Tag Archives for " asset allocation "

Mar 26

What’s After The Bear Market?

By Chris Chen CFP | Financial Planning , Investment Planning , Portfolio Construction , Retirement Planning , Sustainable Investing

What's After The Bear Market?

For the month ending 3/20/2020, the S&P 500 has been down almost 32%. Maybe it is because it’s happening right in front of us, but, somehow, the drawdown feels worse compared to history’s other bear markets.

According to Franklin Templeton, there have been 18 bear markets since 1960 which is about one every 3.1 years . The average decrease has been 26.3%, taking a little less than a year from top to bottom.  

Financial planners often work with averages. But the reality is that each bear market will be different from the norm. At the time that I write this, the depth of this particular drawdown does not even rank with the worst in history. Sure, it may still get worse, but that’s where we are today. 

We may not want to hear about how things will get better, because the situation with the Covid-19 pandemic and its resulting prescription of social isolation and market downdrafts is scary. But, eventually, things will get better. 

Keep in mind that things may get worse before they get better. The count of people with the virus will almost certainly increase. If you don’t have a source yet, you can keep up with it over here. But eventually, the Coronavirus epidemic will run out of steam. We will get back to our places of work. Kids will go back to school. Financial markets will right themselves out. We will revert to standard toilet paper buying habits. We will start going out to eat again. Life will become normal again. 

Financially, the question is not just how bad will things get, but how long it will take for our nest eggs to rebuild, so we can put our lives back on tr

Historically, since WWII, it has taken an average of 17 months for the S&P 500 to get back to its peak before a bear market .

The longest recovery since we have had reliable stock market records has been the Great Depression. The longest recovery post-WWII was in the wake of the dot-com crash at the beginning of this century. That took four years. The stock market recovery following the Great Recession of 2008 and 2009 took only 3.1 years

Hence, it could take us a while before we make it back to the previous market peak. However, we may want to look at the data differently. This graph shows that, historically, we have needed to achieve a return of 46.9% to recover from a bear market .  According to Franklin Templeton calculations, these numbers can look daunting. However, they have been achieved and exceeded after every past downturn. While there is no guarantee, these numbers suggest that there will be strong returns once we have reached the bottom of the market. I like to think of this as an opportunity.  

With the time that it takes for investments to grow and get your money back, there is time to take advantage of higher expected returns. For those who have resources available, this means that there is time to deploy your money at lower prices than has been possible in recent months.

Those of us who have diversified portfolios and are not in a position to make new investments, the opportunity is to rebalance to benefit from a faster upswing. 

We know from history that every US stock market downturn was followed by new peaks at some point following.

Could this time be different? 

Of course, that too is possible.

I like to think that the future will be better. We will still wake up in the morning looking to improve ourselves, make our lives better, and achieve our goals. We are still going to invent new technologies, fight global warming, and struggle for a more equitable society. 

We are living through difficult times right now. Losses in our brokerage and retirement accounts are not helping. But we will get through this. Please reach out to me if you have specific questions or concerns.

Jul 19

Don’t Ignore the Chatter – a Trade War represents a Major Risk

By Eric Weigel | Capital Markets , Portfolio Construction , Risk Management

Quarterly Capital Market Perspectives

There’s been a lot of sideways action in this year’s capital markets. We have had a couple of mini-corrections already but equity markets have done a remarkable job of ignoring some clouds on the horizon.

The big elephant in the room that investors have chosen for the most part to ignore is the possibility of an all-out global trade war.

What started back in February as aluminum and steel tariffs has delved into a war of words and escalation of tariffs between the world’s three largest economies of the US, China and Europe.

There is almost a sense of disbelief that this could be happening after decades of globalization.  We are so used to the free flow of goods and services across borders that we hardly ever stop and think about where things are made.

Is a Toyota Camry Japanese or a “Made in the USA” car from a company that so happens to be domiciled in Japan? Is your iPhone an American product or a product made in Asia for a US-based company?

Global companies such as Apple or Toyota operate in highly inter-linked global supply chain and sales channels. A trade war will be highly disruptive to global trade and manufacturing.

Ultimately, an all-out trade war creates massive uncertainty and significantly lowers global economic growth going forward. According to Oxford Economics a trade war could cost the global economy $800 Billion.

To read more about our views on key risk factors facing investors for the rest of 2018 and our intermediate-term outlook for major asset classes please read our Quarterly Capital Market Perspectives.

Apr 13

Capital Market Perspectives – April 2018

By Eric Weigel | Capital Markets , Portfolio Construction , Risk Management

Capital Market Perspectives - April 2018

 

Photo by Dawn Armfield on Unsplash

The last couple of months have tested investors.  In a sense, we all got lulled by the wonderful returns of last year and any hiccup was bound to create some stress.

The talk at the end of 2017 was all about tax cuts and the short-term boost that lower tax rates would provide to consumer spending and the bottom-line of US corporations.

For the first month of the year, things couldn’t have been going better for equity investors. Bond investors while not exactly sitting in the catbird’s seat were slowly adapting to the inevitable rise in yields.

Emerging market equities, in particular, jumped ahead and the mood among global investors was one of optimism.  Market commentators were even talking about a stock market melt-up!

Two months later the mood has changed drastically. Investors are nervous and we have already witnessed two small corrections in the equity markets.

Figure 1

Source: FRED (Federal Reserve Economic Data), Insight Financial Strategists, April 2018

The first mini-correction attributed to rising inflationary expectations took the S&P 500 from a peak of 2873 on January 26 to a low of 2581 on February 8. The 11% drop while not unprecedented was keenly felt by investors accustomed to the record low levels of volatility seen in the last year. It felt like going from a newly paved highway to a dirt road without any warning signs!
 

Were rising inflationary expectations to blame for the early February stock market fall?  Our research did not support this story.  We had been seeing a slow rise in inflationary expectations for about a year but US Inflation Protected Note prices containing the market’s consensus forecast of inflation over the next 5 and 10 years did not exhibit any significant upward pressure.

Inflation in the US seems to be fairly range bound with the latest year over year reading of 2.3% (February). Inflationary expectations as of April 6 for the next 5 years stand at 2.0% and for 10 years out at 2.1%.

The market implied forecast may turn out to be too benign, but for now, our own view of economic conditions in the US is closely aligned with these market-based expectations.

A number of events could have caused the early February correction, but in the context of long-term capital market history, we think that this episode will appear as a mere blip on price charts. Rising inflationary expectations do not seem a likely culprit for this episode of equity market stress.

Figure 2

Source: Quandl, FRED, Insight Financial Strategists, April 2018

What about the most recent late March equity market drawdown? US equity market markets staged a strong recovery from the February lows with the S&P 500 having recovered all but 3% of the losses from the January 26 peak. Since early March the global markets have, however, been on a roller coaster ride.  Up one day, down big the next. As of April 6, the S&P 500 has lost over 6% since March 9.

The second mini-correction of the year has re-tested the resolve of equity investors. Volatility levels have jumped up and have risen significantly from the lows of 2017. The intraday movement of markets (the difference between the high and low of the day) has been about 2X that of normal periods and 4X that experienced last year.

Figure 3

Source: Quandl, FRED, Insight Financial Strategists, April 2018

Market volatility has been historically low over the last few years but the large intraday swings we have been seeing this year are distressing to even seasoned investors.  John Bogle in a recent interview for Marketwatch commented that he had not seen such a volatile market in his lifetime. He was referring specifically to the huge intra-day moves seen over the last two weeks.

 What has caused this recent bout of stock market volatility? As always there are many possible reasons, but this time around we see a more direct link to the uncertainty surrounding a possible global trade war.

Markets do not react well to uncertainty especially to events that are both hard to quantify in terms of the probability of occurrence and the magnitude of consequences.

Trade wars are not everyday events.  The last time wholesale tariffs were imposed in the US happened in 1930 when the Smoot-Hawley Tariff Act was passed.  While economists will debate whether the Act exacerbated the Great Depression, in general, it is acknowledged that tariffs limit economic growth.

Free-trade has been a goal of most nations for the last 50 years. Gains from free trade provide a win-win outcome enabling producers to focus on goods and services where they enjoy a comparative advantage and consumers to reap the benefits through lower costs is one of the strongest held beliefs of modern economics.

Global trade of goods and services currently accounts for 27% of worldwide output (according to the OECD). Disrupting global trade by imposing tariffs on a large number of items seems reckless.  It is especially reckless when considering that we picked a fight with the world’s largest economy – China.  China also owns 19% of the outstanding supply of US Treasuries.

No doubt Chinese trade practices are unfair to US companies. Forcing US companies to transfer technical know-how to Chinese firms seems especially egregious given the state of China’s economic development.  China is the largest global economy and many of its technology companies are already global powerhouses.

Another bone of contention for some is the under-valuation of the yuan.  An undervalued currency is a huge weapon for increasing the attractiveness of a country’s exports.  However, it is not clear that the yuan is under-valued. According to an IMF report in July of 2017, the fair value of the yuan was roughly in line with market prices and fundamentals.

At first, the tariffs proposed by the Trump administration seemed fairly innocuous – washing machines and solar panels. Then on March 1, the US proposed tariffs on steel and aluminum.  Not good especially since many traditional allies of the US (mainly Canada and South Korea) would be the primary targets. Gary Cohn, the administration’s top economic advisor, resigned in protest sending shockwaves through the financial community. The S&P 500 reacted with a 1.34% loss for the day

However what really got the capital markets in a tissy was the announcement on March 22 of tariffs on $50 billion worth of Chinese imports.  The fight was on and it did not take very long for Chinese authorities to retaliate with in-kind tariffs on US goods.

The S&P 500 dropped 2.55% on March 22 and 2.12% on the next day.  Likewise, Chinese equity markets reacted quite negatively to the possibility of an all-out trade war with the US with the iShares China Large-Cap ETF (FXI) dropping 3.8% and 2.4% respectively on those days.

 

Where is this all going to end up? In an all-out trade war like after the passage of the Smoot-Hawley Act? Or, in serious bilateral negotiations between the US and China?

Our guess is that there are enough rational agents in both the US and Chinese administrations to avert an all-out trade war, but getting the negotiations going will not be easy and will take time.  China has already requested negotiations through the WTO Dispute Settlement Mechanism. Luckily there is at least a 60 day comment period separating talk and action.

The US is not likely to be a winner in a global trade war.  Nobody is really.  The most likely outcome is lower overall global growth and increased uncertainty – not a good recipe for capital markets especially in light of current above-average valuation levels.

 

The main problem for the US is that as a nation we are not saving enough.  The current net savings rate as a function of GDP currently stands at 1.3%. This number has been steadily trending down – the average since 1947 when numbers were first compiled is 6.6%.

The US balance of payments and trade deficits are a function of the imbalance between domestic savings and our thirst to grow and consume.  In 2017, the US had merchandise trade deficits with 102 countries. China is not our only problem!

Let’s hope that cooler heads prevail and that the disruption to global trade proves minimal.  Some of the damage has already been done as uncertainty has engulfed global capital markets.

The real economic damage of a global trade war is likely to be substantial.  Both equity and bond markets would come under significant stress.  Equities would likely take the most immediate hit as earnings growth, especially for multi-nationals, would drop significantly.

Bonds are also likely to take a hit as a likely reaction by the Chinese authorities would be to decrease their investments in the US Treasury market. Interest rates in the US would likely jump up causing pain to fixed income investors as well as worsening the federal budget deficit.

 

What do we expect in the intermediate-term from capital markets? While all this talk about trade wars and inflation scares may fill our daily news capture, it is worthwhile to remember that fundamentals drive long-term asset class performance.

In the short-term, capital markets can be heavily influenced by changing investor sentiment, but over the horizons that truly matter to most investors most periods of capital market stress tend to wash out.

Our current capital market perspectives assume that a trade war will not materialize.  Our views are informed by a number of proprietary asset class models updated as of the end of March.

Our current intermediate-term views reflect:

  • A preference for stocks over bonds despite their higher levels of risk
  • A desire for international over US equity based on valuation differentials and a depreciating US dollar – we especially like emerging market stocks
  • Within the fixed income market, we favor corporate bonds as we believe that economic conditions will remain robust and default risk will be contained
  • Small allocations to commodities as this asset class gradually recovers from the bear market it’s been in since the 2008 Financial Crisis
  • A reduction in our exposure to real estate as the asset class is being heavily penalized in the markets for its interest rate sensitivity
  • Minimal allocations to cash – the opportunity cost of holding large sums of low yielding cash is high especially for investors with a multi-year horizon
  • A return of risk on/off equity market volatility– this will surely stress investors without a solid plan for navigating market turbulence

 

 What should individual investors do while politicians flex their muscles? For starters evaluate your goals, risk attitude, spending patterns and investment strategy.  Make sure that the shoe still fits.  Capital markets are not static and neither are personal situations.

A long-term orientation and tactical flexibility will be a necessity for investors as they navigate what we think will be difficult market conditions over the next decade.

Such an approach will be especially important for individuals near or already in retirement. The sequence-of-returns-risk is especially important to manage in the years surrounding retirement when the individual will start drawing down savings.

Our approach at Insight Financial Strategists explicitly deals with this type of sequence-of-returns-risk by building the individual’s portfolio around the concept of goal-oriented buckets. Each bucket has a distinct goal and risk profile.

The short-term bucket, for example, while customized for each individual, has the overriding goal of providing a steady stream of cash flow to the individual.  This is the safe money designed to exhibit minimal volatility.

The goal of the intermediate-term bucket is different – this part of the portfolio is designed to grow the purchasing power of the individual in a risk-controlled manner. A sometimes bumpier ride is the price of growth for this bucket but the rewards should be more than commensurate with the additional risk taken.

Finally, the long-term bucket is designed to maximize the long-term appreciation of this portion of the portfolio.  This bucket will be the most volatile over the short term and is suitable for individuals with time horizons exceeding ten years and able and willing to withstand the inevitable periods of capital market stress.

Apr 13

Understanding Asset Class Risk and Return – Your Pocketbook and Psyche Will Thank You

By Eric Weigel | Capital Markets , Portfolio Construction , Risk Management

Investment risk is an inevitable part of capital markets.

 

Markets do not just go up as much as we wish for that to be always the case.

Sometimes capital markets experience stress and the draw-downs can be extremely uncomfortable to investors.

How investors react to periods of capital market stress is incredibly important.

Become too aggressive and you could end up with major short-term losses and your financial survival may be at stake.

On the other hand, become too cautious and you may end up excluded from any future capital market appreciation.

 

So, if risk is inevitable, what can you do about it? Being either extremely aggressive or extremely risk-averse are probably the least desirable options especially if you wait to act until there is a market meltdown.

In the first case, you may not be able to stay invested as short-term losses cripple your psyche and your pocketbook.  Even though you believe in your investments, your emotions will be tugging at you and second-guessing you.  This is the curse of being too early.

In the case where people become too risk-averse, being too cautious prevents you from making up the losses experienced during periods of capital market stress by participating in the good times. Most likely you second guess yourself and by the time you take the plunge back in you have probably already missed out on some large gains.  This is the curse of being too late.

 Investing is not easy especially when things go against you in the short-term. It is best to understand what you are getting yourself in and have a plan for when things go awry. As Mike Tyson once said, “everybody has a plan until they get punched in the nose”.

Getting punched in the nose is not an uncommon experience for stock market investors.  For bond market investors the experience is not as common but it still happens.

Understanding that investing can at times be brutally taxing on your pocketbook and psyche is an essential element of reaping the benefits of any investment plan. A great game plan is useless unless you have the ability to withstand the dark periods.

Investors are frequently confused by capital market behavior.  Over the short-term asset classes can go almost anywhere as investment sentiment is usually a strong driver of returns.  Market pundits attempt to provide some rationale for why things are moving in a certain direction, but in reality, most of what goes on from day to day in capital markets is usually nothing more than noise.

Markets are prone to bouts of over-confidence where all the bad news gets ignored and investors appear overly upbeat.  Other times, markets will be laser-focused on negative short-term events of little economic significance and investors will become overly pessimistic.  Even seasoned investment professionals feel sometimes that there is no rhyme or reason for what is happening to financial asset prices.

Over longer-term horizons, asset class fundamentals start being reflected in prices as investment sentiment becomes secondary.  Profits, valuations, profitability, growth potential become the drivers of prices.  Periods of stress are frequently forgotten and appear as mere blips on historical price charts.

One of the key tenets of long-term investing is that risk and return are inextricably tied together.   Without any risk, you should not expect any incremental returns. Investing is inherently risky as outcomes – short or long-term – cannot be predicted with total certainty.

Most investors understand that, on average, stocks do better than bonds but that the price of these higher returns is a lot more risk.  Investors also understand that longer-maturity bonds will do better most of the time than simply purchasing a CD at the local bank or investing in a money market mutual fund.

But beyond this high-level understanding of capital market behavior, there is lots of confusion. Gaining a better understanding of key asset class risk and return relationships will help you become a better-informed consumer of investment strategies.

Understanding what you are getting yourself in when evaluating different investment strategies could significantly alter your wealth profile for the better and allow you to take advantage of market panics rather than simply react to crowd psychology like most people.

To become an informed consumer of investment strategies the first step is understanding key asset class risk and return tradeoffs.  We use a dataset kindly provided online by Professor Aswath Damadoran at NYU to look at calendar year returns on US stock, bond and bill returns.  Bond returns proxy for a 10-year constant maturity US Treasury Note and bills correspond to a 3 month US t-bill.  US stocks are large capitalization stocks equivalent to the S&P 500. Figure 1 depicts the annual asset class returns since 1937.

The first thing that jumps out from the chart is the much higher level of return variability of stocks.

The second thing that jumps out is the incredible year over year smoothness of T-bill returns.  Bonds are clearly somewhere in between with volatility characteristics much more similar to bills.

The third thing that jumps out are the rare but eye-popping large equity market meltdowns such as during 1937, 1974, 2002 and 2008.  Lastly, of notice are the very large positive spikes in equity returns during years such as 1954, 1958, 1975, 1995 and 2013.

 Figure 1

What is not entirely clear from looking at the yearly return chart is the huge cumulative out-performance of stocks relative to both bonds and bills. Table 1 provides summary statistics on calendar year returns for each asset class.

Table 1


Key highlights:

  • Over the 1928-2017 period, stocks have returned on average 12% per year with an annual standard deviation of 20% year. Bonds are next in line with an average return of 5% and a volatility of 8%. Bills have had the lowest rate of return at 3% with a volatility of 3%. These numbers correspond to the usual risk/reward relationships that investors know all about.
  • In 27% of the years between 1928 and 2017, stocks have had a negative return. The average return when the market has gone down is -14%. Nobody likes losses but even bond investors saw negative returns in 18% of the years and when they happened the average loss was -4%. The only way never to lose money in any given year is to invest in bills.
  • If one had invested $100 in December 1927 and held that investment the ending portfolio value would be $399,886 – a huge rate of growth despite the infrequent yet terrifying equity market meltdowns. Bonds don’t come even close with an ending portfolio balance of $7,310. Playing it safe with bills would have yielded a portfolio value of $2,016.
  • From a cumulative wealth perspective, stocks are clearly the superior asset class but only if the investor is able to stomach the rare but large equity drawdowns and seeing losses in over a quarter of the years.
  • If the investor is seeking stability with no chance of principal loss, T-bills are the preferred asset class. The rewards compared to stocks will be meager, but the ride will be smooth and predictable.

 

What happens when you extend the holding period out to, say 10 years? Does the spikiness of stock market returns disappear? What about the frequency of down years?

Using the same data set as before and forming rolling 10-year holding returns starting in 1927 we observe in Figure 2 that some of the volatility of stocks and bonds has dissipated. Instead of spikes we now have mountains and slopes.

Figure 2

 

The chart on rolling 10-year returns exposes the massive cumulative out-performance of stocks during most ten-year holding periods.  There are instances of negative 10-year stock returns (6% as shown in Table 2) but they are swamped by the mountain of positive returns especially when viewed in relation to bond and bill returns.

We see only three periods when equity investors would have loved to play it safe and be either in bonds or bills – the early years post the Great Depression (1937-39), the Financial Crisis (2008-9), and economic stagnation and inflationary years starting in the mid-70s through the beginning of the equity bull market of 1982.  In the first two instances, equity holders lost money.  In the latter instance, equity investors enjoyed positive returns but below those of either bonds or bills.

Table 2

Some observations are in order:

  • As one extends the holding period from 1 to 10 years some of the spikiness of one-year returns is smoothed out – not every year is fantastic and not every year is terrible, periods of stress are usually followed by periods of recovery and so on
  • Over a ten year holding period stocks do not look as scary – only in 6% of our observations do we see a negative return. When those losses occur the average loss is 10% on a cumulative basis.
  • Rolling 10-year maturity bonds every year over a decade yields no periods in our sample where the strategy exhibits a loss. The same holds true for bills.
  • Investors able to extend holding periods from short to longer maturities such as ten years significantly lower their odds of seeing negative returns as confirmed in the empirical data

 

What happens when we mix and match asset classes? Does that help lower our probability of loss? We look at some typical multi-asset class mixes over one-year holding periods:

  • The 60/0/40 portfolio composed of 60% stocks and 40% bonds – a traditional industry benchmark
  • The 40/0/60 portfolio composed of 40% stocks and 60% bonds – a moderately conservative mix
  • The 25/50/25 portfolio composed of 25% stocks, 50% bills and 25% bonds – a conservative mix for a very risk-averse investor

Mixing asset classes is usually referred to as multi-asset class investing.  The premise for such an approach is based on the diversification benefits afforded by allocating in varying proportions to asset classes with their own unique risk and return characteristics.

It turns out that over the 1928-2017 period stocks were essentially uncorrelated to both bonds and bills.  The correlation between bonds and bills was 0.3.  Building portfolios with lowly correlated asset classes is hugely beneficial in terms of lowering the volatility of the multi-asset class mix.

Table 3

 

What are the main conclusions that we can reach when mixing asset classes with widely different risk and return characteristics?

  • When combining stocks, bonds, and bills in varying proportions we arrive at portfolio results that fall between those of equities and bonds
  • The traditional 60/0/40 portfolio had a lower frequency of negative returns compared to an all-equity portfolio, significantly lower volatility and a cumulative ending portfolio value only about a 1/3 as large. What you gain in terms of lower risk, you lose in terms of compound returns.
  • The 40/0/60 portfolio which represents a lower risk alternative to the investor lowers volatility (to 9%) but at the expense of also lowering average returns (to 8%) and especially cumulative wealth (ending value of $58,090)
  • The lowest risk multi-asset class strategy that we looked at – the 25/50/25 portfolio – had the lowest average returns (6%), lowest volatility (6%) and lowest long-term growth.
  • A key implication of multi-asset investing is by combining asset classes with disparate risk and return characteristics you can build more attractive portfolios compared to single asset class portfolios
  • Comparing two traditionally low-risk portfolios – 100% bonds and the 25/50/25 portfolio – demonstrates the benefits of multi-asset class investing. The multi-asset class portfolio not only has higher average returns but lower risk. The frequency of calendar year loss is smaller (11% compared to 18%) and the long-term portfolio growth is over 2X that of the all-bond portfolio.

 

Three very significant lessons emerge from our study of asset class behavior that can vastly improve your financial health.  The first relates to the holding period.  Specifically, by having a longer holding period many of the daily and weekly blips that so scare equity investors tend to wash away.

Equity investments do not look as volatile or risky when judged over longer holding periods of say 10 years.

The second lesson relates to the power of compounding. Small differences in average returns can yield huge differences in long-term cumulative wealth.  In terms of the multi-asset class portfolios – the 60/0/40 versus the 40/0/60 – yields only a 1% average return difference but a 2X difference over the 1928-2017 period.

Seemingly small differences in average calendar year returns can result in massive wealth differences over long holding periods.

The third lesson relates to diversification. By mixing together asset classes with varying risk and return characteristics we can significantly improve the overall attractiveness of a portfolio. Lower portfolio risk is achievable with proper diversification without a proportional sacrifice in terms of returns.   Properly constructing multi-asset class portfolios can yield vastly superior outcomes for investors.

 

Every investor needs to come to terms with the risk to reward relationships of major asset classes such as stocks, bonds, and bills.  Understanding the risk and return tradeoffs you are making is probably the most important investment decision affecting the long-term outcome of your portfolio.

Some investors can stomach the sometimes wild ride offered by stocks and choose to overwhelmingly use equity strategies in their portfolios. They don’t worry much about the daily vicissitudes of the stock market.  They accept risk in return for higher expected returns.

Not everybody, however, can stomach the wild ride that sometimes comes from owning stocks despite understanding that over the long-term stocks tend to better than bonds and bills.

Some investors are willing to leave a bit of money (but not too much, please) on the table in return for a smoother ride. They may elect to hedge some of the risks.  Or they may mix in varying proportions of risky and less risky asset classes and strategies.

Yet other investors are so petrified of losses and market volatility that they will forego any incremental return for the comfort and steadiness of a safe money market account. They choose to avoid risk at all costs.

 

Which is the better approach for you? Avoid all risks, save a lot and watch your investment account grow slowly but smoothly?

Or, take some risk, sweat like a nervous high schooler when capital markets go bust and grow your portfolio more rapidly but with some hiccups?

The answer depends on you – your needs, goals and especially your attitude toward risk and your capacity to absorb losses to your wealth.  If you already have a financial plan in place great. If you need help getting started or refining your plan, the team at Insight Financial is ready to share our expertise and bring peace of mind to your financial life. Book an appointment here.

Understanding that investing can at times be brutally taxing on your pocketbook and psyche is an essential element of reaping the benefits of any investment plan.  In subsequent articles, we will be exploring different ways of managing risk and structuring portfolios.

 

 

Sep 24

How to choose a financial planner

By Chris Chen CFP | Financial Planning

How to choose a Financial Planner

Chris Chen CFPHow to choose a financial planner is a question that vexes many people looking for one, even as a number of online resources address the topic.  For instance, the Financial Planning Association as well as a number of online resources in the financial and popular media offer advice on that.

I was prompted to think about this issue by a question I received recently

Question:  

“Currently I am pulling about 4% on my trading accounts.  These are probably below what is going on in the market, but that’s one of the reasons I am seriously looking at a financial adviser.

Do you have any empirical data (history) on what returns I could expect.  I am a numbers type so that would definitely help me in my decision making process. “

It is a great question!  Clients want results, and Financial Planners want results.  The difficulty with using results to measure effectiveness, and as a benchmark on how to choose a financial planner, is that there are so many moving variables that using historical results to choose a financial planner is not effective. As the saying goes, there are lies, damn lies and then there are statistics.

Hence my answer:

Before answering the question “…we would need to work a little more on your objectives and your comfort with risk.  An investment portfolio would have to reflect both. For instance, if you have a short term goal, you would want the money allocated to that goal to be in a lower risk investment allocation.  If you have a long term goal, you would want the opposite. Then, could you compare the performance of the two? They would be like apples and oranges, so probably not.

Now if you and I had the same long term goal, should we be invested in the same way?  Only if we have the same attitudes toward risk, ie how we feel when the market goes down.  Depending on our respective comfort with risk, you and I would have different asset allocations.  Could you compare the performance of our two asset allocations? It would be like comparing a red delicious with a granny apple.  Sort of the same thing, but not quite.

With regard to your results, I assume that they are year to date.  Compared to a S&P 500 return of 19.33% year to date on 9/23/2013, a 4% return year to date would be reflective of a fairly conservative asset allocation with relatively little risk.  In a stock trading situation, your 4% probably came with taking substantial risk.

My job as a financial planner is to understand your goals and your comfort with risk.  Then I can propose an investment allocation and investments that efficiently help you reach your goals with the appropriate amount of risk.

In summary, I could provide you with numbers, but they would not be meaningful without the underlying context of where they came from. Chances are they will be better than some other financial planners’, and worse than some others. In and of itself that would not be meaningful, and, in my opinion, you should not rely on those numbers to decide how to choose a financial planner.”

Check out our Financial Planning Page and our Investment Page

Jul 01

What is Tactical Asset Allocation?

By Chris Chen CFP | Financial Planning

Tactical asset allocation can enhance a long term strategy

Asset Allocation

Strategic asset allocation, the practice of maintaining a strategic mix of stocks, bonds, and cash, has guided many investors in creating portfolios that suit their risk profile and long-term investing goals.  This widely used strategy is a long-term, relatively static tool and is not intended to take advantage of short-term market opportunities.

Proponents of tactical asset allocation, in contrast, take a shorter-term view. Tactical asset allocation is the practice of shifting an asset allocation by relatively small amounts (typically 5% or 10%) to capitalize on economic or market conditions that may offer near-term opportunities. Tactical asset allocation differs from re-balancing, which involves periodic adjustments to your strategic allocation as a result of portfolio drift or a change in personal circumstances. With tactical asset allocation, you maintain a strategic allocation target, but fine tune the exact mix based on expectations of what you believe will happen in the financial markets.

Tactical asset allocation also can involve shifting allocations within an asset class. For example, an equity portion of a portfolio may be shifted to include more small-cap stocks, more large-cap stocks, or other areas where an investor perceives a short-term opportunity. Note that mutual funds that invest in these areas may impose restrictions on short-term trading, and it is important to understand these restrictions before making an investment.

A tactical approach involves making a judgment call on where you think the economy and the financial markets may be headed. Accordingly, a tactical asset allocation strategy can increase portfolio risk, especially if tactical allocations emphasize riskier asset classes. This is why it may be a good idea to set percentage limits on asset allocation shifts and time limits on how long you want to keep these shifts in place.

In addition, when evaluating investment gains that are short-term in nature, such as those on investments held for one year or less, it is important to understand taxes on short-term capital gains. Currently, short-term capital gains are taxed as ordinary income, where the highest marginal tax rate is 39.6%. In contrast, long-term capital gains on investments held for more than one year are taxed at 15% for most investors, 20% for joint filers earning more than $450,000.

 

© 2013 S&P Capital IQ Financial Communications. All rights reserved.