Posts by alex

An Index Overview (Part IV)

June 1st, 2017 Posted by Asset Allocation, Financial Education, Foreign Investing, Investment Strategy, Investment Vehicles, Uncategorized 0 thoughts on “An Index Overview (Part IV)”

Part IV: Index Investing – Opportunities and Obstacles

Legend has it, a pharmacist named John Pemberton was searching for a headache cure when he tried blending Coca leaves with Cola nuts. Who knew his recipe was destined to become such a smashing success, even if Coca-Cola® never did become the medicine Pemberton had in mind?

In similar vein, when Charles Dow launched the Dow Jones Industrial Average (the Dow), his aim was to better assess stock prices and market trends, hoping to determine when the market’s tides had turned by measuring the equivalent of its incoming and outgoing “waves.” He chose industrials (mostly railroads) because, as he proposed in 1882, “The industrial market is destined to be the great speculative market of the United States.”

While the actively minded Dow never did achieve market-timing clairvoyance (and neither has anyone else we’re aware of), he did devise the world’s first index. We’d like to think his creation turned into something even greater than what he’d intended – especially when Vanguard founder John Bogle and other pioneers leveraged Dow’s early work to create among the most passive ways to invest in today’s markets: the index fund.

Bogle launched the first publicly available index fund in 1976. Initially dismissed by many as “Bogle’s folly,” its modern-day rendition, the Vanguard 500 Index Fund, remains among the most familiar funds of any type.

Index Investing Is Born

In defense of Dow’s quest to forecast market movements, it’s worth remembering that his was a world in which electronic ticker tape was the latest technology, there were no open-ended mutual funds or fee-only financial advisors, and safeguards and regulations were few and far between. Essentially, speculating was the only way one could invest in late-nineteenth century markets.

Compared to actively managed funds that seek to “beat” the market by engaging in these now-outdated speculative strategies, passively managed index funds offer a more solid solution for sensibly capturing available market returns. As the name implies, an index fund buys and holds the securities tracked by a particular index, which is seeking to represent the performance of a particular slice of the market. For example, the Vanguard 500 Index Fund tracks the popular S&P 500 Index, which in turn approximately tracks the asset class of U.S. large-company stocks.

Compared to actively managed solutions, index funds lend themselves well to helping investors more efficiently and effectively target these three pillars of sensible investing:

  1. Asset allocation – How you allocate your portfolio across various market asset classes plays a far greater role in varying your long-term portfolio performance than does the individual securities you hold.
  2. Global diversification – Through broad and deep diversification, the sum of your whole risk can actually be lower than its individual parts.
  3. Cost control – The less you spend implementing a strategy, the more you get to keep.

Index Investing: Room for Improvement

As we’ve described throughout this series, indexes weren’t specifically devised to be invested in. There’s often a lot going on underneath their seemingly simple structures that can lead to inefficiencies by those trying to retrofit their investment products on top of popular indexes.

Index Dependence – Whenever an index “reconstitutes” by changing the underlying stocks it is following, any funds tracking that index must change its holdings as well – and relatively quickly if it’s to remain true to its stated goals. In a classic display of supply-and-demand pricing, this can generate a “buy high, sell low” environment as index fund managers hurry to sell stocks that have been removed from the index and buy stocks that have been added.

Compromised Composition – Asset allocation is based on the premise that particular market asset classes exhibit particular risk and return characteristics over time. That’s why your investment “pie” should be carefully managed to include the right asset class “slices” for your financial goals and risk tolerances. As we described in Part III of this series, if you’re invested in an index fund and you aren’t sure what its underlying index is precisely tracking, you may end up with off-sized pieces of pie. For example, the S&P 500 and the Russell 3000 are both positioned as U.S. stock market indexes, but both also track some real estate. If you don’t factor that into your plans, you can end up with a bigger helping of real estate than you had in mind.

Introducing Evidence-Based Investing

So, yes, index investing has its advantages … It also has inherent challenges. No wonder academically minded innovators from around the globe soon sought to improve on index investing’s best traits and minimize its weaknesses. In fact, many of these thought leaders were the same early adapters who introduced index fund investing to begin with. Building on index investing, they devised evidence-based investment funds, to offer several more advantages:

Index-independence – Instead of tracking an index that tracks an asset class … why not just directly capture the asset class itself as effectively as possible? Evidence-based fund managers have freed themselves from tracking popular indexes by establishing their own parameters for cost-effectively investing in most of the securities within the asset classes being targeted. This reduces the need to place unnecessary trades at inopportune times simply to track an index. It also allows more patient trading strategies and scales of economy to achieve better pricing.

Improved Concentration – Untethering themselves from popular indexes also enables evidence-based fund managers to more aggressively pursue targeted risk factors; for example, an evidence-based small-cap value fund often has more flexibility to hold smaller and more value-tilted holdings than a comparable index fund. This provides more refined control for building your personal investment portfolio according to your unique risk/return goals.

Focusing on Innovative Evidence – Evidence-based investing shifts the emphasis from tracking an index, to continually improving our understanding of the market factors that contribute to the returns we are seeking. By building portfolios using fund managers who apply this same evidence to their funds, you can make best use of existing academic insights, while efficiently incorporating credible new ones as they emerge.

An Index Overview, Revisited

From describing an index’s basic functions, to exploring some of the intricacies of their construction, we’ve covered a lot of ground in this four-part series on indexing. To recap, indexes can help us explore what is going on in particular slices of our capital markets. In the right context, they also can help you compare your own investment performance against a common benchmark. Last but not least, you can invest in funds that track particular indexes.

Equally important, remember that indexes do not help us forecast what to expect next in the markets, nor do high-water markets such as “Dow 20,000” foretell whether it’s a good or bad time to buy, hold or sell your own market holdings. And, while low-cost, well-managed index funds may still play a role in your overall investment portfolio, it’s worth ensuring that you select them when they are the best fit for your evidence-based investment strategy, not simply because they are a popular choice at the time.

What else can we tell you about indexes or index investing? Let’s take a look at your unique financial goals, and see how indexing fits into your globally diversified world of investments. To learn more, please get in touch with us at OpenCircle Wealth Partners, 203-985-0448.

[Photo curtesy of ekta kapoor]

 

An Index Overview (Part III)

May 11th, 2017 Posted by Financial Education, Investment Strategy, Investment Vehicles 0 thoughts on “An Index Overview (Part III)”

Part III: Index Mechanics – Interesting Idiosyncrasies

Market indexes. You read about them all the time, such as when the Dow Jones Industrial Average (the Dow) topped 20,000 points in early 2017 … and then broke 21,000 just over a month later. In our last piece, we explored what those points actually measure, which isn’t always what you might guess. Today, we’ll take a closer look at the mechanics of indexing, to gain a better understanding of why they do, what they do.

The Birth of Indexing

When you hear the term “stock index,” you’re in good company if the first thing that comes to mind is the S&P 500; some of the world’s largest index funds are named after it. We’ll talk more about index investing in our next piece, but we’ll note here that, despite its familiarity, the S&P 500 is a babe in the woods compared to the world’s first index. That honor goes to the Dow.

The Grand Old Dow

As described in “Capital Ideas” by Peter Bernstein:

“The first Dow Jones Average appeared in the Afternoon News Letter on July 3, 1884. It consisted of the closing prices of eleven companies: nine railroads and two industrials. [Charles] Dow’s idea was to provide an overall measure of the performance of active companies, at a time when an average day’s activity on the New York Stock Exchange was about 250,000 shares.”

Eleven companies, nine of them railroads, wouldn’t make for much of a market proxy these days! And yet the Dow still only tracks 30 stocks, as it has since 1928. Plus, it still uses mostly the same methods for tracking them. As expressed by James Mackintosh, a senior market columnist for The Wall Street Journal (the effective birthplace of the Dow): “It’s time to ditch the Dow. After 120 years, the venerable Dow Jones Industrial Average is an embarrassing anachronism, abandoned by professionals and beloved only by a media that mostly knows no better. It needs to be updated or, better, replaced.”

And yet, despite its flaws, the Dow persists. Markets are made of people, and people can be sentimental about their past. More pragmatically, the Dow serves as a time capsule of sorts, offering historical perspective no other index can match. It’s also just plain familiar. As its parent company the S&P Dow Jones Indices says, “It is understandable to most people.”

 How Do Indexes Get Built?

What about all those other indexes? New ones come along whenever an indexer devises a supposedly better mousetrap for tracking market performance. If enough participants accept the new method, an index is born.

That’s our free markets at work, and it sounds simple enough. But if we take a closer look at the various ways indexers track their slices of the market, what may seem clear at a glance is often seething with complexities just under the surface. Here are some (not all!) of the ways various indexes are sliced and diced.

Which Weighting?

How much weight should an index give to each of its holdings? For example, in the S&P 500, should the returns delivered by Emerson Electric Company hold the same significance as those from Apple Inc.?

  • The Dow is price-weighted, giving each company more or less weight based on its higher or lower share price. As Mackintosh explained, “share prices are arbitrary, as they depend on how many shares are issued; some companies have very high prices, which give them more influence on the Dow, even though they may be less valuable overall.”
  • Market-cap weighting is the most common weighting used by the most familiar indexes around the globe. It factors in outstanding shares as well as current share price to give more weight to the bigger players and less to the smaller fry.
  • Some indexes are equal-weighted, giving each holding, large or small, equal importance in the final tally. For example, there’s an equal-weighted version of the S&P 500, in which each company is weighted at 0.2% of the index total, rebalanced quarterly.

There are many other variations on these themes. The point is, indexes using different weightings can reach significantly different conclusions about the performance of the same market slice.

Widely Inclusive or Highly Representative?

How many individual securities does an index need to track to correctly reflect its target market?

  • As we mentioned above, the Dow uses 30 securities to represent thousands of publicly traded U.S. stocks. A throw-back to simpler times, it’s unlikely you’ll see other popular indexes built on such modest samples. In its defense, the Dow favors stocks that are heavily and frequently traded, so prices are timely and real … at least for the 30 stocks it’s tracking.
  • At the other end of the spectrum, the Wilshire 5000 Total Market Index “contains all U.S.-headquartered equity securities with readily available price data.”
  • The S&P 500 falls somewhere in between, tracking around (not always precisely) 500 publicly traded U.S. securities.

Tracking a Narrow Slice or a Mixed Bag?

What makes up “a market,” anyway? Consider these possibilities:

  • If an index is tracking the U.S. market, should that include real estate companies too?
  • If its make-up tends to include a heavier allocation to, say, value versus growth stocks, how does that influence its relative results … and is it a deliberate or accidental tilt?
  • Is an index broadly covering diverse sectors (such as representative industries or regions) or is its focus intentionally concentrated?
  • If it’s tracking bonds, are they corporate and municipal bonds, or just one or the other?

The Use and Abuse of Indexing

How well do you really know what your index is up to? Remember, in Part I of this series, we described how every index is a model – imperfect by definition. How might each index’s inevitable idiosyncrasies be influencing the accuracy of its outcomes?

We’ve just touched on a few of the questions an indexer must address. Like the proverbial onion, many more layers could be peeled away and, the deeper you go, the finer the nuances become.

One practical conclusion is that some indexes are much easier to translate into investable index funds than others. In addition, some lend themselves better than others to a sound, evidence-based investment strategy. In fact, indexes often may not be the ideal solution for that higher goal to begin with. In our next and final segment, we’ll explore the strengths and weaknesses inherent to index investing.

[photo curtesy of Kiss My Buttercream]

An Index Overview (Part II)

May 9th, 2017 Posted by Financial Education, Investment Strategy, Investment Vehicles, Uncategorized 0 thoughts on “An Index Overview (Part II)”

Part II: A Few Points About Index Points

As we covered in our last piece, indexes have their uses. They can roughly gauge the mood of a market and its participants. If you’ve got an investment strategy that’s designed to capture that market, you can see how your strategy is doing in comparison … again, roughly. You can also invest in an index fund that tracks an index that tracks that market.

This may help explain why everyone seems to be forever watching, analyzing and talking about the most popular indexes and their every move. But you may still have questions about what they are and how they really work. For example, when the Dow Jones Industrial Average (the Dow) exceeded 20,000 points last January, what were those points even measuring?

An index’s total points represent a relative value for the market it is tracking, calculated by continually assessing that market’s “average” performance.

If that’s a little too technical for your tastes, think of it this way: Checking an index at any given time is like dipping your toe in the water to see how the ocean is doing. You may have good reasons to do that toe-check, but as with any approximation, be careful to not misinterpret what you’re measuring. Otherwise, you may succumb to misperceptions like: “The Dow is so high, it must be in for a fall. I’d better get out.”

With that in mind, when it comes to index points, we’d like to make a few points of our own.

Indexes Are Often Arbitrary

It helps to recognize how popular indexes become popular to begin with. In our free markets, competitive forces are free to introduce new and different structures, to see how they fly. In the same way that the markets “decided” that the iPhone would prevail over the Blackberry, popular appeal is effectively how the world accepts or rejects one index over another. Sometimes the best index wins and becomes an accepted reference. Sometimes not.

Measurements Vary

Different indexes can be structured very differently. That’s why the Dow recently topped 20,000, while the S&P 500 is hovering in the 2,000s, even though both are often used to gauge the same U.S. stock market. The Dow arrives at its overall average by adding up the price-weighted prices of the 30 securities it’s tracking and dividing the total by a proprietary “Dow divisor.” The S&P 500 also takes the sum of the approximately 500 securities it’s tracking … but weighted by market cap and divided by its own proprietary divisor.

With mysterious divisors, terms like “price-weighted” and “market cap,” and additional details we won’t go into here, this probably still doesn’t tell you exactly what index points are.

Think of index points as being like thermometer degrees. Most of us can’t explain exactly how a degree is calculated, but we know hot from cold. We also know that Fahrenheit and Celsius both tell us what the temperature is, in different ways.

Same thing with indexes. You can’t directly compare an S&P 500 point to a Dow point; it doesn’t compute. Moreover, neither index adjusts for inflation. So, while index values offer a relative sense of how “hot” or “cold” a market is feeling at the moment, they can’t necessarily tell you whether a market is too hot or too cold, or help you precisely predict when it’s time to buy or sell into or out of them. The “compared to what?” factor is missing from the equation. This brings us to our third point …

Models Are Approximate

There’s an important difference between hard sciences like thermodynamics and market measures like indexes. On a thermometer, a degree is a degree. With market indexes, those points are based on an approximation of actual market performance – in other words, on a model.

A model is a fake copy of reality, with some copies rendered considerably better than others. Here’s what Nobel Laureate Eugene Fama has said about them: “No model is ever strictly true. The real criterion should be: Do I know more about markets when I’m finished than I did when I started?”

Your Take-Home

According to Professor Fama’s description of a model, indexes have long served as handy proxies to help us explore what is going on in particular slices of our capital markets. But, they also can do damage to your investment experience if you misinterpret what they mean.

For now, remember this: An index’s popular appeal is the result of often-arbitrary group consensus that can reflect both rational reasoning and random behavioral bias. Structures vary, and accuracy is (at best) approximate. Even the most familiar indexes can contain some surprising structural secrets. In our next post, we’ll unlock some of them for you. Ask us a question at (203) 985-0448.

 

[photo curtesy of ACSM_1954]

 

An Index Overview

May 8th, 2017 Posted by Financial Education, Investment Strategy, Investment Vehicles 0 thoughts on “An Index Overview”

Part I: Indexes, Defined

Since nearly every media outlet on the planet reported the news, you probably already know that the Dow Jones Industrial Average Index topped 20,000 for the first time on January 25, 2017. But when a popular index like the Dow is on a tear, up or down, what does it really mean to you and your investments?

Great question. In this multi-part series, we’re going to cover some of the ins and outs of indexes and the index funds that track them.

What Is an Index?

Let’s set the stage with some definitions.

An index tracks the returns generated by a basket of securities that an indexer has put together to represent (“proxy”) a particular swath of the market.

Some of the familiar names among today’s index providers include the S&P Dow Jones, MSCI, FTSE Russell and Wilshire. It’s perhaps interesting to note that some of the current index providers started out as separate entities – such as the S&P and the Dow, and FTSE and Russell – only to consolidate over time. In any case, here are some of the world’s most familiar indexes (with “familiar” defined by where you’re at):

  • S&P 500, Nasdaq Composite, and Dow (U.S.)
  • S&P/TSX Composite Index (Canada)
  • FTSE 100 (U.K.)
  • MSCI EAFE (Europe, Australasia and the Far East)
  • Nikkei and TOPIX (Japan/Tokyo)
  • CSI 300 (China)
  • HSI (Hong Kong)
  • KOSPI (Korea)
  • ASX 200 (Australia)

…and so on

Why Do We Have Indexes?

Early on, indexes were designed to offer a rough idea of how a market segment and its underlying economy were faring. They also helped investors compare their own investment performance to that market. So, for example, if you had invested in a handful of U.S. stocks, how did your particular picks perform compared to an index meant to track the average returns of U.S. stocks? Had you “beat the market”?

Then, in 1976, Vanguard founder John Bogle launched the first publicly available mutual fund specifically designed to simply copy-cat an index. The thought was, instead of spending time, money and energy trying to outperform a market’s average, why not just earn the returns that market has to offer (reduced by relatively modest fund expenses)? The now familiar Vanguard 500 Index Fund was born … along with index fund investing in general.

There are some practical challenges that prevent an index from perfectly replicating the market it’s meant to represent. We’ll discuss these in future segments. But for now, the point is that indexes have served investors across the decades for two primary purposes:

  1. Benchmarking: A well-built index should provide an approximate benchmark against which to compare your own investment performance … if you ensure it’s a relatively fair, apples-to-apples comparison, and if you remain aware of some of the ways the comparison still may not be perfectly appropriate.
  2. Investing: Index funds that replicate indexes allow you to indirectly invest in the same holdings that an index contains, with the intent of earning what the index earns, net of fees.

Indexes Are NOT Predictive

There is also at least one way indexes should NOT be used, even though they often are:

Index milestones (such as “Dow 20,000”) do NOT foretell whether it’s a good or bad time to buy, hold or sell your own investments.

Indexes don’t tell us whether the markets they are tracking or the components they are using to do so are over- or underpriced, or otherwise ripe for buying or selling. Attempting to use current index values as a way to time your entry into or exit from a market does not, and should not replace understanding how to best reflect your unique investment goals and risk tolerances in an evidence-based investment strategy.

In fact, market-timing of any sort is expected to detract from your ability to build wealth as a long-term investor, which calls for two key disciplines:

  1. Building a cost-effective, globally diversified portfolio that exposes you to the expected returns you’d like to receive while minimizing the risks involved
  2. Sticking with that portfolio over the long run, regardless of arbitrary milestones that an index or other market measures may achieve along the way

As one commentator observed the day after the Dow first broke 20,000: “Sensationalism of events like these [Dow 20,000] has the ability to trigger our animal spirits or our worst fears if we don’t have a long-term investment plan to keep them in check.”

So first and foremost, have you got those personalized plans in place? Have you constructed a sensible investment portfolio you can adhere to over time to reflect your plans? If not, you may want to make that a top priority. Next, we’ll explore some of the mechanics that go into indexing, to help put them into the context of your greater investment management. Ask us a question at (203) 985-0448.

[photo curtesy of journeyman62 at flickr.com]

How to Lower the Volume on Social Media Noise

December 5th, 2016 Posted by Investor Behavior 0 thoughts on “How to Lower the Volume on Social Media Noise”

Does this scenario sound familiar? In the morning, you pick up your smart phone or sit down at your computer and, immediately, little numbers alert you to emails, texts, voice mail, and notifications from your apps. You delete the ones you don’t need or want.  You process as many quick actions, and skim as many messages and articles, as you can before the actual business of your day begins. You feel that maybe you have today under control.

But then, as the day progresses, you get beeps or banners begging for yet more of your attention. And if you have to be away from your digital screens for any length of time, you are buried under another barrage when you return. It doesn’t help that the flurry of social “noise” around current events has increased stress levels around issues that are already stressful.

We have at our fingertips immense amounts of information, as well as disinformation. It is more than one person can thoroughly process. It can be overwhelming. But deal with it we must, if we do not want to be left behind as the rest of the world rushes by in sound bites and visual distractions. So how can you juggle everything and maintain any sense of calm?

We will share some thoughts here, keeping in mind that the response to all this noise varies from one person to the next. If you are someone who thrives on frenetic activity, you do not need to read further. If you think you are ready to give up and get rid of all your sources of electronic information, you can stop here as well. But if you are looking for a happy medium that can bring your life into more balance, read on. We will focus primarily on email and touch on some other forms of electronic communication.

Email consists of mass marketing, personal conversations, business communications, and more. There are ways that you can manage the deluge. You can trash a message immediately, of course. You can send quick replies when appropriate, saving thoughtful replies for a dedicated time you have set aside (as people did when writing letters on paper was the norm). Ultimately, you can label and file emails for future reference in separate mailboxes organized by subject matter. If you do not want to file, keep only what you need and use your server’s search engine to find an item you need to look at again. Starring or flagging email messages is helpful, too, if you don’t overdo it.

There are other options for dealing with mass emails you don’t want. You may mark them as spam or junk, so that future messages from the same source go directly to your junk box. But remember to check your junk/spam box occasionally to make sure you haven’t missed an important item. Finally, you can take a moment to locate the unsubscribe option buried somewhere in the content. Click on it and confirm, or choose to receive fewer messages, if that choice is provided. (A word to the wise here—only unsubscribe from things that you know you signed up for. Some senders you don’t recognize will offer the unsubscribe option just to lure you into their system.) Gradually, you will see a meaningful reduction in the amount of time you spend reviewing and deleting messages.

When sending an email, do yourself and your recipients a favor. Unless you are writing a rambling letter, limit the action items or vital information to what can be summarized in the subject line. You may end up sending more messages, but they will be easier for people to identify and to assess what is urgent. The replies you receive will be more efficient, as well.

Texting, Instagram, Snapchat, Twitter, and other “instant” messaging can add to the clutter of your day. Just because they are instant does not mean they all need instant action. One of the nice things about texting is that you can send a message and not worry about disturbing someone with a phone call at a bad time. But how often do we feel impatient when someone doesn’t reply right away? If you need to reach someone about an urgent matter, follow up with a phone call. If the person doesn’t answer, at least they will know that you are serious about reaching them (if they have their device on and within reach).

Now a bit about Facebook: Manage your settings so that you receive fewer (or no) notifications via email. Categorize your friends so that your closest ones appear higher in your newsfeed. If you enjoy scrolling in your leisure time, go for it. Otherwise, discipline yourself not to scroll when your focus should be elsewhere. You’ll feel less scattered.

LinkedIn, Pinterest and other apps can also be demanding. Be sure to manage your settings so that you are only receiving alerts that you want. You can designate special times of the day to deal with these apps, so that you have a more cohesive experience with each of them.

Finally, here is our pledge to you:

The emails we send you will be useful and not too frequent. If you have preferences, please let us know and we will honor them. Our website blog and social media postings offer helpful information that may stand alone, or may link to related items. We generally post on a weekly basis, unless unusual circumstances deem otherwise. Our goal is to keep you informed. And, of course, if you ever have any questions, please give us a call at 203-985-0448.

 

[Photo credit: Flickr Philips Communications]

 

Tax-Loss Harvesting: Opportunities and Obstacles

November 22nd, 2016 Posted by Investor Behavior, Taxes and Tax Management 0 thoughts on “Tax-Loss Harvesting: Opportunities and Obstacles”

So much of investing is beyond our control (picking stock prices, timing market movements and so on), it’s nice to know that there are still a number of “power tools” we can employ to potentially enhance our clients’ bottom line. Tax-loss harvesting is one such instrument … although the analogy holds true in a couple of other ways: It’s best used skillfully, and only when it is the right tool for the task.

The (Ideal) Logistics

When properly applied, tax-loss harvesting is the equivalent of turning your financial lemons into lemonade by converting market downturns into tangible tax savings. A successful tax-loss harvest lowers your tax bill, without substantially altering or impacting your long-term investment outcomes.

Tax Savings

If you sell all or part of a position in your taxable account when it is worth less than you paid for it, this generates a realized capital loss. You can use that loss to offset capital gains and other income in the year you realize it, or you can carry it forward into future years. We can realize losses on a holding’s original shares, its reinvested dividends, or both. (There are quite a few more caveats on how to report losses, gains and other income. A tax professional should be consulted for how it all applies in specific cases.)

Your Greater Goals

When harvesting a loss, it’s imperative that you remain true to your existing investment plan as one of the most important drivers in achieving your ultimate financial goals. To prevent a tax-loss harvest from knocking your carefully structured portfolio out of balance, we reinvest the proceeds of any tax-loss harvest sale into a similar position (but not one that is “substantially identical,” as defined by the IRS). Typically, and when appropriate, we then return the proceeds to your original position no sooner than 31 days later (after the IRS’s “wash sale rule” period has passed).

The Tax-Loss Harvest Round Trip

In short, once the dust has settled, our goal is to have generated a substantive capital loss to report on your tax returns, without dramatically altering your market positions during or after the event. Here’s a three-step summary of the round trip typically involved:

  1. Sell all or part of a position in your portfolio when it is worth less than you paid for it.
  2. Reinvest the proceeds in a similar (not “substantially identical”) position.
  3. Return the proceeds to the original position no sooner than 31 days later, as appropriate.

Practical Caveats

An effective tax-loss harvest can contribute to your net worth by lowering your tax bills. That’s why we keep a year-round eye on potential harvesting opportunities, so we are ready to spring into action whenever market conditions and your best interests warrant it.

That said, there are several reasons that not every loss can or should be harvested. Here are a few of the most common caveats to bear in mind.

Trading costs – You shouldn’t execute a tax-loss harvest unless it is expected to generate more than enough tax savings to offset the trading costs involved. As described above, a typical tax-loss harvest calls for four trades: There’s one trade to sell the original holding and another to stay invested in the market during the waiting period dictated by the IRS’s wash sale rule. After that, there are two more trades to sell the interim holding and buy back the original position.

Market volatility – When the time comes to sell the interim holding and repurchase your original position, you ideally want to sell it for no more than it cost, lest it generate a short-term taxable gain that can negate the benefits of the harvest. We may avoid initiating a tax-loss harvest in highly volatile markets, especially if your overall investment plans might be harmed if we are unable to cost-effectively repurchase your original position when advisable.

Tax planning – While a successful tax-loss harvest shouldn’t have any impact on your long-term investment strategy, it can lower the basis of your holdings once it’s completed, which can generate higher capital gains taxes for you later on. As such, we want to carefully manage any tax-loss harvesting opportunities in concert with your larger tax-planning needs.

Asset location – Holdings in your tax-sheltered accounts (such as your IRA) don’t generate taxable gains or realized losses when sold, so we can only harvest losses from assets held in your taxable accounts.

Adding Value with Tax-Loss Harvesting

It’s never fun to endure market downturns, but they are an inherent part of nearly every investor’s journey toward accumulating new wealth. When they occur, we can sometimes soften the sting by leveraging losses to a client’s advantage. Determining when and how to seize a tax-loss harvesting opportunity, while avoiding the obstacles involved, is one more way we seek to add value to our clients’ end returns and to their advisory relationship with us. Let us know if we can ever answer any questions about this or other tax-planning strategies you may have in mind. Feel free to give us a call at 203-985-0448.

[Photo Credit: Flickr user B. Gilmour]

Post-Election Reflections

November 10th, 2016 Posted by Investor Behavior, Politics 0 thoughts on “Post-Election Reflections”

Whether you’re feeling elated, deflated or mostly just jaded about what just happened in the U.S. elections, we wanted to share a few thoughts related to the “What’s next?” that may be on your mind.

First, a word: There are more than enough political analyses available from even a single Google search, so we won’t enter into that fray ourselves.

With respect to our clients’ investments, here’s a quick reminder of how we feel about that: Ample evidence informs us that it is unwise to alter your well-thought-out, long-term investment strategy in reaction to breaking news, no matter how exciting or grim that news may seem, or how the markets are immediately responding.

As we saw with the unexpected outcome of this summer’s Brexit referendum, the biggest surprise may be how resilient markets tend to be, as long as you give them your time and your patience. In fact, early results indicate that the markets may already have priced in the possibility of the relatively long-shot outcome that occurred.

That said, if any of our clients want to make changes to their investment portfolio in the aftermath of Tuesday’s election, we urge them to be in touch with us first, so we can do the job they hired us to do. Specifically, they can count on us to advise and assist them based on our professional insights, their personal goals and – above all – their highest financial interests.

In the meantime, consider these words by billionaire businessman and “stay put” investor Warren Buffett, from his 2012 letter to Berkshire Hathaway shareholders:

“America has faced the unknown since 1776. It’s just that sometimes people focus on the myriad of uncertainties that always exist while at other times they ignore them (usually because the recent past has been uneventful). American business will do fine over time. And stocks will do well just as certainly, since their fate is tied to business performance. Periodic setbacks will occur, yes, but investors and managers are in a game that is heavily stacked in their favor. … The risks of being out of the game are huge compared to the risks of being in it.”

Buffett published these sentiments on March 1, 2013, shortly after the last presidential election cycle. If you review the volume of his writings, you’ll find that he has expressed similar viewpoints on many occasions and through many markets, fair and foul.

Presidential terms are four years long. If you are one of our clients, your investment portfolio has been structured to last a lifetime. Remember that as you consider your personal “What next?” … and please call us if we can assist. And if you are not our client, we still encourage you to give us a call at 203-985-0448. We’d be happy to answer your questions.

Structured CDs: Buyer Beware!

September 29th, 2016 Posted by Investment Strategy, Investment Vehicles, Investor Behavior 0 thoughts on “Structured CDs: Buyer Beware!”

Most investors are familiar with Certificates of Deposit (CDs). You purchase one, and the bank pays you a bit of interest on it, plus your principal back. They don’t yield much, but they’re nearly as dependable as it gets. As such, CDs can often serve as sensible tools for offsetting the risk inherent to pursuing higher expected returns in the stock market.

Wall Street’s product pushers, however, have figured out a way to swipe the name from this traditional household workhorse and turn it into a monster money-maker … for themselves, that is. We’re talking about “structured” or “market-linked” CDs. The name may seem familiar, but the rules of engagement are quite a bit different.

A recent Wall Street Journal article, “Wall Street Re-Engineers the CD – and Returns Suffer,” exposed the ways that big banks are peddling these products. It starts with a tempting pitch that goes something like this: As long as you hold the product to maturity, your principal is returned. If the stock market goes up (as defined by whatever market “basket” the providers happen to choose) you also receive a percentage of the increase.

At a glance, what’s not to like about this sort of “heads you win, tails you don’t lose” appeal? Unfortunately, there are usually plenty of traps lurking in the fine print. Positive returns are typically capped to single-digit annual percentages, while negative returns can plummet much more steeply before they’ll no longer impact your end returns. And the fees can run into multiple percentage points of the structured CD’s face value.

The WSJ article reports (emphasis ours): “The adviser who actually sells the [structured] CD, for example, can get commissions of up to 3% of the CD’s value, according to information sent to brokers reviewed by the Journal. ‘Banks have to be delighted with these structured products,’ said Steve Swidler, a finance professor at Auburn University. ‘There’s virtually no risk to them, and [the banks] sit back and rake in fees.’”

It may be easy to overlook the significance of these costs and imbalances, especially if you’ve decided that you’re okay with paying extra for the promise that you will not lose your nest egg. But in fulfilling their role as a safe investment, structured CDs can be more than a little skewed in favor of the big banks. From the WSJ article:

 

  • “[O]f the 118 structured CDs that were issued at least three years ago, only one-quarter posted returns better than those of an average five-year conventional CD. And roughly one-quarter produced no returns at all as of June 2016.”
  • “[M]arket-linked CDs issued since 2010 by Bank of the West … revealed a similar pattern. Sixty-two percent produced returns lower than an investor would have received from a five-year conventional CD, while almost a quarter have yet to pay any return at all.”

 

Given how many other far less complex and costly ways there are to expect similar results, why start with an uphill climb? The WSJ article noted how one investor, a 79-year-old widow, was shocked to see her $100,000 investment immediately drop to $95,712 after incurring upfront fees. The fees had been disclosed in the 266-page description that came with her purchase, but she hadn’t read it. Would you have?

“This was not a CD as I know a CD,” she complained.

Our preferred approach?

  • Insist on transparent costs and clear, understandable performance reports.
  • Be highly skeptical of one-off products that promise both higher returns and lower risks. There are almost always expensive tricks and traps lurking in the fine print.
  • Focus instead on investing according to a well-thought-out, customized plan that positions your total portfolio to reflect your long-term goals and risk tolerances.

These essential concepts may not be fancy or new-fangled, but unlike those allegedly higher returns that a structured or market-based CD is supposed to deliver, they’re far more likely to see you through to your own end goals.

Questions? We would welcome your call at 203-985-0448.

 

What If Everyone Were an Evidence-Based Investor?

September 16th, 2016 Posted by Investment Vehicles, Investor Behavior 0 thoughts on “What If Everyone Were an Evidence-Based Investor?”

For as long as we’ve been in business, we have encouraged investors to adopt a patient, long-term approach to capturing the market’s expected returns. In industry parlance, some have categorized our approach as “passive,” versus active attempts to beat the market. We prefer to think of ourselves as evidence-based.

Call it what you will, a frequently asked question remains.

What if everyone were a passive investor? Wouldn’t the markets collapse?

The question has resurfaced in a recent AllianceBernstein client note entitled “The Silent Road to Serfdom: Why Passive Investing is Worse Than Marxism.” Its authors reportedly proposed that a “supposedly capitalist economy where the only investment is passive is worse than either a centrally planned economy or an economy with active market led capital management.”

If every investor embraced evidence-based investing, it is true that markets as we know them would cease to exist. But does that put passive investing on level with Marxism, or worse?

Is passive investing “unfair” or bad for the economy?

In “Indexing Is Capitalism at Its Best,” AQR Capital Management’s Cliff Asness counteracts the presumption that passive investing is an enemy to free market economies: “[T]he use of price signals by those who played no role in setting them may be capitalism’s most important feature. … That most of us and most of our dollars don’t have to pick stocks, or to price air conditioners, is a great benefit and taking advantage of it makes us honest smart capitalists, not commissars.”

In other words, we arrive at relatively efficient “supply and demand” pricing in our capital markets the same way we do in any other market around the world. Whether it’s for stocks or socks, donuts or dollars, all it should take is a handful of active, engaged players to create relatively fair pricing that interested buyers and sellers can agree to.

It’s also interesting to note that the players who object the most to allegedly free-loading passive investors are usually the same ones whose profits are being squeezed down by the market forces at work when passive investors avoid hyperactive trading costs.

In his review of the note, Morningstar’s John Rekenthaler observed: “Whenever active investment managers write about indexing, the suspicion arises that they arrived at the conclusion first, then searched for their reasons later. This AllianceBernstein paper does nothing to change that view.”

How many active investors does it take to keep the markets chugging along?

There is no definitive answer on how many active investors are required to set reasonable trading prices. In his ETF.com column, financial author Larry Swedroe explains that passive investors “receive all the benefits from the role that active managers play in making the financial markets efficient without having to pay their costs. In other words, while the prudent strategy is to be a passive investor, you don’t want everyone to draw that conclusion.”

Swedroe suggests that “at least 90% of the active management industry could disappear and the markets would remain highly efficient.” Vanguard founder John Bogle (who launched the world’s first public index fund) also has estimated that a 90% passive market should be sustainable. Burton Malkiel, author of the classic, “A Random Walk Down Wall Street,” has set the number even higher. “[W]hen indexing is 95 percent of the total, I might start to worry about that,” he says. “But I think with indexing [at] 30 to 35 percent of the total, there is [sic] still plenty of active managers out there to make sure that information gets reflected quickly. And in fact I think it’ll always be the case.”

How plausible is it that we’ll reach a breaking point, with too many passive investors?

Malkiel’s comments bring up another good point. Let’s say we’re wrong. What if, to remain relatively efficient, the markets need a lot more active players than we’re suggesting?

We’re still not worried about it.

Echoing Malkiel’s estimates, Swedroe observes of the U.S. markets: “Despite their growing share of the market (passive funds now control perhaps one-third of all assets under management), they still account for only a small percentage of trading activity. According to a Vanguard spokesman, on a typical day, only 5–10% of total trading volume comes from index funds.”

In other words, there are still plenty of active trades taking place for effective pricing, and there is good reason to believe that this necessary level of price-setting will persist indefinitely.

Behavioral finance is alive and well. The study of behavioral finance informs us that investors are, after all, only human, and are often driven by chemically generated instincts and emotions that have nothing to do with solid evidence and rational decisions. We see examples of this every time investors chase the latest trend or flee real or perceived risk en masse. Behavioral traits such as herd mentality, recency, and tracking-error regret take over, and are reflected in the market’s prices. This is not passive investing; it’s active. And it appears to have remained highly pervasive, among individual and institutional investors alike.

Capitalism is also alive and well. In their purest sense, “active” and “passive” investing represent opposite extremes on a vast spectrum of possibilities. A wholly passive investor would simply buy and hold the entire market and accept its returns. A fully active investor would always seek to trade profitably by forecasting future prices.

In reality, most investors are neither fully passive nor fully active. They are often more one or more the other, especially when we consider global markets. This means we should expect price-setting participants to remain a substantial force in the markets … regardless of what we call them, and which label may be more prevalent.

As Malkiel observes: “That’s the wonderful thing about capitalism. If you have free markets and somebody can jump into the markets if there is an opportunity, you can count on the fact that somebody will. … If in fact it was the case that markets were getting less and less efficient in reflecting information, believe me, there would be a profit motive for somebody to jump in.”

Evidence-Based Investing in Capital Markets

Where does that leave an evidence-based investor? To help us chart a sensible course in an environment where even our own instincts can steer us wrong, we turn to the best evidence we can find on how to effectively manage our money in markets that mostly set fair prices.

Practically speaking, that evidence informs us that generating long-term returns calls for a patient approach, focused on managing the market risks involved, minimizing unnecessary costs, and avoiding the many behavioral traps that otherwise lead investors astray.

If we can serve you by helping you invest according to these and similar principles – if we can serve your highest interests and personal financial goals – we believe you can expect that the capital markets will continue to serve you well, as well. If you have any questions, please give us a call at 203-985-0448.

Presidents, Politics, and Your Portfolio: Thinking Beyond Stage One

August 31st, 2016 Posted by Investment Strategy, Investor Behavior, Politics 0 thoughts on “Presidents, Politics, and Your Portfolio: Thinking Beyond Stage One”

It’s no surprise that this year’s U.S. presidential race has become a subject of conversation around the globe. In “Why Our Social Feeds are Full of Politics,” Canadian digital marketing executive Tara Hunt observes, “American politics, it seems, makes for high-intensity emotions far and wide.” The intensity will probably only increase as the November 8 election date nears.

We are by no means endorsing that you ignore what is going on in the world around you. Politics and politicians regularly and directly affect many aspects of our lives and our pocketbooks. But as you think through this year’s raucous race, remember this:

The more heated the politics, the more important it is to establish and maintain a well-planned, long-term approach to managing your investments.

So go ahead and talk politics all you please – and if you are an American, be sure to vote. But when it comes to your investments, it’s best to ignore any intense emotions and the dire or ebullient predictions that spring from them, as dangerous distractions to your financial resolve.

Thinking in Stages

Have you ever heard of stage-one and stage-two thinking? They’re terms popularized by economist Thomas Sowell in his book, “Applied Economics: Thinking Beyond Stage One.” Basically, before acting on an event’s initial (stage one) anticipated results, it’s best to engage in stage-two thinking, by first asking a very simple question:

“And then what will happen?”

By asking this question again and again, you can more objectively consider what Sowell refers to as the “long-run repercussions to decisions and policies.”

Investing in Stages

In investing, we see stage-one thinking in action whenever undisciplined dollars are flooding into hot holdings or fleeing immediately risky business. Stage-two thinking reminds us how often the relationship between an event and the world’s response to that event is anybody’s guess and nobody’s certain bet. A recent Investopedia article, “Does Rainfall in Ethiopia Impact the U.S. Market?” reminds us how market pricing works:

“No one knows how any of these events will impact markets. No one. That includes financial advisors who have access to complex computer models and investment strategists in the home office with cool British accents. They don’t know, but their livelihood depends upon appearing to know. Few of them are ever held accountable for the innumerable predictions they got wrong. They simply move on to the next prediction, the next tactical move.”

Investors should avoid trying to predict future market pricing based on current market news.

Reflections on Presidential Elections

Stage-two thinking is especially handy when considering the proliferation of predictions for anything from financial ruin to unprecedented prosperity, depending on who will next occupy the Oval Office.

Again, the problem with the vast majority of these predictions is that they represent stage-one thinking. As financial author Larry Swedroe describes in a US News & World Report piece, “Stage one thinking occurs when something bad happens, you catastrophize and assume things will continue to get worse. … Stage two thinking can help you move beyond catastrophizing. … [so you can] consider why everything may not be as bad as it seems. Think about previous similar circumstances to disprove your catastrophic fears.”

In the current presidential race, we’re seeing prime examples of stage-one thinking by certain pundits who are recommending that investors exit the market, and sit on huge piles of cash until the voting results are in. At least one speculator has suggested that investors should move as much as 50 percent of their portfolio to cash!

And then what will happen?

Here are some stage-two thoughts to bear in mind:

  • Regardless of the outcome of the election, there’s no telling whether the markets will move up, down or stay the same in response. By the time they do make their move, the good/bad news will already be priced in, too late to profit from or avoid.
  • In the long run, the market has moved more upward, more often than it moves downward, and it often does so dramatically and when you least expect it.
  • Moving to cash would generate trading costs and potentially enormous tax bills. Worse, it would run contrary to having a sensible plan, optimized to capture the market’s unpredictable returns when they occur, while minimizing the costs and manageable risks involved.

In this or any election, stage-two thinking should help you recognize the folly of trying to tie your investment hopes, dreams, fears and trading decisions to one or another candidate. Politics matter – a lot – but not when it comes to second-guessing your well-planned portfolio. If you still have questions, please give us a call at 203-985-0448.