. In 2014, for example, Kohlberg Kravis Roberts & Co. used $38.6 million of investors’ funds to help the firm settle a lawsuit. According to fund documents, this expense was permitted—and it was disclosed. But as the Times notes, that disclosure was on page 35 of a 37-page report. These may be the exception rather than the rule, but the private fund framework makes it easier for this sort of thing to happen.

2. Transparency. In 2015, Harvard University’s endowment exited an ill-fated private investment. Years earlier, it had purchased 33,600 acres of timberland in Romania. But Harvard’s representative in Romania turned out to be dishonest, and the endowment overpaid for the land. This is also the kind of thing that’s more likely to happen with a private investment. And if Harvard’s endowment—the largest in the world, with hundreds of employees—can be deceived, it can happen to anyone. Of course, public companies aren’t perfect. But in general, they’re subject to much more scrutiny, making it harder to engage in malfeasance.

3. Strategy. The purpose of private funds is to pursue strategies that are unusual. Oftentimes those work out fine—and sometimes very profitably. But when a fund is pursuing strategies that are farther from the beaten path, risk inevitably increases.

4. Concentration. In recent months, there’s been concern about the S&P 500, because its largest constituents have appreciated significantly, while many of its smaller constituents have dropped in value. The result is the top 10 companies in the index now account for almost 30% of the total. The concern is that this diminishes the diversification benefit.

But with a private investment fund, where investments need to be hand-picked by the fund’s manager, the concentration risk can be even greater. To the Department of Labor’s credit, it’ll only allow private equity investments into 401(k) plans when they’re part of a larger, diversified fund, such as a target-date fund. This ensures that no investor can allocate all their savings to private equity. Still, to the extent that investors have any private equity exposure, there is concentration risk—and disclosure documents aren’t much help.

If you look at the web page for a simple index fund, it’s easy to understand what the fund owns. See, for example, the iShares Core S&P 500 ETF’s holdings page. It couldn’t be more straightforward. By contrast, Partners Group, one of the private equity firms that lobbied the Department of Labor for the recent rule change, provided this holdings’ disclosure last month. It’s the opposite of straightforward. To be clear, the Partners fund might be a great investment. The problem is that, as an individual investor, it’s very hard to know.

5. Returns. Despite the above drawbacks, haven’t some investors made a fortune with private funds? In other words, if the net returns are great, isn’t that all that really matters? To some extent, that’s true.

But the problem with private funds is that they aren’t all created equal. Some are much better than others—and the difference between the best and worst among private funds is much greater than the difference among public funds. This report from the consulting firm McKinsey illustrates the size of that gap. See exhibit four on page 11. As at least one industry participant has acknowledged, the best funds are reserved for the largest institutional investors, not individuals. This, ultimately, is my biggest concern with private funds.

Yes, I see the appeal of private funds. They offer a seemingly attractive alternative to staid stocks and bonds, especially at a time when the prospective returns on traditional investments look more limited. Still, I’d be cautious.

Adam M. Grossman’s previous articles include Eyeing the Exit, Making Time and Portfolio Checkup . Adam is the founder of Mayport , a fixed-fee wealth management firm. In his series of free  e-books , Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman .

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Playing Dumb

TO MANAGE OUR money better, often we don’t need to know more. Instead, we need to unlearn what we think we already know.

Here are just some of the things that, at various points in my 35-year investing career, I’ve thought I’ve known:

Which fund managers will outperform.
Which way the economy is headed.
What’s next for interest rates and share prices.
Whether the overall stock market is overvalued or not.
Which individual stocks will beat the market.
Which stock market sectors and national stock markets will fare best.

Fortunately, this “knowledge” never greatly influenced my investment strategy. Still, I have little doubt that my portfolio’s performance would have been better if I hadn’t imagined that I knew these things—and I certainly wouldn’t have wasted so much time and mental energy.

Why do we think we know such things? It’s partly because Wall Street and the financial media talk endlessly about these issues. The financial media needs to fill airtime, websites and printed pages. Meanwhile, Wall Street wants to convince you that you know something about the future, so you actively manage your portfolio and thereby fatten the Street’s coffers.

But not all the blame belongs to others. Our belief that we have knowledge also partly stems from the way we’re wired. That wiring leaves us vulnerable to a host of behavioral mistakes, including extrapolation, overconfidence and recency bias, which together conspire to convince us that we know what the future will bring.

The problem: When we think we know something, we’re inclined to act upon that knowledge. In the financial markets, action almost always triggers investment costs and perhaps big tax bills. If we mess with our basic mix of stocks and conservative investments, we may miss a big market move—and any time we opt to reduce our overall stock exposure, we also lower our portfolio’s expected long-run return. And if our purported knowledge causes us to make narrow investment bets, we risk a permanent loss of capital, as we bet on stocks and market sectors that could potentially plunge—and never bounce back.

Even if we put our hands on our heart and we swear we aren’t inclined to forecast, predictions often creep into our behavior. We hold off investing because we sense share prices could fall. We tilt toward U.S. stocks because we think that they’ll always outperform foreign markets. Instead of prudently diversifying, we hang on to the employer shares we’re granted, because we can see that the company is prospering and we believe the stock price doesn’t fully reflect that.

What if we thought harder about such issues? No matter how much we analyze individual stocks, different market sectors and the overall market, there’s no evidence we’ll come up with a better forecast. Instead, our best bet is to not forecast. We need to unknow these things that we think we know, and instead focus on facets of investing where we have some control and where we truly can add value. We’re talking here about the amount of portfolio risk we take, the investment costs we incur and the taxes we pay.

There are also other areas of our financial life where hard work and more thought can pay handsome dividends. We can substantially improve our financial life by figuring out which debts to pay off first, what sort of home it makes most sense to buy, when to claim Social Security, what insurance we need and what estate planning steps we ought to take. We can also improve our life by spending more thoughtfully and saving more diligently—and by putting in the hard work needed to change our own damaging financial behavior.

To be sure, none of this has the seductive pleasure of making forecasts and imagining we’ll be proven right. But over a lifetime of investing, that pleasure, alas, almost always carries a steep price tag—and that’s one thing we all need to know.

Latest Articles

HERE ARE THE SIX other articles published by HumbleDollar this week:

“The highly successful are unusually resilient and hardworking,” observes Anika Hedstrom. “It’s about what goes through their head when they fall down, and how that—not talent or luck—determines what happens next.”
A sorry tale in which Rick Connor finds himself the unhappy owner of a timeshare, for which he blames himself—and the CFA Institute.
Got investments in your taxable account that you need to unload? Adam Grossman discusses how to sell—without losing too much to taxes.
“A real financial plan is a living and breathing creation that begins with each person’s goals and aspirations, and then works back from there,” writes Robin Powell. “The goals determine the strategy, not vice versa.”
How much should you invest in foreign stocks? On Tuesday, Rick Moberg presented three arguments for venturing abroad. On Wednesday, he offered three arguments for staying close to home.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Small Pleasures, Brain Candy and Think Like Eeyore 

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Effort Counts Twice

WHEN ROSE O’DONNELL was five years old, her mother passed away from the 1918 flu epidemic. This was shortly after her four-year-old brother died. Rose, and her remaining brothers and sisters, were raised by their father, Edward O’Donnell, in San Francisco. Edward had left school after the ninth grade.

What Edward lacked in formal education, he made up for with grit—a special blend of passion and perseverance. Edward became a self-taught expert in copper, founded O’Donnell Copperworks and held several patents, including the invention of heat exchangers used for pasteurization. He accomplished all this during the Great Depression and Second World War.

When I was growing up, I often heard the story of Edward and Rose—because Edward was my great-grandfather and Rose was my grandmother. How did adversity help Edward—and later Rose—to succeed? Why do some flourish when others fail?

Angela Duckworth, a professor at the University of Pennsylvania and author of Grit, has found that no matter the domain, the highly successful are unusually resilient and hardworking. They know deeply what it is they want. It’s about what goes through their head when they fall down, and how that—not talent or luck—determines what happens next.

Edward didn’t always have grit. Instead, it was something that developed over time by continually putting one foot in front of the other. As he discovered, effort counts twice and greatness is doable.

Edward’s commitment was simple and noble: provide an education for all five of his children. His relentless dedication and discipline made this mission possible. Many years later, Rose relied on her education, independence and grit when she ironically faced a similar fate, losing her husband and raising five children on her own. As a child of the Depression, Rose was extremely frugal and resourceful. She prioritized her children’s education and extracurricular activities. Living in the trenches with her father paved a gritty path to her own success.

According to Duckworth, grit can be cultivated. There are two ways to do so—from the inside out and the outside in.

Individually, we can grow and expand our interests, develop consistent habits of challenging ourselves beyond our existing skills, and connect our work to a purpose greater than ourselves. But like Rose, we can also use our parents—or coaches, mentors and friends—to help us develop our own personal grit.

Surround yourself with people who have grit, and they’ll rub off on you. Indeed, I like to think some of Rose’s grit may have rubbed off on me.

Anika Hedstrom’s previous articles include Stay in Your Lane, Known and Unknown and  Trek to Retirement . An assiduous researcher, Anika Hedstrom is a Certified Financial Planner who writes on the motivational and behavioral aspects of financial planning. Follow Anika on Twitter  @AnikaHedstrom .

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What’s the Plan?

IF YOU ASKED everyday Americans to define a financial plan, chances are they’ll talk about investment strategy. And for many people who call themselves financial advisors, that’s what a financial plan amounts to.

But a real plan is so much more than that.

To be sure, investment strategy will form part of a financial plan. But a strategy that isn’t moored to each individual’s goals, risk tolerance, financial situation, family circumstances and values isn’t really a strategy at all. It is more likely just a product that’s being sold off the shelf.

A real financial plan—as drawn up and constantly reviewed by a good financial planner—is really a living and breathing creation that begins with each person’s goals and aspirations, and then works back from there. The goals determine the strategy, not vice versa.

Another identifying feature of a bona fide plan is there isn’t just one goal or one strategy. Most people will have a long-term goal, such as generating sufficient income in retirement. But they will also have medium-term goals, like funding the children’s education, paying off the mortgage or helping with the care of elderly parents. On top of that, they’ll have short-term goals, like next year’s vacation. Each goal will come with its own strategy.

Then there’s the fact that your life rarely moves in straight lines and smooth roads. Recent events provide a stark reminder that the unexpected and unplanned can force us to rethink even the most locked-in goals. This means that managing risk will be a pivotal element of any plan worth its salt: Cash needs in a crisis will be part of the mix, as will life and disability insurance. What will happen to your estate after you’re gone has to be considered as well.

Furthermore, a good plan will take account of the day-to-day as well as the long term. A planner will assess your current financial situation, including regular incomings and outgoings, and how best to manage your assets and liabilities—what you own and what you owe.

The investment part of the strategy—the part that most people believe constitutes a financial plan—isn’t as straightforward as you might think, either. Markets are unpredictable, as we’ve seen recently. A planner needs to balance the need for strategies that maximize your chances of reaching your goals with those that you can actually live with.

You need your money to grow, of course. But you also need a shock absorber in your portfolio to help you deal with the inevitable downtimes. And you need sufficient cash as a buffer when unexpected events occur in your life or in the financial markets. These considerations, along with your time horizon, all influence how your assets are allocated to stocks, bonds, real estate and cash.

Complicating matters further is that nothing stays the same. When stock markets have a strong year, you can find yourself with a portfolio that’s riskier than you bargained for. A planner will rebalance at regular intervals to keep you on track, selling assets that have gone up in price and buying those that have gone down.

The bottom line: A financial plan serves a wide range of functions. It connects your short-term, medium-term and long-term aspirations to different strategies. It takes account not only of those goals, but also of your preparedness to live with the inevitable volatility involved in getting you there.

A financial plan, therefore, is not a static document, but an organic one. It changes as your life and circumstances evolve. Careers change, children come along, education costs increase, children leave home, health challenges arrive, families merge, retirement looms. A financial plan may start out as one thing, but it frequently evolves in style and content as our life story evolves. In some ways, it’s never finished.

Of course, no single plan can ever prepare you for everything that occurs in your life. But the plan is there to help you better prepare, to give you leeway when unexpected change comes along, to give you comfort and to make explicit the choices that you have. When it comes down to it, a great financial plan is really a great life plan.

Robin Powell is an award-winning journalist. He’s a campaigner for positive change in global investing, advocating for better investor education and greater transparency. Robin is the editor of The Evidence-Based Investor, which is where a version of this article first appeared. Regis Media owns the copyright to the above article, which can’t be republished without permission. Robin’s previous articles include The Good Advisor, No Need for Prophets and Death by Lifestyle. Follow Robin on Twitter @RobinJPowell.

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Happier at Home

YESTERDAY, I made the case for investing heavily in foreign stocks. Were you convinced? Many investors aren’t. They feel there’s no need to venture abroad. Here are three key arguments for keeping your stock portfolio close to home:

No. 1: The U.S. market provides adequate diversification.

Proponents cotend that, on their own, U.S. stocks offer all the diversification that an investor needs. U.S. shares represent a majority of global stock market capitalization, there are some 3,500 stocks to choose from and large U.S. companies provide significant exposure to foreign economic growth.

True, it’s possible that the U.S. could suffer a long period of terrible stock market returns, similar to Japan. The $64,000 question: Could this happen while foreign stock markets continue to fare well? Probably not. Foreign economies are highly dependent on the U.S., so it’s hard to imagine how our problems (or whatever caused them) wouldn’t affect overseas markets.

No. 2: The U.S. has been a better place to invest—and that’s likely to continue.

Proponents cite two key reasons to favor U.S. stocks. First, history tells us that U.S. shares have performed better. Yes, as fans of foreign stocks rightfully point out, overseas shares have beaten U.S. stocks in three of the past five decades. But that doesn’t tell the whole story.

How so? It leaves out the early part of the 20th century, when U.S. stocks beat foreign stocks in almost every decade. In addition, it doesn’t capture the margin of victory. When the U.S. dominates, it handily outperforms foreign shares—and, when it loses, it typically loses by a relatively small margin. Indeed, over the period through year-end 2019, U.S stocks outperformed foreign stocks over the trailing five, 10, 15, 20, 25, 30, 40 and 50 years.

To be sure, the fact that U.S. stocks delivered better results in the past doesn’t mean that’ll continue. That brings us to the second reason to favor U.S. over foreign stocks: America’s future continues to look brighter.

According to proponents, the U.S. remains a more attractive place to invest because it has significant advantages. We’re talking here about the U.S. political and economic system, the business environment, the legal system, rigorous stock market regulation and financial reporting, demographics, technological innovation and productivity. An added bonus: U.S. stocks don’t expose American investors to currency risk.

Meanwhile, the 10 largest overseas developed markets comprise 85% of foreign developed market capitalization. In order of size, these markets are Japan, the U.K., Canada, Germany, France, Switzerland, Australia, South Korea, the Netherlands and Hong Kong. Businesses operating in these countries are often hindered by restrictive laws and regulations, a less business-friendly economic system and policies, stagnant or shrinking populations, aging populations, less technological innovation and greater barriers to trade.

Japan deserves special mention because it’s a major position for many foreign stock funds. From its 1989 peak of some 38,900, the Nikkei index plummeted to 25,000 in 1991, as the Tokyo market bubble burst. But even after that initial precipitous decline, the Nikkei remains mired today at around 23,000, below 1991’s level. Why? Japan’s biggest problem is demographics. It not only has the world’s oldest population, but also its population is shrinking. That inhibits economic growth and puts severe fiscal pressure on the government. There’s nothing to suggest this situation will change soon.

Meanwhile, the six largest emerging market countries make up 82% of emerging stock market capitalization. In order of size, these six countries are China, Taiwan, India, Brazil, South Africa and Russia. But as with developed foreign markets, emerging markets are hampered by a slew of problems. Companies are often hindered by issues like totalitarian governments; business environments marked by great uncertainty, fraud and corruption; inferior legal systems; weak stock market regulation and lax financial reporting; a lack of technological innovation; and steep trade barriers.

Like Japan, China warrants special mention, because it accounts for a huge portion of most emerging market stock funds. Investing in China is likely to be profitable over the long haul, but it’s also accompanied by significant risk. The Chinese government has complete control over the financial markets—and it can do whatever it wants. Chinese companies have a history of issuing large numbers of new shares, thus diluting the stake of existing investors. On top of that, U.S. shareholders may get treated badly if things get ugly between the U.S. and China.

No. 3: Bogle and Buffett are pro-USA.

Warren Buffett is intellectually brilliant, an investment genius and a font of common sense. Similar praise has been heaped on the late Jack Bogle. Both are on record advocating that U.S. investors stick close to home. It’s difficult to ignore their views.

Rick Moberg is the retired chief financial officer of a publicly traded software company. He has an MBA in finance, is a CPA and has a passion for personal finance. Rick lives outside of Boston with his wife. His previous articles include Venturing Abroad, Six Tips and Give Me Five.

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Venturing Abroad

STOCKS WORLDWIDE have a total market value of some $85 trillion, with the U.S. accounting for 54%, developed foreign markets 35% and emerging markets 11%. Should your stock portfolio have similar weightings, as some experts suggest?

Tomorrow, I’ll look at the argument for keeping your stock market money close to home. But today’s article presents the case for venturing abroad—by focusing on three key arguments:

No. 1: A global stock portfolio is less risky than a U.S.-only portfolio.

Proponents contend that U.S. stock investors should hedge their bets by diversifying worldwide. That broader diversification lowers risk in three ways. First, you spread risk over more countries. Second, foreign stocks give U.S. investors exposure to industries that are underrepresented in the U.S stock market, as well as to great companies such as Bayer, Daimler, Nestle, Samsung, SAP, Siemens and Toyota.

Third, foreign stocks reduce home country risk—the danger that your domestic stock market experiences a large and prolonged decline. Japan is the classic example. Japan’s stock market peaked in 1989, declined precipitously in 1990 and still hasn’t recovered. The U.S. is not immune to that sort of protracted bear market.

The U.S. has enjoyed more than 200 years of prosperity, growth and good fortune. One day, its fortuitous streak will likely end, just as it ended for the British, Dutch, Spanish and Roman empires, among others. It’s impossible to know when that might happen, so now’s a good time to hedge against that risk.

Proponents also note that foreign stocks reduce portfolio volatility. Foreign stocks aren’t perfectly correlated with U.S. stocks, so they sometimes zig when the U.S. zags. That said, this argument isn’t as strong as it once was, because global stock markets have become more highly correlated over the past few decades.

No. 2: Foreign markets are poised to outperform U.S. stocks.

Proponents argue foreign stocks are likely to deliver higher returns in coming decades. There are three reasons:

Valuations. U.S stocks have outperformed foreign stocks over the past decade. That has left U.S. stocks with significantly higher price-earnings multiples.
Reversion to the mean. Since 1970, U.S. and foreign stocks have seesawed back and forth, with each delivering better returns for a decade or longer. Foreign stocks beat U.S. stocks in the 1970s, 1980s and 2000s. U.S. stocks won out in the 1990s and 2010s. Given the great run that U.S. stocks have had of late, foreign stocks may be primed to outperform.
Emerging market growth. That faster economic growth among developing countries could translate into superior stock returns in countries such as China, India and Taiwan.

No. 3. Experts recommend stashing 20% to 50% of a stock portfolio abroad.

The institutions making this recommendation include Charles Schwab, Fidelity Investments and Vanguard Group. The people include Bill Bernstein, Ben Carlson, Charles Ellis, Rick Ferri, Morgan Housel and Burton Malkiel. This is an impressive crowd of thoughtful, intelligent, respected and trusted people. Their collective opinion is quite an endorsement.

A final thought: Whatever you decide is the right amount of foreign stock exposure, you need to be committed to it. Flip flopping back and forth is a bad idea—and will likely hurt your long-run returns.

Rick Moberg is the retired chief financial officer of a publicly traded software company. He has an MBA in finance, is a CPA and has a passion for personal finance. Rick lives outside of Boston with his wife. His previous articles were Six Tips, Give Me Five and To Roth or Not.

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Paradise Lost

BACK IN AUGUST, Adam Grossman wrote a thought-provoking article about regret. He offered six strategies to minimize the chances you’ll end up kicking yourself for a choice you made. That got me thinking about the financial decision I most regret.

I bought a timeshare.

I know this admission will generate strong reactions in the personal finance community. I’d like to claim the ignorance of youth, but I was in my early 50s. I’d like to blame my wife, but it was mostly my doing. Maybe we—or should I say I?—were intoxicated with the beauty of the Hawaiian Islands. Who isn’t?

But the real blame belongs to an organization so unlikely that it requires explanation. The real reason we bought a timeshare: The CFA Institute—the organization for Chartered Financial Analysts—made me do it.

I traveled extensively throughout my career. My colleagues emphasized the importance of picking one hotel chain and then maximizing the benefits of its rewards program. I spent more than 1,000 nights at various Marriott properties. I learned the rules on how to get the most out of my many nights away from home. I am now a lifetime “titanium” member. The benefits I accumulated have provided my family with a number of memorable vacations.

In 2009, we had a wonderful stay at the Ko Olina Marriott on Oahu. The hotel was great, the scenery beautiful and the weather spectacular. We toured the whole island and loved it. We were offered 10,000 Marriott points if we would tour the Marriott Vacation Club timeshares just around the cove. It would take less than an hour and we were promised no hard sell. Still, I wasn’t interested and ignored the offer for most of the trip.

But on our second-to-last day, we were swimming in the cove next to our hotel. There was another couple, about our age, swimming nearby, and they engaged us in conversation. The husband said they were from Wisconsin and they had just bought a timeshare. He extolled its benefits, saying what a bargain it was. He also said it was the most valuable property that Marriott owned and could easily be traded for destinations around the world.

I listened to him, asking questions about how it worked and how hard it would be to sell. He again pointed to the value of the Hawaiian property. He seemed pretty good with numbers, so I asked what he did for a living. He said he was a finance professor at a well-known state university in the Midwest. His specialty: developing and teaching the Chartered Financial Analyst, or CFA, curriculum.

That was all it took. I was pretty familiar with the CFA designation and how rigorous it was. If someone who taught the CFA thought this particular timeshare was one good deal, well, who was I to contradict him? We signed up to take the tour the next morning, our last day in Hawaii. The property was beautiful and the salespeople offered an every-other-year option that cost $19,000, which we could afford. We convinced ourselves we could use it to host a family vacation somewhere warm every other winter. The deal was good for one day only. We signed up.

We used it for a family vacation in Aruba the following year. There were fees for the location exchange, but not too bad. Since we were new at this, we waited too long to book. We got a nice apartment, but it was located above the building’s noisy air conditioners and didn’t have a view. We learned that you had to reserve beach chairs and water gear each day, which meant you had to be up with the sun to get in line. We quickly realized there was a lot of education required to manage the timeshare system successfully.

And then there was the yearly maintenance fee. It started around $900 and grew to more than $1,200. We paid this every year, not just the years we had access to our timeshare. Timeshares also impose deadlines to use it or lose it. Trying to organize our three families got harder. We met nice people, who did it every year, knew all the ropes and loved it. They navigated the system to their benefit. But it just wasn’t the way we vacationed. It took only a few years for the regret to start building. At least Marriott allowed you to trade your week for points, which could be used later.

After a few years, I started to look into selling, but learned it was almost impossible. There were too many units on sale at a steep discount to our purchase price. And the value of the Hawaii property was not what we were led to believe—there were too many units available. After a few years, I started to wonder about the friendly CFA professor. Could he have been a plant, luring innocent tourists with the CFA designation? I’ll never know.

I kept researching how to sell. Last fall, I became aware of a Marriott program to buy back units. I called and the representative made an instant offer. It was about 20% of the purchase price. It took four months, but I was able to sell the unit just before the pandemic hit and I didn’t have to make the 2020 maintenance payment.

To be sure, many people make timeshares work for their families and love it. If you’re willing to put in the time to learn and navigate the rules, you can no doubt have some great vacations in beautiful places. I would carefully research the timeshare program’s rules and check out the secondary market to get a discounted price.

That said, if you ever find yourself swimming in an idyllic tropical cove and are approached by a CFA instructor, take my advice: Swim the other way.

Richard Connor is  a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include Much Appreciated, Victims of the Virus and Refi or Not . Follow Rick on Twitter  @RConnor609 .

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Eyeing the Exit

TWO WEEKS AGO, I described how to scour your portfolio for holdings that no longer fit your financial plan. At a high level, these investments fail at least one of two tests:

Risk. Some investments are just inherently unsuitable or excessively risky. Alternatively, an investment might be perfectly fine, but it represents a big risk simply because you own so much of it.
Return. You might have an investment that has chronically underperformed, charges excessive fees or generates large tax bills. These investments may not be especially risky in the short term, but over time they could erode your financial security.

If you hold an investment like this in a retirement account, the solution is easy: You can sell it without tax consequences. But what if it’s in a taxable account, where a sale would trigger a taxable gain? There’s no one-size-fits-all solution. But here are five strategies that’ll allow you to unload the investment without unleashing a tax bill:

1. Do nothing. While this might not seem like much of a strategy, it’s an option to consider. That’s because—at least under current law—there’s the step-up in basis at death. That means that, when your heirs inherit your assets, they won’t pay any tax on your unrealized gains. While that is hopefully many years down the road, it’s worth keeping in mind.

Here’s why: If you sell an investment at a gain today, you’ll owe some amount of tax. That means it will necessarily take time to break even. Depending on how long that breakeven period is, you might decide it’s worth holding the investment for the long term. This will, of course, depend on the specifics of the investment, your tax situation and other variables. To help weigh these factors, I recommend this free online spreadsheet.

2. Donate it. If you have charitable intentions, there’s no better solution for an appreciated asset. You’ll get a tax deduction. Better yet, you’ll never pay tax on the unrealized gain—that is, the difference between the price you paid and the price on the day you donate it. The best way to do this, in my view, is with a donor-advised fund, which combines tax efficiency, flexibility and simplicity.

3. Give it away. If you have an adult child who’s in a lower tax bracket, and you want to make a gift to your child, this could be a tax-efficient solution. Suppose you have pretax household income of more than $520,000. Under current rules, you’d pay 23.8% on long-term capital gains at the federal level. But if your son or daughter earns less, he or she might pay just 15%. For married taxpayers with pretax household income under some $105,000, there would be no tax at all. This tax advantage would be amplified if you live in a high income-tax state and your child lives in a low-tax or no-tax state.

4. Adjust elsewhere. Suppose you’ve earned big gains on a stock or stock fund in your taxable account and you now feel overexposed to the stock market. If you also have a retirement account, you could change the investment mix in that account—making it less aggressive. That would allow you to reduce your overall market exposure without incurring any taxable gains.

5. Find a pair. If you have a mix of investments—some with losses and some with gains—that opens the door to another solution. As long as you do it in the same year, losses count against gains, allowing you to offload holdings without incurring any net tax. Keep in mind, however, that taxes are just one piece of the puzzle. As you make these kinds of sales, be sure you don’t distort the composition of your remaining portfolio.

What if you’ve exhausted the above tax-free solutions and you’re still left with investments you want to unload? Consider one of these three strategies:

1. Bite the bullet. Sometimes, you should take care of a problem all at once, though I recommend this only in situations where the risk is very high. Suppose you’ve retired from a public company with a boatload of company stock. Or maybe you had the foresight to load up on Tesla or some other highflyer. If one stock accounts for enough of your net worth that it could jeopardize your goals if it imploded, selling the entire position right away might be the best solution.

2. Use a formula. Let’s say you want to reduce a holding but don’t feel the urgency to do so all at once. In these cases, you can establish a formula to guide your sales. For instance, you could sell a specific dollar amount periodically. This is similar to dollar-cost averaging, but in reverse. You’d end up selling fewer shares as the investment’s share price rose and more as it fell. An alternative I prefer: Instead of targeting a dollar amount for each sale, target a share count. Increase that count if the share price climbs and reduce it if the price decreases. This would result in selling more shares as the price rose and fewer if it fell.

3. Wait. Life isn’t a straight line. Markets rise and fall—and so, too, will your income. Depending upon the urgency, you might delay any sale until a more opportune market environment or tax year.

Over the years, I’ve implemented all of the above approaches with clients. One common theme: Hindsight invariably offers a better solution. But as I noted a few weeks ago, you can only make decisions with the facts currently in front of you.

A final note: You may have heard of exchange funds—a construct designed to help investors with extreme concentrations in one stock. They might seem like the perfect solution to this problem. But unfortunately, they have so many drawbacks and limitations, including a possible seven-year lockup, that I don’t recommend them.

Adam M. Grossman’s previous articles include Making Time, Portfolio Checkup and Don’t Feel Bad . Adam is the founder of Mayport , a fixed-fee wealth management firm. In his series of free  e-books , Adam advocates an evidence-based approach to personal finance. Follow Adam on Twitter @AdamMGrossman .

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The post Eyeing the Exit appeared first on HumbleDollar.

Small Pleasures

TODAY, I SING the praises of spending—on the little things in life.

We fiercely resist the suggestion that money doesn’t buy happiness. Commentators will often trot out the quote—which has been attributed to all kinds of folks—that, “I’ve been poor and I’ve been rich. Rich is better!”

I think that’s true. But it isn’t proportionally true. If you went from earning $100,000 a year to earning $200,000, or your portfolio grew from $500,000 to $1 million, would you be twice as happy?

Similarly, on a recent Friday, I found myself alone, with no desire to cook, so I simply heated up a $5.99 pizza from the supermarket. Yes, I admit it, it was a little sad, especially for a Friday night.

The following evening, I went out with three friends to one of my favorite restaurants and we spent more than $100 a head, or some 20 times more. The food was undoubtedly better and there were other perks, including the anticipation of a fun evening, the company and the brief reprieve from dishwashing. Still, I’d be hard pressed to claim that the entire experience was 20 times better than the prior night’s supermarket pizza.

What’s my point? There’s huge variation in the cost of goods and services—but the resulting boost to happiness varies far less. Buying a new Kindle eight-inch tablet computer might cost you $110, while purchasing a new car would set you back an average $38,000. To be sure, most folks need a car.

Still, if the goal is greater happiness, wouldn’t it make sense to spend, say, $11,000 less on the vehicle, which would give you savings equal to the cost of 100 Kindles? That way, you could buy perhaps one new Kindle, plus 99 other treats costing $110 or so.

That would almost certainly be a prescription for greater happiness. Why? Whatever you do with your money, the happiness you receive from the spending will wane, as the initial thrill quickly turns to ho-hum, thanks to so-called hedonic adaptation. The $38,000 car might generate greater excitement than the $110 Kindle, but you’ll get to indifference—and perhaps even disdain—soon enough.

One of the upsides of less expensive but more frequent purchases: You might be able to afford, say, a small thrill every week or two, rather than a somewhat larger thrill every three years. Moreover, by favoring smaller purchases, you limit the magnitude of your financial mistake if—as often happens—you misjudge what will make you happy.

I’m hardly the first person to suggest this strategy. For instance, it’s one of many mentioned in the brilliant paper by academics Elizabeth Dunn, Daniel Gilbert and Timothy Wilson. Like the idea of small pleasures? Here are eight additional thoughts on that strategy:

Ponder your purchases for a few weeks or months before pulling the trigger. You may discover that the best part of each purchase is the anticipation.
Go for variety. I’m not saying you shouldn’t repeat a small purchase that had previously made you happy. But try not to do it too often. Don’t always stay at the same country inn. Don’t buy a Starbucks specialty coffee every day. Don’t always go to the same restaurant. If you make it a habit, it won’t seem special. If you do it occasionally, it’ll feel like a treat.
Buy time. It’s our ultimate limited resource. Pay others to do chores you dislike, such as cleaning the house or mowing the lawn, so you have more time for activities you enjoy.
Don’t finance your spending with debt and, if possible, pay ahead of time. You’re more likely to enjoy a purchase if you aren’t worrying about how you’ll foot the bill. For instance, when you book a hotel room, you might prepay, which will often also get you a small discount. It’s also why I like it when family members give me gift cards to local restaurants. I can then focus on the food, without thinking about the cost.
Involve people. We’re frequently reminded that experiences tend to deliver greater happiness than possessions. Why do experiences win out? A key reason is that others are typically involved. The experience of going to a museum or a concert is a whole lot more fun if you have company.
Give to others. We get a surprising amount of happiness from making gifts and giving to charity. Want to make that gift extra special for the recipient? Make the gift when it’s not expected. Your spouse will be happy to get flowers on Valentine’s Day. But if you really want to see her smile, buy her a dozen roses today.
Another reason to favor smaller purchases: They typically involve little ongoing maintenance and they often aren’t worth repairing. That isn’t true for major purchases like cars and homes. Yes, some folks enjoy rotating the tires and fixing the leaky faucet. But most of us don’t—which is why cars and homes are frequent sources of unhappiness.
Avoid signaling. We often spend money not because it’s something we really want, but because we want to make a statement to the world about what sort of person we are. For instance, folks will buy luxury goods as a way to signal their financial success. Indeed, almost everything we say and do can be interpreted as signaling to others how we want to be perceived. A Rolex watch makes one statement. A Timex says something very different.

Obviously, there’s pleasure to be had from signaling. But I presume there’s greater pleasure to be had if we can each figure out what we truly enjoy. So what do you enjoy? Make a list—the longer, the better—and then focus on those items with more modest price tags.

Latest Articles

HERE ARE THE SIX other articles published by HumbleDollar this week:

Kristine Hayes is approaching retirement age—and trying to figure out the best strategy for generating retirement income. Her biggest stumbling block: the overwhelming number of financial choices.
“In many cases, debt is merely convenient—not necessary—and it comes with costs that go far beyond the low, easy monthly payments,” writes Isaac Cathey, who details five key drawbacks.
Got to generate cash from your portfolio? To figure out what to sell, you need to know not just your income tax rate, but also the rate on your capital gains. Rick Connor explains.
“Playing to someone else’s scoreboard is easy,” argues Anika Hedstrom. “The harder thing—playing our own game—begins when we turn our energy toward what we’re capable of and how we can improve ourselves.”
Want to be more productive—without being more stressed? Adam Grossman highlights 10 great strategies.
Refinancing. Portfolio design. The 4% rule. Minimizing regret. Insurance products for retirees. Check out HumbleDollar’s seven most popular articles in August.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Brain Candy, Think Like Eeyore and Getting Emotional.

Do you enjoy HumbleDollar? Please support our work with a donation. Want to receive daily email alerts about new articles? Click here. How about getting our weekly newsletter? Sign up now.

The post Small Pleasures appeared first on HumbleDollar.