Posts in Asset Allocation

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Compared to actively managed funds that seek to “beat” the market by engaging in these now-outdated speculative strategies, passively managed index funds offer a more solid solution for sensibly capturing available market returns.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]


Reflections on Real Estate Investing

August 4th, 2016 Posted by Asset Allocation, Foreign Investing, Homes and Mortgages, Investment Strategy, Investment Vehicles, Investor Behavior, Loans and Debt 0 thoughts on “Reflections on Real Estate Investing”

Just as the natural world around us comes from the elements found in the periodic table of elements, capital markets are made up of asset classes, broadly organized into stocks, bonds, and hard assets like commodities and real estate.

As elemental as asset classes are to investing, it may make sense to include some real estate investments in your globally diversified portfolio. That said, as with any investment, there are better and worse ways to go about implementing an otherwise sound strategy … with a lot of misleading misinformation out there to add to the confusion.

If you intend to invest in the market’s risks and potential rewards with informed discipline rather than as a speculative venture, most of the same principles apply, whether it’s for real estate or any other asset class. To help you avoid hanging out with the wrong elements (so to speak), let’s review those essential guides.

Seek Global Diversification

As with stocks, it’s wise to spread your real estate risks around by diversifying the number and types of holdings you own. By diversifying your holdings across a number of investments and a mixture of property types, you are best positioned to earn the returns that the asset class is expected to deliver, without being blindsided by holding-specific risks such as property damage, deadbeat tenants or unscrupulous property managers.

One way to achieve diversification is through a well-managed, low-cost Real Estate Investment Trust (REIT) fund, or a “fund of funds” combination of multiple REIT funds. As one REIT fund prospectus describes, this enables you to own hundreds of properties across a diversified range of domestic and global companies “whose principal activities include ownership, management, development, construction, or sale of residential, commercial or industrial real estate.”

Understand the Risks and Expected Rewards

Why bother with real estate? The magic word is “correlation.” As Forbes contributor Frank Armstrong III wrote in 2013, “It’s really nice in times of volatile markets like now to have an asset class that may zig when traditional stocks and bonds zag. An asset with low correlation to others in your holdings can both reduce risk at the portfolio level and increase returns.”

In his July 2016 column, “The best performing asset class no one talks about,” Reformed Broker Josh Brown observes that, “Going back to the year 2000, REITs are the best performing asset class in the market, according to JP Morgan, up 12% on an average annual basis. … [I]t’s weird that people generally don’t focus on them.”

So, real estate can serve as a stabilizing force and a source of returns in your portfolio. But, like any investment, potential rewards are accompanied by notable risks.

  • Taxes – Real estate investing tends to be relatively tax-in Domestic and international tax codes vary and change, with different treatments required for different kinds of real estate investments. Due to potentially unfavorable tax treatments on distributions, they are best located in your tax-sheltered accounts, lest the taxes incurred exceed the benefits.
  • Liquidity – Unlike publicly traded stocks, which can usually be traded with relative ease in busy markets, real estate ventures can be relatively illiquid investments that don’t always lend themselves to being bought and sold on a dime. This can be tricky for an individual investor purchasing them directly. It also can impact a fund investor. If the fund manager is forced to place ill-timed trades to meet popular demand, the trades can be costly for all shareholders.
  • Volatility – Although an allocation to real estate can contribute to decreased volatility in your overall portfolio, the asset class itself typically exhibits a wide range of performance along the way. Some providers may try to mask this reality by playing fast and loose with their reporting strategies, but you really should expect a relatively bumpy course with your real estate holdings, whether or not it’s being reported to you as such.

Investors discovered these risks in 2007–2009 when a U.S. and U.K. housing market collapse generated a global credit crisis. Investors had been treating any and all real estate prices as sure bets, despite the underlying risks involved. We’re seeing these risks play out again in the U.K.: Due to heavy sell-offs, investors in Open Ended Property funds are discovering that the return “smoothing” they thought they were enjoying may have been built on a house of cards. As one columnist observed: “Just because risk is not immediately visible, does not mean it isn’t there.”

Select an Appropriate Allocation – for You

In light of its potential returns and known risks, evidence-based investment strategy suggests that stocks and bonds are typically the staples in most investors’ portfolios, with real estate acting more as a flavor-enhancing ingredient.

Beyond this general rule of thumb, your personal circumstances also may influence the allocation that makes sense for you. For example, if you are a real estate broker, or you own a rental property or two as a side business, you may want to hold less real estate in your investment portfolio, to offset the real estate risks that you’re already exposed to elsewhere.

Incidentally, we suggest you avoid treating your home as a real estate investment. If it happens to appreciate over the years, that’s great. But don’t forget that its highest purpose is to provide you and your family with a dependable roof over your heads. This is one of several reasons your home is best thought of as a consumable expense rather than a reliable source of investment returns. At the very least, you do not want to over-expose your home to the risk of loss.

Manage the Costs

As always, the less you spend on your investments, the more returns you get to keep. Given that there are well-managed REIT funds that offer relatively cost-effective and efficient exposure to the asset class being targeted … why would you choose a more complicated alternative where the costs may be both insidious and excessive?

Adopt a Long-Term Perspective

While it can often make sense to include real estate in your globally diversified portfolio, the advantages are accompanied by portfolio performance that may often deviate from “the norm.” That’s by design, to help you achieve your own financial goals, not some arbitrary norm. Given these practical realities, it’s essential to embrace a patient, long-term approach to participating in real estate’s risks and expected returns. If your time horizon or risk tolerance isn’t in line with such an approach, you may be better off without the allocation to begin with.

Use Investment Vehicles That Best Complement All of the Above

If an allocation to real estate makes sense for you and your financial goals, the final ingredient to successful application is to select a fund manager whose strategies align with yours. Look for a fund that clearly discloses the investments held, the approach taken, the risks realized, and the costs incurred. Consider a provider who scores well on all of these counts; offers diversified exposure to domestic and global markets; and appeals to disciplined investors like yourself, who are less likely to panic and force unnecessary trading during times of stress.

Also, note that you may already be invested in real estate without knowing it. It’s not uncommon for a stock or hybrid fund to include a shifting allocation to real estate. Unless you read the fine print in the prospectus, it’s hard to know just what you hold, in what amounts.

Ask for Help

Is real estate investing right for you? If it is, how much should you invest in, which holdings make sense for you, which account(s) should hold which assets, and how can you maintain control over your target allocations? These are the kinds of questions we cover when helping investors with their real estate investments, embracing each family’s highest interests as our personalized guide. Please be in touch at 203-985-0448 if we can help you with the same.

[Photo Credit: Flickr user thinkpanama]

Does Diversification Still Work?

February 9th, 2016 Posted by Asset Allocation, Economics, Investment Strategy, Investment Vehicles, Investor Behavior, Stock Options 0 thoughts on “Does Diversification Still Work?”

When building an investment portfolio, you have often heard that you should consider your time horizon, risk tolerance and rate-of-return objective. You should also consider diversification in the allocation of assets. But given recent volatility, is diversification still a good idea?

We just completed the second consecutive year when US large-cap (large companies) stocks outperformed most other asset classes, including US small-cap (small companies) stocks, US value (distressed companies) stocks and international stocks. This development has led some investors to wonder whether diversification still works. We believe diversification should remain an essential part of a well-devised, long-term investment plan, and that investors should resist the temptation to re-allocate their portfolios toward strategies with high recent performance. Research shows that basing a current investment strategy on past performance typically leads to poor future performance because of the difficulty of successfully timing markets.

US large-cap stocks (using the S&P 500 as a proxy) had substantially higher returns in 2015 than most other equity asset classes. This performance is at odds with longer-term historical returns data, which show that both small-cap stocks and value stocks tend to earn higher returns than large-cap stocks. We continue to believe that portfolio tilts toward small-cap and value stocks are the most reliable way to enhance expected return. Such tilts, however, can go through periods of underperformance, in the same way that stocks can underperform bonds for extended periods of time. This underperformance of small-cap and value stocks is what investors experienced over 2014 and 2015.

Over the very long term, US and international stocks have tended to have similar returns, although performance can diverge significantly over other periods of time. In each decade starting in the 1970s, US stocks have significantly outperformed international stocks or vice versa. We now see some investors tempted to increase their allocation to US stocks after a period of strong performance. But will the outcome be better than moving more heavily into international stocks after the 80s? We don’t think so and would instead argue that the best approach is to maintain a long-term, substantial allocation to both US and international stocks, since no one knows which will outperform the other over the long term. Concentrating in only one country is not a prudent approach to portfolio diversification.

Market Timing

The temptation is to believe that seemingly long periods of past performance tells us something about future performance. What we know, however, is that it is very difficult for either individual investors or professional investors to successfully execute market-timing strategies precisely because past returns data tells us very little about the future.

A common strategy is to look back over three- or five-year performance periods and re-allocate assets into strategies that have performed well over those windows of time. This behavior is referred to as “returns chasing” and, unfortunately, is still a common method investors use to make portfolio decisions. But when we examine past evidence from 1931 forward, we see that the timing strategy would have earned markedly lower returns than the more straightforward approach of allocating assets equally across the four asset classes.


Although many investors have gone through a recent period of underperformance relative to market benchmarks like the S&P 500, we believe that broad diversification remains a crucial component of a well-thought-out investment plan. The long-run evidence shows that such periods will indeed happen, but investors are best served to avoid the urge to engage in returns-chasing behavior. Strategies that chase high recent performance tend to reduce – not increase – long term performance.

[Photo credit: Flickr user Team Dalog]

What Do You Think About Gold?

September 4th, 2015 Posted by Asset Allocation, Investment Strategy, Investment Vehicles, Investor Behavior, Saving 0 thoughts on “What Do You Think About Gold?”

I was playing golf with a retired dentist the other day and he asked me about investing in gold. It turns out he had been purchasing large positions in gold in his retirement account, because he believed that this would protect him from inflation and serve as a currency hedge. He was clearly convinced that gold was the best place to put his retirement capital.

This was not the first time I have been approached on this subject. I often get asked about gold as an investment option. These are the questions I usually hear:

  • Is gold a smart inflation hedge?
  • Is gold a good currency hedge?
  • Is gold a safe haven during a bear stock market?
  • What is the story behind the gold supply?
  • What about the long-term picture for gold?

You may hear answers to these questions that encourage you to invest in gold. If they sound too good to be true, they probably are. In any case, I urge you to look further before you leap. And in a moment I’ll recommend some worthwhile reading on the subject.

But first I have a funny story about an advisor I work with. He was in the operating room of the hospital, about to have surgery. The anesthesiologist knew that he was a financial advisor. As my friend was “going under,” the anesthesiologist (clearly looking for a short answer) asked him about investing in gold. The last thing this advisor remembers doing before he went to sleep was to shout (perhaps it was more of a mumble), “No gold!” My friend not only lived to tell about it, but I’m happy to report that the surgery was a success. I hope things turned out as well for the anesthesiologist.

So now to some more detailed answers to the questions about gold. Our Director of Research through the BAM ALLIANCE, Larry Swedroe, has studied this issue in depth and has carefully examined some common misconceptions about investing in gold. He has written an excellent article about it for and it addresses all the questions I raised before. It’s called “Why All the Interest In Gold?” and I suggest you read it.

If you are looking for more answers, you can find all kinds of material online about respected investor Warren Buffett and his simple wisdom about gold. Some of his views that I share are:

  • Gold is not an income-producing investment.
  • Investing in gold plays on fear.
  • Gold will not yield a crop or lay eggs.
  • An ounce of gold will always be an ounce of gold.
  • Gold must be stored and insured.

At the end of the day, the decision to invest in gold is yours, but it should be part of a well-thought-out investment plan. Learn how OpenCircle’s investment strategy helps our clients create their financial plans.

The Market Sell-Off May Not Be Such a Bad Thing

August 26th, 2015 Posted by Asset Allocation, Economics, Investment Strategy, Investor Behavior, Sectors, Stock Options 0 thoughts on “The Market Sell-Off May Not Be Such a Bad Thing”

There are two important things to remember as an investor. One, have a well-thought-out written plan. Two, stick to your plan. This second point is especially important when the market is experiencing the sort of ups and downs such as we have seen in the last week.

I was happy to see The New York Times spreading a similar message in their lead story on the front page of their Business section on August 22. In “This Week’s Market Sell-Off May Not Be Such a Bad Thing”, Neil Irwin gives readers a healthy perspective. He writes, “If you step back a bit, what has happened in financial markets this week looks less like a catastrophe in the making and more like a much-needed breather when various markets had been starting to look a little bubbly.”

Irwin goes on to discuss some explanations for the sell-off, but says, and I agree with him, that “those explanations, while accurate, are part of a bigger story.” While the drop seems dramatic in the short-term, it looks like a minor adjustment in the long-term, especially in view of the market run-ups since 2009.

One thing that is certain is that markets fluctuate. There will always be downward slips. But the evidence proves that the general trend over time is upward, and occasional drops may serve to keep the upward trend within a sustainable range.

I was also glad to see Ron Lieber’s article on the same front page of the August 22 New York Times Business section. In “Pension Advisers Learn the Folly of Trying to Beat the Market,” he profiles two pension advisers for the State of Nevada who are very careful not to gamble with their client’s investments. In fact, Steve Edmundson and Ken Lambert go trail running to avoid making emotion-driven decisions.

Edmundson and Lambert don’t try to outperform the market. “According to Lambert,” Lieber writes, “a pension fund manager (and an individual investor) has to begin any strategic analysis with the acknowledgment that most investors who try to pick stocks or bonds that outperform their market segment will fail to do so over long periods.” I cannot stress this point enough.

OpenCircle avoids actively picking individual stocks or timing markets. We do not try to beat the market. We aim to capture market returns while minimizing taxes and expenses. We believe in creating a sensible written plan, and sticking to it. We agree with Irwin that you should “take a deep breath” and “appreciate the remarkable run-up of the last five years.” And if you still start to feel panicky, remember to keep your eye on the big picture. Thinking in the long term is key.