One of the difficulties of being a Financial Wealth Manager is the expectation from most of the investors is the expectation that the accuracy of future market predictions has to be as close to 100% as possible to be able to make a successful return. For traditional passive portfolios, this is never a discussion because it is often not part of the strategy. But for those of us that go beyond traditional strategies to reduce the risk for our clients (see Nov. blog on why), it is often preparing for possible negative impacts to a portfolio that may not appear for a time or not at all. This often means that predictions are a lot less accurate than 100%.
It took me quite a number of years to come to terms with this scenario as it did not satisfy my ego. But what I discovered over the years from my mentors and the top hedgefund/traders was that strategies that reduce downside portfolio value risk often meet investors financial goals better than looking for strategies with 100% accuracy. And what investors are usually looking for often leads them to mediocre returns and sometimes charlatans.
With that being said, to look back at the past is to pay attention to the possible risks of the future and how it affects our financial portfolios. Below is an excerpt from a newsletter that comes from one of the fund companies we currently use, LongBoard Asset Management, that I think you will find timely. You will notice the first date in parenthesis is comparing to the second date. Why I think this is important (even if point #6 never materializes) is because human nature always looks for an easy way out of painful situations and thus often leads to repeating the same mistakes. Looking for similar situations will greatly increase your awareness of potential negative surprises and allow the consideration within your investment strategy.
Time and places change but human nature seems to be a constant.
“I believe Ray Dalio, Founder and Co-Chief Investment Officer of Bridgewater Associates, LP, the world’s largest hedge fund, has best articulated the most likely current market cycle. The main points of his thesis are summed up in the 1937 Analog:
1. Debt Limits Reached at Bubble Top, Causing the Economy and Markets to Peak (1929 & 2007)
2. Interest Rates Hit Zero amid Depression (1932 & 2008)
3. Money Printing Starts, Kicking off a Beautiful Deleveraging (1933 & 2009)
4. The Stock Market and “Risky Assets” Rally (1933-1936 & 2009-2017)
5. The Economy Improves during a Cyclical Recovery (1933-1936 & 2009-2017)
6. The Central Bank Tightens a Bit, Resulting in a Self-Reinforcing Downturn (1937)
In 1937 the combination of monetary and fiscal tightening pressures created a significant selloff in risk assets, Dalio wrote. “Stocks fell the most, but home prices arrested their gains and dipped negative as well.” Stocks fell more than -50% from March 1937 to March 1938!
You can read Bridgewater’s full thesis here: Part 1 Part 2
We are now seeing markets that may be flashing the beginning of the self-reinforcing downturn outlined in bullet point 6 of Mr. Dalio’s thesis.”
A very interesting perspective of the past and the present situation we find ourselves in and considering Bridgewater published this in 2015. If you do any further research on Ray Dalio you will find that he says “It isn't easy for me to be confident that my opinions are right. In the markets, you can do a huge amount of work and still be wrong. Ray Dalio”
Very compelling for a guy who made the list of the top 100 richest individuals in the world. I dare to say that you will probably also find the same thinking from Warren Buffett and the top minds of the investment world. Now, how much confidence can you put in the guy interviewed on CNBC that preaches how he's been 100% right all the time? Early in my career, I had a mentor tell me "Do you want to be right or make money?"
So I challenge you to the same question, "Do you want to be right or make money?"
Your comments and thoughts are welcome…
After nearly 20 years of investing experience I cannot think of anything more important to consider for your investment strategy. I have a large library of books I have read and re-read, but one central theme appears again and again since the beginning of time, "Downside Investment Risk". As it appears that we are once again on the edge of another Bear Market it moves me to write about the simplicity of avoiding the "Impact of Losses" on investment portfolio values. Below is a graph produced/shown many times and in many different ways over the years, but the numbers are still the numbers that tell a story.
How to read this chart above is rather simple. If you lose 20% of your portfolio value it will take 25% future investment growth to get your investment portfolio back to even. What becomes alarming is to notice the larger increase requirements for growth percentage amounts for every additional 10% decline. A quite common possible scenario now days is a portfolio losing 60% of its value during a bear market. So if you have $1,000,000 starting value you would only have $400,000 after a 60% decline. That means that you will have to get a total return of 150% over the next few years to get from $400,000 back to $1,000,000.
So how long will that take to recover a 60% portfolio value reduction? Well, that depends on what you invest in, but let's say for the purposes of most individuals we just stay invested in the overall market. The average return many analysts and academicians often state can very from 5% to 11%. I think that number is probably a lot closer to the 5%, but for this purpose lets just say its 8%. So if we compound the $400,000 by 8% per year it would take us nearly twelve years to recover a 60% loss. That is also assuming that there are no years in between less than 8%.
Twelve years is a long time to wait!
Now lets take another angle at this theme of market losses. When I started my investment career in 1999 during the time of Y2k panic and technology market euphoria I was shown a chart of why clients should always be in the market. It said that if you missed the top 10 best days of the market your returns would largely under-perform the market. It was meant to encourage investors to stop trying to time the market. But after a number of years of trading I learned that the biggest obstacle to good investment returns is protecting against the downside returns. If anyone has ever attempted to learn trading they will almost certainly stumble into the teaching of keeping your losses short for the very reason shown above. But what made the following graph below so fascinating to me a number of years ago was looking at avoiding the top 25 worst days of the market.
*Chart Borrowed from The Irrelevant Investor.com
Clearly, as shown in the graph above, the strategy of investment returns is to develop better defenses and focus less on the best 25 days. You can see that missing the top 25 best days does impact the investment returns but not nearly the impact that losses take on a portfolio.
Again as I think of the coming Bear Market I would encourage you to make sure you are comfortable with the strategy you have either accepted or developed. Based on just the concept above the strategy should have a part of defensiveness. If not, well then time is of essence and now is the time to make sure you have a great strategy. Both the February and Octobers sharp market losses should be a wake up call that the investment environment is changing.
Your comments and thoughts are welcome…
History has a way of not exactly repeating but rather rhyming. That also generally plays out in the stock, futures, bond and other investment markets. Look at the chart below. Investors and traders have been trying to predict tops and bottoms of a general investment market for more than several hundred years. I wish I could tell you that I was especially gifted at predicting the future on an exact date or point in the market, but that is not the case. If anyone could predict the market shifts with pinpoint accuracy it would still be easier, cheaper and more profitable if someone could predict the winning lotto numbers.
However, there is a difference between predicting lotto numbers and how the market performs. Humans are responsible for the overall market direction and generally, humans have not changed much in thousands of years. Sure we've got new toys and have landed on the moon, but we are still a population of people that respond to fear, greed and love. What that simply means is that the markets are generally a lot more predictable than inanimate objects flying around in a big bubble looking for a way out.
As humans, we tend to get fearful of both extremes in the market. When the market is dumping daily into the black abyss, close to previous market lows, we tend to let our imaginations run with panic that this could be the time when it truly collapses. And when the market is soaring to the sky and approaching the heavens close to previous historical market bull runs we tend to get nervous that the end is near. But to our often surprise when we get so confident and certain that nothing can stop the downward or upward momentum it often turns against our expectations and proceeds to fool the majority.
Even the best investors of all time have been fooled many times and hammered with losses. But one thing I have learned from those great traders and investors, before and now, is that as humans we tend to push the envelope on everything we do. I almost buy into the fact that as humans we just can't stop our selves from jumping off cliffs just find out what it is like.
So what does all this mean, you may ask? For one, when the candy stops being handed out you can be certain there will be riots and stress in the market. Investors are going to push the market envelope till it pops just to make sure it cannot go much higher. And that usually means the once calm and lack of significant volatility (i.e. how much the market moves around daily) will certainly change. Which I believe started last February. Secondly, when the general market volatility increases it often plays significantly on the fears and safety concerns of individual investors. It is often that this volatility exposes bad investor behaviors and as a result starts to shake out these bad investments. If only a few are caught in this shake out then the market will only temporarily make adjustments and then continue its trend. However, if the majority have made bad investments then the market will start a market plunge until the bad behaviors are expunged. And sometimes this process of expunging bad behaviors irreparably damages good investors as well.
So where are we now...? I guess that depends on your view of how much more candy can be handed out till its all gone. You can see from the chart above we are stretching into historical market highs, but the 1990's also show that the previous norms can be violated significantly. My view is that the market is hoping to see the 1929’s and 1990's all over again even if that means living in market non-reality and that type of hope is often not rewarded.
I expect now is the time to start putting your house in order and paying down any debt you have, because the tidal wave that is approaching will not be navigated with a boat full of lead weights (debt). The probabilities and pressures are mounting that you should know in the next year or certainly within the next couple of years whether your financial planner, wealth manager, investment manager or your disclosures with them was worth the weight in gold or not. I would be asking your investment professional what their plan is to navigate the next bear market and if they don't have a plan then ask them to develop one. Good relationships are hard to find so first do everything possible to keep the relationship strong. Only rethink the relationship if they refuse to develop one that you are comfortable with.
Your comments and thoughts are welcome…
Continued from the Last blog …..
But regardless of our profile, thoughts usually creep in with a focus on how we can possibly live off the savings we’ve put away. And the scary question to ask is “What if I discover later that my savings fail to support my retirement, what do I do then?” As we answer that question, we acknowledge that fewer employers want to hire individuals our age and we are less likely to earn the income we now depend on if we go back to work. This simply makes us ask the next question “what happens next if I quit my current occupation?”
If we happen to be closer to the “Extreme Spender” leading up to retirement, then the common decision is to likely stay put in a job we no longer feel challenged or wish continue. The other not so popular choice is deciding to downsize expenses such as vacations, house size or entertainment until forced to do so. In this case, it's very apparent why we would not want to spend our savings, but what is not apparent is why we would resist spending clearly when we have more than enough savings for retirement.
But let's assume that we have saved enough to fund our income needs after retirement. This would possibly mean we have been a better saver vs. spender. Let's also assume that either we worked through our financial plan with an advisor or alone and determined that we financially can continue or even improve our pre-retirement lifestyle.
So why do I see retiree’s in this situation continue to experience a fear of spending during retirement? I’ve come to believe it has to do with how they viewed their savings during their career. Savings for many investors represented a safety net in addition to their current income generator. So during their career, if anything happened to their income they knew they could dip into their savings until they found the next income generator. Therefore, when retirees leave their income generator and replace it with their savings they emotionally no longer feel they have a safety net. This leaves the constant concern and fear of spending that often disrupts the enjoyment of spending.
Often one solution to solve this dilemma is to build a safety net into our investment/savings that again allows us to sleep at night. One suggestion for a safety net could very well be paying off our mortgage. To find our safety nets I would recommend thinking about the “what if’s” and have plans for those situations. Will the future go according to how our “what if” plans indicate? Often the answer is No. However, I can tell from experience that it's easier to modify previous “what if” plans than it is to create a solution on the fly from scratch while under pressure.
And to my business owner readers, I would tell you that planning your retirement is often more difficult because it’s likely 85% of your income will be based on the value you receive from selling your company. And determining the sale value is not an exact method. You may find yourself also carrying part of the sale value in a note to the buyer. This also adds another dimension of risk to your retirement income vs. employees retirement income.
Your comments and thoughts are welcome…
Years ago I received a call from a client, worth 36+ million dollars with a $300,000 a year pension distribution and only used half the pension annual payout, asking if it was going to be ok to spend $250,000 on a recreational vehicle.
One large difficulty with retirement is the challenge and fear of leaving the income generator, whether it be our business ownership or job, and relying on the fruits of our savings. As we get older the fears of change continue to grow relative to our vulnerabilities of income security.
The journey following the start of our young career often leads us to get married, have kids, buy a house, buy more expensive vehicles and essentially depend more on the increase in income we receive from promotions or business growth. Early in our career, we tend to ignore that the future could be any less ideal than our incredibly optimistic vision of the future. When we are young we can allow ourselves to leave a job and pursue another job in hopes of bettering our lives. If the job or career fails to turn out, like we hoped, then we have the ability to continue looking for better possibilities.
Some individuals, “Extreme Spenders”, spend every dollar earned to experience life and believe that better jobs tomorrow will eventually make up for the lack of planning today for retirement. The difficulty with betting on higher incomes in the future is the lack of better-paying jobs the higher we progress up the income ladder.
On the other end, some, “Extreme Savers”, believe that life is unpredictable and save every dollar they earn and don’t spend but on absolute necessities. The difficulty with saving every last dollar is that we don’t really get to experience things like travel, entertainment, and vacations.
Somewhere the rest of us fall in between both extremes. And the closer we are to one extreme viewpoint vs. the other is often dependent on the sensitivity to the fear that the future may not look like our beginning optimistic vision. Also the closer we are to the “Extreme Saver” profile during our career the more likely we will have the necessary funds to continue the lifestyle we have come to enjoy. However, the closer we were to the “Extreme Spender” profile during our career the more likely we will be required to work longer or decrease our current lifestyle during retirement.
This is important to understand, as somewhere along the way, as we get closer to retirement the realization starts to sink in about the cost of all the things we have come to depend on. Things like a big house, expensive nice cars, travel, entertainment, hobbies, and vacations. As the income generator starts to stall or go away the fear of transitioning to living off of retirement income exclusively starts to elevate.
Until next…(Part 2)
Should I try a do-it-yourself approach when beginning to invest .... or hire a financial advisor? Depends??
Below was my reply to another question I answered today on Investopedia. It's a great resource for answers. I hope this helps in your pursuit of investment knowledge.
"Your question holds a couple of interesting concepts. Should you do-it-yourself? How should you invest if you do? The first question is often asked to save on the cost of an advisor.
But what if an advisor was free, would it not pose another question? Do you love to invest and spend your time doing that? If you answer yes, then I would suggest you pursue the do-it-yourself approach. But if you do, then you should really spend the time to self-educate yourself and have patience developing a strategy that fits you.
Using an investment advisor or any professional should be a decision on added value. I use advisors for more experience or just because I don’t want to spend the time and effort myself. How much is your time worth? It’s just a simple cost-benefit analysis on whether to use an advisor. It’s really no different to why a business owner hires employees.
On the second question on how to invest: Over the years I’ve seen thousands of different strategies and a lot of them are useless but then I’ve seen a large amount that gets the investor to their goals. The ones that are successful are usually built around similar principals. I’ve found after 20 years investing for clients and myself that the only strategy that matters is the one that you like that gets you to your goal.
Everyone has a strategy they think best about how to fill a dishwasher, but I only care about the dishes getting clean. If the dishes don’t come out clean then you need to change strategy. Sure, someone can always find another way to include a couple more dishes, but do you care?"
Your questions, comments and feedback are always welcome!
All the best,
I was responding to a short article request from a large newspaper, but when I emailed my reply back to the individual requesting it, I discovered the individual had left the company. So, I have decided to post the question and my short answer here on my blog.
Parents should ask themselves a couple of questions first, “Will this assistance put us in financial difficulty?” If no, then ask the next question, “Is my kid responsible with money?” It may be a good idea if the first question is a “No” and the second question is a “Yes”. If the answers are reversed then it will be a complete disaster for the parent’s retirement and often ends worse for the child as well.
Years ago, I oversaw a couple of parents that paid the mortgage down payment for an irresponsible child (parents definition not mine) and the child kept taking out equity to spend until they eventually lost the house. I’ve also seen where parents that gave a down payment as a wedding gift to a responsible child, years later, unexpectedly received it all back plus more in a thank you card.
Had the first parents left the irresponsible child to renting then it might have saved the child from a mortgage default on their credit report. “As I say often to parents, What are the intents and likely results?”
The last several days in the US market has been a bit of a shock to lots of investors. History has had many surprise events such as the unexpected 1987 super US Market crash. Anyone connected to the markets in some way back then can remember it as easily as those who remember the assassination of President Kennedy. Not too many years ago, we had the "Flash Crash" that saw a 1,000 point swing in the Dow Jones. The main difference I see in markets from years ago and the markets today is the movement of markets around the world all trending in the same direction.
I've talked about this for several years now but I thought a graph below of today's market returns would do a better job of describing what happens when one country's market goes down. Many many years ago this was not the general case. When one country's market went down, other countries markets might be down or up.
The simple reason for all markets trending the same has to do with the fact that companies are now doing business in other countries. When business slows down in a country they are doing business then this affects their bottom line and investors care about the bottom line. So when expectations of a company's revenue are perceived to go down then investors in the parent country trade the stock with those expectations. Essentially now everybody is in everybody's business around the world. The world economy is now acting like what one country's economy used to do.
Trade according to the big movements and investing will be less of a surprise.
This is just a short quick observation. Other than Octobers increase of 968,000 people to the bucket of those who quit looking for work according to the Bureau of Labor Statistics (BLS) the last two months have been really dull. I keep wondering how the BLS can keep 10.9 Million extra people in the bucket who quit looking for work (Not in the Labor Force). The extra expanded from 2.2 million in 2007 to 10.3 million in 2013 and has stayed relatively the same since. Right now that total number is 95.5 Million, but if we adjust for normal percent of the population then the number should be 84.5 million in that bucket. The good news is that at least the extra bucket has not significantly been expanding in the last four years. But why has the number not been decreasing?
How do eleven million people give up looking for work? I have a hard time imagining that many people don't want to work and/or are too discouraged to work. If I had those extra eleven million back into the unemployment numbers then the true unemployment percent is 10.2%, not the wonderful 4.09% reported. Of course, I'm probably making it too simple, right?!
A number of months ago I was asked by Investopedia.com to join many other advisors to answer questions posed by investors looking for direction. This evening I responded to a 66 year old who retired in February of this year. There seems to be only two different types of investors posting questions. The first type is searching for information to go it alone and the second is the type that is trying to understand enough information to find a good advisor. However, many post questions that allude to "going it alone" when they are uncertain whether to "go it alone" or hire an advisor. So the answers to their questions really do not address their objectives and essentially increases their time spent figuring it out. So I thought I would post a copy of my response in this blog as well. In fact I plan to transfer many of my replies on Investopedia.com since most of my replies are more general in nature and I feel very helpful to investors asking the better questions.
"What you pose is a great question “how do I maintain this income stream”. Years ago, when I first entered into the investment world I kept thinking there was a Holy Grail method to be discovered. Many years since I have found that there are probably more investment methods and tools to accomplish investors goals than investors to trade them. However, I found that the success of each method had to rely on universal fundamentals, but more importantly, the method and tools used had to match the viewpoint of the investor or advisor for long-term success. (i.e. if the investor doesn’t believe in using stocks for investment then the least amount of negative market returns will cause the investor to likely sell too soon or some other negative actions).
If I were you I would decide whether you wish to use an investment advisor for advice or go it alone. If you go it alone I would recommend that you should probably reduce your stock exposure and bond maturity length to mitigate a downturn in the stock market and a possible increase in interest rates (bond values go generally opposite of interest rate increases) till you learn a bit more how markets work. Then at some point, you will need to make your method your own. I will caution you to have patience with yourself in learning.
However, if you choose to find an investment advisor I offer you that many advisors probably could get you to your goal. Just understand that you are borrowing their methods, so your responsibility is to hold them accountable to their method and not to instruct them on how to do their job. If you find yourself instructing the advisor it’s probably because you are not confident in their method and/or advisor’s ability. When this happens you should cut your loss and just go find another advisor or method. Think about it like if you had a subordinate you continue to have to micromanage. It will drain you and you would probably be better off just doing the task yourself.
Once you decide which path to take it will be easier to decide on more questions to ask. Good luck and keep asking questions on Investopedia.com. It’s a great resource for investors. "
Your feedback is welcome!