Jonathan Clements's Blog, page 320

Played for Fools

“THE CHINESE PLAY the long game. We play checkers, they play chess.”

You hear such sentiments from Americans a lot. It’s one of the narratives that draws foreign money to China. The story is so good, it distracts investors from an important fact: The oldest China exchange-traded fund, the iShares China Large-Cap ETF (symbol: FXI), has lost a quarter of its value since peaking in 2007. Yet somehow—helped by Chinese government pressure on index providers—China’s weight in the emerging markets indexes is higher than ever. For instance, the country now represents 42% of the Vanguard Emerging Markets Index Fund.

Despite the iShares fund’s incredible run from inception in late 2004 until the financial crisis, and several huge ups and downs since, it has underperformed the S&P 500 significantly in that nearly 16-year span. If China were a value fund, you’d have sold by now. Beijing is indeed playing a long game, but at the expense of foreign investors—including little guys like you and me.

These thoughts crystalized as I chatted recently with Perth Tolle, founder of Life + Liberty Indexes and creator of the Freedom 100 Emerging Markets Index. To be sure, Tolle is “talking her book.” The year-old Freedom 100 Emerging Markets ETF (symbol: FRDM), which tracks the index, shuns Tolle’s native China. It also steers clear of many other developing nations where individual rights are trampled.

Tolle’s thesis is that stock markets of countries that respect the human, civil, political and economic rights of citizens and investors should be better for shareholders over the long run. So, no China, no Russia, no Saudi Arabia in the index. “This is for people who believe in the long-term benefits of freedom and want to stand up for that in their emerging markets allocations,” she says.

Index inclusion is determined not by Tolle’s preferences or by the headlines, but by metrics kept by three organizations: the libertarian Cato Institute in the U.S. and Fraser Institute in Canada, and the liberal Friedrich Naumann Foundation for Freedom in Germany. For instance, India’s weight is limited by its protectionist policies, while Brazil is excluded because of its high homicide rate. “Our think tanks determined that if you can’t walk down the street without getting shot, then you’re not free,” Tolle says.

What about that fast-growing Chinese economy, the one everyone wants a piece of? “Where did that growth go?” Tolle asks. “Why didn’t foreign investors get to participate in that? That’s one of the risks of investing in unfree markets. There’s a lot of government interference in business practices, without the rule of law and investor protections in place. A lot of that growth gets siphoned off to who they want it to go to.”

In Tolle’s view, Wall Street and index companies such as MSCI and FTSE have been bent to China’s will. Even the Securities and Exchange Commission has allowed Chinese companies to come to market without meeting U.S. accounting requirements, though Tolle notes that may be changing.

Recently, the SEC and Nasdaq had a bitter taste of Luckin Coffee, but initial public stock offerings (IPOs) of Chinese companies have been problematic for years. Billed as “the Starbucks of China,” Luckin once had a market cap of nearly $13 billion before a massive fabrication of sales was revealed April 2, about a year after its IPO. Unwitting iShares and Vanguard emerging markets index fund investors got burned: The funds were the largest shareholders.

Tolle reached out to a friend in China after the scandal broke. The joke there? “Luckin is the best company in the world because they give Chinese people free coffee and then they go to the U.S. and get the stupid money,” she says.

I obviously feel strongly about China (as well as Russia, Saudi Arabia and certain other emerging markets) and about investor protection, but this is not a recommendation to buy the Freedom 100 fund. I don’t own it myself, at least not yet, though I admire what Tolle is doing and want her to succeed. It’s important to note that her principled stand rules out about half the market cap of today’s broad emerging markets indexes. The fund is still tiny, with just $16 million in assets, and the expense ratio of 0.49% is well above average, though in line with many factor ETFs.

And I wonder if, in the short term at least, the world is moving away from her. I hope things get better, but it seems like they will get worse first. In addition to China’s increasingly aggressive behavior (summarized well here and here), there is a rising tide of populism and nationalism across the globe. Turkey got booted from the Freedom 100 index in 2018 as a result of President Recep Erdogan’s dictatorial behavior. Rightward-lurching Poland has seen its weighting cut.  

On the other side of the spectrum, many younger Americans are flirting with “socialism”—or some fuzzy notion of it. Do these developments threaten Tolle’s world view? The entrepreneur, who has experienced freedom in the U.S. and in the Hong Kong of two decades ago, but who grew up without it in China, says no. “My faith in democracy is not shaken,” she tells me. “But I can understand why it would be for some people.”

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles include Right from Wrong, Red Flags and Averting My Gaze . In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart .

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 Played for Fools appeared first on HumbleDollar.

Two Reasons to Worry

IN HER MOST recent book, former Secretary of State Madeleine Albright quotes Mussolini. “If you pluck a chicken one feather at a time,” he said, “no one will notice.”

Don’t worry, I’m not veering into political commentary. But when I heard this quote, it brought to mind what we’ve been seeing in the financial markets this year. Taken individually, there’s nothing that strikes me as a clear red flag. But taken together, the current environment looks a little bit like a chicken that—all of a sudden—seems to have lost a whole lot of feathers.

Worry No. 1: Market concentration. There are thousands of companies listed on U.S. exchanges. But recently, the largest stocks by market value have grown disproportionately larger. Today, just five stocks—Microsoft, Apple, Amazon, Alphabet (parent of Google) and Facebook—account for more than 20% of the total value of the S&P 500. The percentage accounted for by the largest five stocks has doubled over the past five years.

Why does this concern me? Isn’t that concentration just a reflection of those companies’ success? Yes and no.

Yes, these companies’ earnings have increased dramatically. But as a group, their valuations have increased even faster. That means that investors are paying more for each dollar of earnings. Call me a stick in the mud, but popularity is not healthy for investment markets. That’s what leads to bubbles.

Even if these stocks weren’t becoming more popular—that is, even if their earnings fully justified their share prices—there’s still a risk in this growing concentration. More of the market’s fate now rests on fewer companies, plus these companies are all, more or less, in the same industry, which further magnifies that risk.

While these stocks have been going up, we’ve all benefited. But if one or more of them should hit a speed bump, it will be felt by everyone, like a gorilla jumping in the kiddie pool.

Worry No. 2: Market speculation. Above, I noted the growing popularity of a small group of stocks. The reality is that stock markets, practically since their inception, have walked a fine line between investing and gambling. Three hundred years ago, we had the South Sea bubble—and there have been many more since.

Both investors and brokers play their part in this. Since industry deregulation in the 1970s, brokers have gotten more creative with their advertising, as they seek to draw in new investors. Recall, for example, eTrade’s talking baby and dancing monkey commercials.

Over the past year, the brokerage industry has taken things to a new level. You may have heard of an online trading platform called Robinhood. With an altruistic name, its website states, “We’re on a mission to democratize finance for all.” On the surface, that’s what it’s doing. To open a Robinhood account, there are no minimums and trades are commission-free. It also pioneered the concept of fractional shares, so an investor with as little as $1 can invest in the stock market.

In theory, Robinhood is a good thing. That’s what I thought at first. But Robinhood seems to be appealing more to speculators, or even gamblers, than to investors. As one observer put it, Robinhood’s website makes investing “feel more like playing Donkey Kong than risking hard-earned money.”

When I visited its website, I was offered a free share of stock as an enticement. “When you sign up, a surprise stock appears in your account.” The prospective stocks were presented in the form of animated playing cards, with my odds of receiving each listed alongside. After a user completes a trade, confetti cover the screen. It feels like a cross between a video game and a casino.

It isn’t just the Donkey Kong aspect of Robinhood that’s troubling. By itself, there’s nothing wrong with an engaging user interface. The problem is, there’s evidence this is leading to unhealthy behavior—not just among Robinhood’s own customers, but industrywide.

You may have seen the news last fall that all of the big online brokers dropped their stock trading commissions to zero. While they didn’t acknowledge it, I believe this was driven by competitive pressure from Robinhood, which has grown rapidly and now has more than 10 million customers.

Again, on the surface, these trends may all appear to be consumer friendly. Aren’t lower prices better for everyone? Usually, that’s the case. But when it comes to stock trading, research has repeatedly shown that frequent trading leads to worse investment results. Even though brokerage commissions aren’t the only cost to trade, there’s evidence that the move to zero commissions has driven stock trading volumes through the roof. Recent data reveals that online brokers have seen trading volumes double over the past year.

What’s worse, the investment choices Robinhood users make are, in many cases, downright scary. Among the top 20 exchange-traded funds (ETFs) owned by Robinhood users, seven are leveraged, according to a recent review. What’s a leveraged ETF? It’s something so risky that last year Vanguard Group banned them from its trading platform—and yet this is a big part of what Robinhood users are buying.

While this is an isolated case, one 20-year-old Robinhood user tragically took his own life after misreading his balance and believing that he had incurred a $730,000 debt. How could this have happened? It turns out that he was trading a complex stock options strategy. In cases like this, an investor’s balance can appear negative until the entire trade has completed.

This isn’t unique to Robinhood, but rather symptomatic of a broader trend. Young people are being drawn in without sufficient education. In the note that he left for his family, this young man wrote, “How was a 20-year-old with no income able to get assigned almost a million dollars’ worth of leverage? I had no clue what I was doing.”

Who’s to blame for all this? I’ve singled out Robinhood, and I do believe it’s responsible for stoking some amount of speculative behavior. But it takes two to tango, and investors play their part—especially high-profile personalities. One in particular is a blogger named David Portnoy. The founder of a site called Barstool Sports, Portnoy explains that, “When COVID-19 caused sports to be postponed indefinitely a few months ago, I turned from sports gambling to day trading….”

On Twitter, Portnoy has 1.6 million followers. His posts and his videos are almost impossible to describe, so I’ll include a few quotes to illustrate:

“This is free money every day…. Stocks only go up. They only go up.” (July 2)
“I just bought ZOM because somebody told me he’s from the University of Michigan, and that’s where I went to school…. So I put two hundred grand into ZOM…. Don’t know what it does.” (June 26)
“I’m sure Warren Buffett is a great guy but when it comes to stocks he’s washed up. I’m the captain now.” (June 9)

This might be amusing—and, again, you might call me a stick in the mud—but Portnoy’s videos often have several hundred thousand views. Can I draw a straight line between these videos and anyone else’s risky stock market behavior? Of course not. But I see it as a data point to bear in mind.

What should you make of all this? Is this a warning sign about the stock market? As I’ve noted before, investing requires a healthy balance between optimism and pessimism. I’ve also cited reasons you should be optimistic. So please view this only as evidence to weigh on the other side of the scale. But in this kind of environment, I feel it’s even more important to stick to time-tested investment principles that, in my opinion, provide the best chance for long-term success:

Diversify—both among asset classes and within asset classes. As noted above, the S&P 500 may not be enough.
Avoid big bets on individual stocks, especially “popular” stocks.
Limit trading.
Seek out reliable, evidence-based resources. For investors at all levels, I recommend finance professor Terrance Odean’s video series. It’s as good a personal finance curriculum as any.

If you follow that prescription, I doubt you’ll have as much fun as David Portnoy. But I do believe it’s the right path.

Adam M. Grossman’s previous articles include Too Slow, Sticking With It and Think Like a Winner.  Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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 Two Reasons to Worry appeared first on HumbleDollar.

Keep Your Distance

IT’S INDEPENDENCE Day. But how truly independent are we, both financially and in our thinking? The two, I believe, are inextricably entwined.

Whether it’s the TV shows we watch, the political views we hold or the investments we buy, we often take our cues from family, friends and colleagues. They, in turn, may be influenced by advertising and the media. But however ideas get spread, the result is that most of us aren’t the fiercely independent thinkers we imagine. Instead, all too often, we’re swayed by the mob.

This isn’t always so terrible. As I’ve noted before, there can be great wisdom to crowds. Investors typically do a fine collective job of valuing corporations, as well as anticipating economic growth and inflation. Similarly, consumers collectively are pretty good at figuring out which movies are worth watching, which electronic goods are worth buying and which restaurants are worth visiting. If we want to lose ourselves in an entertaining novel, we should pick a popular one—and we likely won’t be disappointed.

But what’s typically true isn’t always true. Want to grow wealthy? We need to know when to resist the influence of the mob.

Investing sensibly. What are the major investment blunders? We could pay too much in investment costs, make big undiversified investment bets or make radical portfolio changes at just the wrong time. We often make such undiversified bets and radical portfolio shifts because we’re overly influenced by the investment crowd—and these missteps often have the added misfortune of triggering hefty investment costs, including big tax bills.

Think about the panic selling during this year’s market decline. Or ponder the 2017 bitcoin bubble, the 2008-09 stock market collapse, the mid-2000s housing craziness, the late 1990s tech stock mania or the late 1980s Japanese stock market bubble.

What leads people to feed on each other’s exuberance or despair, thus pushing market prices to such extremes? We don’t know for sure. But economists and psychologists have identified various mental mistakes that can cause the investing crowd to become convinced they know what the financial future holds, prompting them to buy or sell en masse.

Four concepts strike me as especially helpful. First, whether investments are rising or falling, there’s usually a good reason—but folks may get overly enthused or scared if the price move is accompanied by a compelling narrative. Look no further than the coronavirus crash, and the competing stories about the potential economic damage.

Second, there’s extrapolation. We often buy rising investments for the simple reason that we assume they’ll keep on rising. Ditto for when we sell falling investments. Closely related to this is recency bias: We ignore longer-run returns and instead come to believe that an investment’s current strong or weak performance is representative of how it typically performs.

As the early buyers or sellers drive prices higher or lower, others notice and they, too, join in. This brings us to a third concept: herding. As we watch prices rise or fall, we assume others must know something we don’t—and we rush to imitate them. If extrapolation leads us to buy investments simply because prices are rising, herding can prompt us to purchase simply because others are doing the same.

All this buying can give prices a further nudge upward. That brings us to a fourth factor, one typically associated with rising markets: overconfidence. As investors make money, they attribute those gains to their own brilliance, often leading them to make even bigger bets. Related to this is the house money effect: Like the casino gamblers who get lucky early in the evening, investors may feel like they’re ahead of the game financially, causing them to take yet larger risks. Where does all this end? Usually in tears.

Spending wisely. Failing to invest sensibly is unfortunate, but at least it means these folks had money to invest in the first place. Arguably, the bigger problem is those who never invest—because they can’t control their spending and hence they have little or no savings.

Why do so many folks save so little? It could be true economic misfortune. It could be the common mistake of overvaluing today and giving scant thought to the needs of our future self. It could be the mistaken belief—fueled by advertising—that happiness lies just one or two purchases away.

But once again, we shouldn’t overlook the influence of the crowd. There’s no doubt an element of herding, as we imitate the spending of others. But even more important, I suspect, is signaling. Rather than loudly announcing our values or showing our financial statements to our neighbors—neither of which I’d recommend—we instead signal our values and our financial success with how we spend our money. That signal could be “I’m frugal” and the sign could be our Subaru with 200,000 miles on it.

But folks typically go the other way, signaling their success with the new car, the big house and the expensive vacation. The irony: While others may indeed see these as signs of financial success, such expenditures leave the folks involved significantly poorer—and often we later discover that they aren’t nearly as prosperous as we imagined.

The upshot: This Independence Day, let’s commit to true financial independence, where we resist the fleeting comfort of the crowd, and instead spend and invest by thinking about what each of us individually cares about and what makes rational financial sense. The pitfalls described above have been well-documented and their foolishness all too obvious. But being aware of these mistakes, alas, isn’t enough. Rather, the real challenge is summoning the mental fortitude necessary to resist the influence of others—and focus resolutely on what’s best for our own financial future.

Latest Articles

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

“When we analyze our investment moves, we judge them by whether we made money,” says Bill Ehart. “We wanna know if we were ‘right’ right away. But that’s the wrong way to look at it.”
Equity-indexed annuities are one of today’s hottest insurance products. How do they work and do they make sense for investors? Dennis Ho digs into the details.
The stock market was a tad calmer last month—and that meant readers were interested in topics other than the coronavirus and its financial fallout. Result? Check out June’s seven most popular articles.
“Dollar-cost averaging is a behavioral strategy—and it’s a powerful one,” writes Adam Grossman. “Imagine you’d received a windfall in February of this year and invested it in the stock market all at once.”
If older Americans stayed in the workforce for longer, it wouldn’t just be good for their finances and for the economy. It would also be a bonanza for employers, argues Steve Chen.
How much should you invest in stocks? Marc Bisbal Arias wrestled with the question—and decided he was more concerned with sleeping at night than making money during the trading day.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Breaking the Rules, In Our Own Way and Farewell Yield.

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 Keep Your Distance appeared first on HumbleDollar.

Fear of Falling

I’M 28 YEARS OLD. How much should I have in stocks? Some financial experts would suggest allocating 90% of my portfolio, because I have a long time horizon and a steady job. But I don’t think that would be a good idea for me.

My father has driven hundreds of thousands of kilometers over his lifetime—because he’s afraid of flying, despite the much lower risk that air travel entails. Similarly, I have a good idea of what optimal investing behavior looks like for someone of my age. But for me, the right asset allocation isn’t the most “efficient” one, but the one that will let me sleep at night.

So why aren’t I investing as aggressively as some might advise me? For starters, I think it’s important to distinguish facts from opinions. It’s a fact that, if we pay less in investment costs, we’ll keep more of whatever we earn. But it isn’t a fact that stocks will generate better returns than bonds in the coming decade. Rather, it’s an opinion. Our assumptions and beliefs can be—and sometimes are—wrong. What are the implications if our belief in the stock market’s superior performance turns out to be mistaken?

It’s a tradeoff we all make: if we’re conservative in our asset allocation, we benefit less from rising stocks, while suffering less when prices decline. Meanwhile, if we’re aggressive, we’ll reap larger benefits if stocks rise, but we could be severely harmed if the market loses value over the next decade.

It isn’t hard to identify the worst of those two scenarios. The second would obviously have a much bigger negative impact. I find it helpful to think about extremes, because I know I’d prefer avoiding a really bad outcome, even if it means smaller positive ones.

With COVID-19, we’ve seen things we never thought possible. What other events could happen that we haven’t contemplated? And is there a way for us to limit the impact on our wealth? Considering different scenarios may expose weaknesses in our finances. Perhaps we’re holding too little cash or our stock portfolio isn’t diversified enough.

As Morgan Housel recently said in a thoughtful conversation with bestselling author Annie Duke, “Investing is about surviving the widest number of outcomes.” If our goal is to ensure we’re okay financially, pretty much no matter what happens, what does that imply for our portfolio?

Suppose market crises happen about once every 10 years and that they can potentially cause stocks to lose half their value. If you’re 100% in stocks, your portfolio would be down 50%, while a 40% allocation to stocks would leave you down 20%—and that assumes no offsetting gains from other parts of your portfolio.

After going through this exercise, I realized I wouldn’t be comfortable investing more than 70% in stocks. This should limit the potential decline in my portfolio to around 35%. Anything more than that would be simply too painful for me.

Marc Bisbal Arias holds a bachelor’s degree in business and economics,  and is a Level I candidate to become a Chartered Financial Analyst. He started his professional career at Morningstar, performing research and editorial tasks, and is currently employed by Dow Jones in Barcelona, Spain. Marc’s previous articles were Mind Over Money, The Upside of Down and Setting Boundaries. Follow him on Twitter  @BAMarc .

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 Fear of Falling appeared first on HumbleDollar.

No Down Less Up

INDEXED ANNUITIES have been taking the insurance world by storm. According to industry sources, sales of indexed annuities—also known as equity-indexed annuities or fixed-indexed annuities—topped $70 billion last year and estimates for 2020 call for continued growth in the market.

On the surface, indexed annuities seem simple enough: You deposit a lump sum and earn interest based on stock market returns, with a guarantee that your annual return will never be less than zero. In other words, you can get the upside of the stock market, but with your principal protected. While these products might make sense in certain situations, it’s important to grasp what you’re getting—and what the drawbacks are.

To understand equity-indexed annuities, you need to understand fixed annuities generally. Fixed annuities have traditionally been low-risk savings vehicles, similar to a bank CD, or certificate of deposit. Like a CD, you get a guaranteed fixed rate of return provided you hold the annuity until it matures, which might be just two years’ away or perhaps as long as 15 years. Also like a CD, your guaranteed interest rate is net of all insurance company charges, so there are no other fees or expenses to worry about.

Traditional fixed annuities can be attractive relative to CDs, because they usually offer higher rates of return. Recently, top five-year CDs were paying 1.5% a year, while a fixed annuity from an A-rated insurer was crediting as much as 3%. And because fixed annuities are insurance contracts, taxes on the interest are deferred until you withdraw the money.

Indeed, at a fixed annuity’s maturity, you can roll the funds into a new fixed annuity (or any other type of annuity) via a 1035 exchange and continue deferring taxes on the interest indefinitely. The downside of a fixed annuity: The money is not FDIC-insured, so you’re taking greater “counterparty” risk, meaning there could be problems if the insurer got into financial trouble. In addition, there are heavy surrender charges if you withdraw your money early.

Finally, once you deposit money into a fixed annuity, you must keep it inside an annuity until at least age 59½. What if you pull money out earlier? There’s a 10% tax penalty on withdrawals, even if the specific annuity you own has reached its maturity. This final point generally makes fixed annuities suitable only for those close to or in retirement.

That brings us to equity-indexed annuities. They’re a twist on the fixed annuity product. Instead of crediting you with a fixed rate of interest, you get interest based on the return of a stock market index, like the S&P 500. At the same time, if the index return is negative in any given year, you get a 0% return, so your principal is protected.

How can insurers offer this? Consider the earlier example of a five-year traditional fixed annuity. Rather than pay you the 3% interest, the insurance company takes the interest you’d normally receive and instead purchases derivatives that increase in value if the stock market goes up. If the market performs well, the gain in the derivatives is used to pay you interest based on a predetermined formula. If the market goes down, then the derivatives expire worthless and you don’t get any interest. Indexed annuities can be attractive for individuals who want a principal-protected investment with the opportunity for higher returns than bonds or similar conservative investments.

But there are several caveats to be aware of. First, because of today’s low yield, the interest payments generally aren’t enough for insurers to purchase full exposure to the index. In many cases, your annual return will be a portion of the index return based on a “cap rate” or “participation rate.” For example, a 5% cap rate means you’ll get the next year’s index return up to a maximum of 5%, while a 70% participation rate means you’ll get 70% of the index’s return over the next year. The amount credited to annuity holders is based on share price changes only, with dividends excluded.

In years when the stock market does well, the indexed annuity will likely underperform significantly. Yes, the annuity will outperform when market returns are negative. But that’s not enough to offset the lost gains in good years. Result: Indexed annuities will generally underperform the market over the long term. You might be okay with this, because you’re looking to take less risk. But buyers should be aware that indexed annuities are not a substitute for owning stocks, which is how many insurance agents position the product.

Second, your participation rates can change over time. The initial 5% cap rate you signed up for can be changed each year by the insurer as derivative prices change. This can be good if interest rates rise and the cost of derivatives becomes cheaper, but bad if the opposite happens. Think of indexed annuities as akin to floating rate bonds—but in this case it isn’t your interest rate that fluctuates, but rather your participation in the stock market’s performance.

Third, it’s impossible for the average investor to assess whether they’re getting a good deal relative to other investments. Is a 5% cap rate on an S&P 500 indexed annuity a good value—or should it be 10% based on current market conditions? With traditional fixed annuities, you can look to bank CDs to assess whether you’re getting a good deal. But there’s no similar external benchmark for equity-indexed annuities.

Finally, as with other annuities, advisors are paid via commissions. In many cases, longer lock-in periods and more complicated products mean higher commissions for advisors, so they have an incentive to steer you toward these products. For example, a “plain vanilla” five-year fixed annuity might pay a commission of 1% to 2%, while a 10-year equity-indexed annuity could pay advisors 5% or more.

Dennis Ho is a life actuary and chief executive of Saturday Insurance, a digital insurance advisor that helps people shop for life, disability and long-term-care insurance, as well as income annuities. Prior to co-founding Saturday, Dennis spent 20 years in the insurance industry in a variety of actuarial, finance and business roles. His previous articles include Questions I’m Asked, Retire That Policy and Care to Choose. Dennis can be reached at dennis@saturdayinsurance.com or via LinkedIn. Follow him on Twitter @DennisHoFSA.

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 No Down Less Up appeared first on HumbleDollar.

June’s Hits

THE FINANCIAL markets haven’t been calm over the past month, but they have been calmer—and that’s meant readers have been interested in articles about topics other than the stock market and the coronavirus. Here are June’s seven most popular blog posts:

Is your estate plan in order? Richard Connor, who has helped settle five estates, offers his list of seven must-haves.
Adam Grossman has written 143 earlier articles for HumbleDollar. But this may be his best: Check out the five minds of the successful investor.
If you’re saving for a long and active retirement, make sure you’re healthy enough to enjoy it, says Robin Powell. “You don’t need to run marathons,” he writes. “Just resolve to move more.”
The pandemic quickly became a financial crisis for many. Want to be ready for the next money crunch? Richard Quinn advises preparing for eight “what ifs.”
“We don’t know whether this is an inflection point, but it is a warning signal,” says Mike Zaccardi. “If you’re one of those folks whose portfolio is all S&P 500 or all large-cap growth, perhaps it’s time to diversify.”
“Paying hefty taxes meant I was making good money, right?” asks Sanjib Saha. “Wrong. Little did I know that high taxes can also be a sign of financial ignorance.”
“The car was to be delivered the next day,” recounts Richard Quinn. “Only thing is, I couldn’t sleep. Why would this 76-year-old want a four-year, $40,000 car loan, even if there was no interest?”

What about our newsletters? June’s two most popular were Farewell Yield and Breaking the Rules.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include In Our Own Way, Knowing Me and The Road Back.

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 June’s Hits appeared first on HumbleDollar.

Older but Wiser

A REVOLUTION in the workforce is creating an underutilized resource: workers over age 50. These workers represent more than a quarter of the U.S. labor force, and that number is expected to climb sharply as the population ages.

For these workers, it would be a boon—financially and otherwise—if they could stay in the workforce for longer. It would also be great for the economy, ensuring we continue to have enough workers to produce the goods and services that society needs. But what’s often overlooked is that hiring and retaining older workers can also be a bonanza for employers.

To be sure, many folks believe otherwise. Facebook co-founder Mark Zuckerberg has declared that, “Young people are just smarter.” The legend of the prodigy business founder took shape in the 1980s. That was the decade when brash, young geniuses like Bill Gates and Steve Jobs took their companies public and became billionaires. Since then, some of the most renowned companies in the world have been founded by people in their 20s, including Amazon, Facebook, Snap and Stripe. Meanwhile, older workers have a reputation for being out-of-sync with technology, lacking drive and resisting change.

But this caricature appears to be a myth. Harvard Business Review crunched the numbers on the average age of successful entrepreneurs, and it turns out to be 45. Admittedly, in software and information technology, founders tend to be younger—age 40, on average. By contrast, in industry sectors like energy and biotechnology, the founders are somewhat older, averaging age 47.

Those middle-aged and older don’t just launch innovative companies. They can also make great employees. True, younger workers often don’t have families, so employers assume they’ll have more time for work, plus they can be paid less. Companies also assume that younger workers are more driven and that they have an innate understanding of technology.

But this picture overlooks the downside of younger workers. They may have greater enthusiasm, but they lack experience. Younger workers are also more likely to switch jobs for modest increases in pay—and that creates significant costs for employers. Every business knows it’s expensive to bring new employees on board and train them.

By contrast, older workers have the experience to know what they bring to the table and the wisdom to turn down a new position that isn’t a good fit. In addition, older workers are generally more dependable and harder working.

In fact, a 2015 study by Columbia University’s Aging Center found that businesses with high turnover typically prefer older workers: “Business after business spoke about older workers being the first ones to arrive for a shift, as remaining focused throughout the day and as people who rarely miss work, even in fast-paced, physically demanding businesses.”

Older workers also bring greater emotional intelligence to their work. As Josh Bersin and Tomas Chamorro-Premuzic explained, “For most people, raw mental horsepower declines after the age of 30, but knowledge and expertise—the main predictors of job performance—keep increasing even beyond the age of 80.”

Indeed, management, leadership and communication skills all continue to develop as we age. On top of that, people who have spent decades learning the first principles of how businesses work, and the rules about what’s an effective method and what’s a waste of time, adapt easily to new institutions and rules.

As Marick Masters, a professor of management at Wayne State University, puts it, “Having an older workforce provides great opportunities for building institutional capital in the workplace. Between great mentorship and the ability to experiment with working arrangements, productivity is boosted.”

Are employers—captive of prevailing myths about older workers—missing out? Andrew Chamberlain, chief economist for Glassdoor, thinks so. In his study on job and hiring trends for 2020, he argues, “Employers who broaden their definition of inclusivity to welcome older workers, and develop the learning programs to make the most of the 65-plus talent pool, will enjoy a strategic hiring advantage in 2020 and beyond.”

Stephen Chen is the founder and chief executive of NewRetirement.com , which offers independent, low-cost online financial planning. The site has helped almost 100,000 people build free plans. Follow Steve on Twitter @NewRetirement.

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 Older but Wiser appeared first on HumbleDollar.

Right From Wrong

I’VE BEEN WRONG many times, as I’ve noted in earlier articles. But the past few months have made me—and maybe you—look like an investment genius.

I’ve had some nice “wins” since March 13, when I started buying the stock market dip. Does that make me brilliant? Of course not. Was I “right”? That depends on how I made my decisions. A quick profit doesn’t necessarily mean I made the right call.

Too often, when we analyze our investment moves, we judge them by whether we made money—and usually our focus is short term. We wanna know if we were “right” right away. But that’s the wrong way to look at it.

As Wall Street Journal investment columnist Jason Zweig reminded readers recently, he touched on this topic in 1999. He was writing then about assessing whether certain investment strategies “worked.”

“More than ever, people think the test of an investment’s validity is whether it ‘worked’.… But investing successfully over the course of a lifetime has nothing to do with being right in the short term.… Imagine that two places are 130 miles apart. If I observe the 65-mph speed limit, I’ll drive this distance in two hours. But if I go 130 mph, I can get there in just one hour. If I try this and survive, am I ‘right’?”

Exactly right. That is to say, no, he would be wrong.

Evaluating an investment over a long period gets closer to answering the right vs. wrong question. But even then, the result doesn’t wholly validate or invalidate the decision.

Eight years ago, was I “wrong” to buy Pepsi and Coca-Cola instead of Apple for my son and daughter, respectively, when I wanted to teach them about investing? It’s hard to say I was “right.” Since the purchases, Apple has returned 375%, versus 153% for my son’s Pepsi and 66% for my daughter’s Coke. Vanguard Group’s S&P 500 index fund returned 177%.

But how was I “wrong”? The Pepsi and Coke investments served their primary purpose: to teach the kids the superior return potential of stocks versus a savings account—and to show them how money can work for them, rather than the other way around. At least Pepsi and Coke have been, ahem, less volatile than Apple.

I had told myself explicitly that I wasn’t trying to beat the market, just trying to buy a couple of companies that two teenagers could understand. As indexers know, there was no way for anyone to predict which of the three stocks would do better. Apple at that point was up about 1,700% from its March 2000 peak, versus about 15% for the Vanguard S&P 500 fund. (Incidentally, when I bought the shares in 2012, the vast majority of analysts recommended Coke over Pepsi.)

The point is, my decision making was sound enough. It was rational and defensible based on my objectives, on what I knew and—in fact—on what was knowable.

Back to this year’s market decline: I bought the dip fairly aggressively in March, in accordance with my plan. Even though I got spooked in April and deviated from my plan by trimming stocks during the rally—score those sells “partially wrong”—the moves I made have netted out fairly well so far.

I bought a small-cap value fund on March 13. In my Mom’s portfolio, I worked with her advisor to sell a muni fund and buy a total world stock fund. Both have performed spectacularly since then.

Was I “right”? Again, that depends. The quick gains don’t make me right. I did know that small-cap value often outperforms coming out of a market bottom. During the dot-com bust 20 years ago, small-cap value started rising shortly after the insanely valued large-cap tech stocks began to crater. But when I bought this year, I had absolutely no way of knowing whether we’d reached bottom or were even close to it.

So what was right about those two decisions? The same thing that would be right if both funds were “losers” right now. They were rational decisions made in accordance with a pre-existing plan to buy dips of a certain magnitude and not to let my allocation to stocks get too low. They also made sense as diversifying moves. Mom’s portfolio—literally one for “widows and orphans”—was heavily skewed toward muni bonds and domestic value stocks.

The bottom line: Don’t judge yourself by how much money you make. Instead, judge whether you tend to make well-reasoned decisions appropriate for your situation and based on known facts, rather than on hunches, hopes or fears—or the fact that your cousin is making a fortune in Apple and can’t stop boasting about it.

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles include Red Flags, Averting My Gaze and In and Out . In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart .

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 Right From Wrong appeared first on HumbleDollar.

Too Slow?

THIS PAST WEEK, I received an email from a reader—let’s call him Tom. He described his experience during this year’s unruly stock market. After the market dropped in February and March, he said, the stock side of his portfolio lost a lot of its value. He decided to rebalance—that is, to buy more stocks so his original asset allocation would be restored. That is just what I would have done. But the key question—always, but especially this year—is timing. 

With all of the doom-and-gloom news, Tom figured the market might be in for a prolonged slump. Rather than buying stocks all at once, he set up a 52-week schedule for purchasing stocks in small increments. But after hitting bottom in late March, the market quickly turned around and has since recouped nearly all its losses. Tom’s reaction? “In retrospect,” he said, his 52-week schedule was “too slow.”

To say “in retrospect” is the same as saying “with the benefit of hindsight.” In other words, there’s no way Tom could have known that the market would bounce back so quickly. I don’t know a single person who predicted the lightning-fast recovery. No one could call Tom’s go-slow decision a mistake. Still, it did give him pause. Tom wrote to ask if there was a better approach. Below are a few thoughts on the topic.

Tom’s question fits into a broader category of question, which is: When you have a sum of money, whether it’s from a bonus, a windfall or an inheritance, or you’re shifting money from one side of your portfolio to another, should you invest all at once or incrementally? The all-at-once approach is straightforward. But let’s take a closer look at the incremental approach, the approach that Tom took.

There’s a variety of incremental approaches, the most common of which is called dollar-cost averaging (DCA). Investors often ask if there is an ideal way to structure a DCA plan. Does it make sense to invest in weekly increments, as Tom set out to do, or to opt for monthly investments instead? And what is the ideal time frame? Should a dollar-cost averaging plan span weeks, months or even years?

There’s no scientific answer to this question—because dollar-cost averaging isn’t an evidence-based strategy. It’s what I would call a behavioral strategy. What do I mean by that? If you think about it, the stock market goes up more frequently than it goes down. In 69 of the past 95 years, the U.S. stock market has delivered a positive return. That’s more than 70% of the time. If you’re planning to invest in the market strictly according to the statistics, you’re much better off investing all at once rather than incrementally. After all, the market is more likely to rise than fall in the year after you invest.

Vanguard Group has analyzed this in detail. In a 2016 report, it studied a variety of markets and time periods and confirmed that “lump sum” investing beats dollar-cost averaging about two-thirds of the time.

But as I said, dollar-cost averaging is a behavioral strategy—and it’s a powerful one. Imagine you’d received a windfall in February of this year and invested it in the stock market all at once. In less than six weeks, you would have seen 35% of your money evaporate. And like Tom, you wouldn’t have had any assurance that it would return any time soon. That, in a nutshell, is the value of dollar-cost averaging. To be sure, events like the one we saw this year are unusual. But they’re not that unusual. As you may recall, the market dropped about 20% near the end of 2018. It recovered quickly in that case, too, but other bear markets have been longer and more unpleasant.

This is why, despite the statistics, I still recommend dollar-cost averaging. But because it isn’t a principle that is based in math, the downside is that there’s no scientific way to approach it. The only thing the data say is that, if you’re going the route of dollar-cost averaging, quicker is better. The longer you draw out an investing schedule, the more likely it is to work against you.

Here are two more thoughts on how best to construct a schedule. First, since there’s no ideal strategy, you should feel free to approach your investment schedule flexibly. In general, I think monthly investments are more manageable than weekly. But again, there’s no science to it. What’s most important, in my view, is to choose a pace that’s slow enough that you’ll be able to stick with it through market declines like we saw this year. That’s especially important because declines are a gift if you’re dollar-cost averaging and you wouldn’t want to miss out. In fact, it would largely defeat the purpose to stop investing during a market downturn since you’d end up buying at higher prices.

Second, while it’s important to stick to a schedule, I also think it’s a good idea to accelerate things if the market does decline. As I said, that’s a gift if it happens, so you might increase your monthly investments if a bear market comes along. There are lots of ways to do this. The simplest would be to double your investments in months when the market is down. A more aggressive approach would be to ratchet up your investments in a way that’s inversely proportional to market declines. In contrast to traditional dollar-cost averaging, which involves fixed monthly investments, this sort of ratchet approach would result in more dollars being invested when the market goes on sale.

Bottom line: Like most things in finance, I recommend keeping it simple. There are lots of more complicated approaches out there, such as value averaging, an idea that’s interesting but so complicated that it has little appeal in the real world. And since none of these techniques is based in science, there’s no sense being too scientific about it. The “right” approach is the one that’s right for you.

Adam M. Grossman’s previous articles include Sticking With It, Think Like a Winner and Looking for an Edge.  Adam is the founder of  Mayport Wealth Management , a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter  @AdamMGrossman .

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 Too Slow? appeared first on HumbleDollar.

Breaking the Rules

YOU KNOW THOSE timeless financial principles? Sometimes they don’t age so well.

Since I started writing about money in 1985, all kinds of financial principles have gone out the window—and that’s continued right up until 2020. Indeed, if you’re still hewing to the financial wisdom of the 1980s, you’re likely hurting yourself today. Here are four examples:

1. Goodbye, Peter. In the late 1980s, America’s most celebrated fund manager was Fidelity Magellan’s Peter Lynch. Back then, and for years after his 1990 retirement, the hunt continued for the next superstar fund manager. Investors would scour past mutual fund performance, confident that it would be a reliable guide to future results.

Today, that confidence has largely evaporated—with good reason: Most fund managers lag behind the market and, among those who don’t, there’s no surefire way to identify the winners ahead of time or distinguish the truly skillful from the merely lucky. Indeed, the proliferation of index funds over the past two decades hasn’t just offered investors an alternative to actively managed funds. It’s also given folks a measuring stick against which to compare those active managers—and, year after year, the managers keep coming up short.

What’s amazing isn’t that investors have lost confidence in past performance and their belief in exceptional money managers. Rather, what’s amazing is that it took so long. It’s been clear since Alfred Cowles’s groundbreaking 1933 study in Econometrica that professional investors typically lagged behind the stock market averages. But for years after, Wall Street continued to propagate the myth that the professionals could make money by exploiting the stupidity of everyday investors—which was not only self-serving nonsense, but also insulting to the very customers they hoped to win over.

2. Broken yardsticks. Starting in the 1990s, stock market valuations broke out of their historical range and climbed skyward. Old timers warned that valuations would soon come crashing back to earth. They’re still waiting.

To be sure, rising price-earnings ratios and declining dividend yields can be partly explained by falling interest rates, which have made stocks more attractive relative to the main alternative—bonds. But it seems some enduring financial trends are also driving the rise in stock valuations, including falling investment costs, ever more capital available to invest, a rising appetite for risk, corporations’ growing preference for stock buybacks over dividends, and the move to spend less on plant and equipment and more on research and development. This last change has resulted in lower reported earnings and hence higher price-earnings multiples.

The upshot: Today’s stock market valuations are undoubtedly rich by historical standards. But it’s hard to know what to do with that information or whether we should even worry—because it doesn’t tell us anything about short-term returns and it may not be that important to long-run results.

3. Loans’ love lost. Our constantly changing tax code has long kept investors on their toes, whether it’s embracing Roth IRAs and Roth 401(k)s, funding health savings accounts or shoveling money into 529 plans.

But arguably the biggest tax change of recent decades came in 2017, when Congress voted to double the size of the standard deduction. That meant that these days just 10% or so of taxpayers itemize their deductions—and, for these folks, their itemized deductions are often barely above their standard deduction. Result? Most homeowners get no tax benefit from the mortgage interest they pay and, among those who do, the tax savings are often modest.

Some financial experts used to argue that homeowners should take out the largest mortgage possible. That was always a dubious financial principle, but now it’s downright foolish. In fact, paying down debt—including mortgage debt—is typically the best conservative investment we can make. Yes, we should earn higher returns over the long haul by buying stocks rather than repaying borrowed money. But paying off debt will almost always prove more rewarding than buying high-quality bonds and cash investments, because today’s yields are so low.

4. Yielding to reality. Two weeks ago, I wrote about the key implications of today’s tiny bond yields. The biggest impact is on retirees. Because yields on high-quality bonds are so low, delaying Social Security and buying immediate fixed annuities have become more attractive ways to generate retirement income.

Indeed, the core strategy for many retirees—buying bonds and then paying the household bills with the interest—simply doesn’t work anymore. After all, how many retirees are rich enough to live off a portfolio of high-quality bonds, which today would likely kick off less than 2%? It’s time to stop thinking about bonds as a standalone investment. Instead, their sole remaining role is as a complement to stocks. They can provide offsetting gains when the stock market nosedives, a rebalancing partner for stocks, and a way to raise cash if it’s a bad time to sell shares.

My advice for retirees: Forget investing for yield and instead aim to earn a healthy total return by allocating at least half your portfolio to stocks. In buoyant years for the stock market, look to harvest gains. In rough years, get your spending money by selling bonds and cash investments.

Think about what all of the above changes have meant for our personal finances. Two or three decades ago, many folks would have had a portfolio of actively managed funds, a nervous eye on stock market valuations, a collection of bonds to pay for retirement, and a hefty mortgage that they grumbled about each month but celebrated on April 15. Are you still managing your money that way? Maybe it’s time to revisit those “timeless” principles.

Latest Articles

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

Want to be a savvy consumer of news and advertising? Pay attention not just to the content of messages, but also to how they’re packaged, says Jim Wasserman.
“No matter how mindful I thought I was about my financial habits, checking my spending showed me the truth: I had regularly failed to make the right choices in the moment,” writes Marc Bisbal Arias.
Is your estate plan in order? Richard Connor, who has helped settle five estates, offers his list of seven must-haves.
Shining shoes. Cleaning parakeet cages. Shoveling coal. Selling greeting cards. Returning soda bottles for the deposit. Richard Quinn recounts the many ways he made money as a kid.
Catherine Horiuchi can’t bring herself to sell the company stock her late husband owned. “Avoid emotional and irrational decision making,” she advises. “Except when you can’t.”
Yes, says Adam Grossman, today’s crisis is scary and unprecedented. But that’s true of every crisis—and, after all of them, the economy recovers and stocks march higher.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include In Our Own Way, Farewell Yield and Knowing Me.

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 Breaking the Rules appeared first on HumbleDollar.