Posts in Foreign Investing

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Compared to actively managed funds that seek to “beat” the market by engaging in these now-outdated speculative strategies, passively managed index funds offer a more solid solution for sensibly capturing available market returns.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

No Reason to Fear Brexit – Why We Prepare and Don’t Panic

June 30th, 2016 Posted by Economics, Foreign Investing, Investor Behavior, Politics 0 thoughts on “No Reason to Fear Brexit – Why We Prepare and Don’t Panic”

Throughout the first part of last week, polls in Europe predicted that the U.K. would choose to remain a member of the European Union (EU). Global stock markets rallied based on those forecasts. However, the opposite happened. The U.K. will spend the next two years determining how to disengage from the EU.

The “Brexit” vote is a perfect example of why we do not make investment decisions based on predicting or forecasting the future. What we do is PREPARE and PLAN for the unexpected. One way we do that is by owning high-quality U.S. bonds, CDs, bond funds and Treasury securities in all client accounts. When the unexpected happens in the financial markets, money leaves risker assets, like stocks, and flows into the safety of high-quality fixed income investments. The U.S. dollar improves. Global interest rates fall. Bond prices rise. Stocks decline.

So what? Now what?

Larry Swedroe, our Director of Research through the BAM ALLIANCE, recently shared some sage advice in an article he wrote on what to do in a similar situation. To summarize:

Avoid making things worse. Do not focus on the bad news and spiral downward into a cycle of negativity about the future. This cycle begins with a perfectly reasonable worry that snowballs into a perceived catastrophe. Do not go there. This emotional state leads to indecisiveness, and that causes investors to abandon well-conceived plans and investment discipline.

Imagine a positive outcome. Find the silver lining in the dark clouds. For example, European stock valuations are now more attractive than U.S. stocks. Lower valuations point to higher future returns for long-term investors. European stocks have positive earnings momentum, whereas U.S. stock earnings are close to a peak. European central banks will be providing increased liquidity while the Federal Reserve is less accommodative. Negative interest rates in Europe will cause investors to move into stocks once the dust settles.

Engage in “stage-two thinking” not “stage-one thinking.” “Stage-one” thinking perceives the risk in a crisis but cannot see beyond the event, so the stomach takes over investment decisions. On the other hand, Warren Buffett engages in “stage-two” thinking. He expects that a crisis will in turn lead governments and central bankers to come up with solutions to address the problem. While he doesn’t know specifically what those actions will be, he knows that the greater the crisis, the greater the response is likely to be. That allows him to see beyond the crisis at hand, enabling his head to keep control over his stomach and his emotions.

So what? Now what? There is no reason to fear the U.K.’s decision to leave the European Union, but expect that increased volatility will present opportunities to rebalance portfolio allocations into global stocks at lower valuations, thus providing the potential for higher future returns.

[Photo Credit: Flickr user James Cullen]

Brexit Votes and Market Outcomes

June 28th, 2016 Posted by Economics, Foreign Investing, Investment Strategy, Investor Behavior, Politics 0 thoughts on “Brexit Votes and Market Outcomes”

Here at OpenCircle, we get it. Following the Brexit referendum and its startling outcome, it’s hard to view current news without feeling your stomach twist over what in the world is going on. Whenever the markets shift dramatically downward, your instincts deliver a sense of unrest ranging from discontent to desperation.

Financial author Larry Swedroe has called this your GMO response: Get me out! The Wall Street Journal personal finance columnist Jason Zweig explains it this way: “Losing money can ignite the same fundamental fears you would feel if you encountered a charging tiger, got caught in a burning forest, or stood on the crumbling edge of a cliff.”

Basically, you can’t help it. These sorts of responses are being generated by basic reflexes in your brain, over which you literally have no control.

What’s Next?

So, first, take a breath. Now another one. Next, remember that there is a fine line between remaining informed about global goings on, versus letting an onslaught of news take over your brainwaves and trick you into rash reactions.

In that context, it doesn’t take long to realize that the Brexit news raises myriad questions, with few swift and comforting answers currently available.

In lieu of fixating on the bounty of in-depth analyses (when in reality the answer to exactly what is coming next is: “Who knows?”) it’s worth remembering that capital markets have been encountering and absorbing startling news for centuries. When viewed close up, the mechanics can be ear-piercingly loud, but they actually have a history of working marvelously well in the long run – at least for those who heed the evidence on how to participate in the upside rewards while managing the inevitable downside risks.

What Should You Be Doing?

If you are one of our clients, you know that we work to accurately position your portfolio to withstand high market risk when it occurs. This means that you have already prepared as best you’re able. And at this time you should be doing very little… which we understand, can be one of the very hardest things to (not) do. So let’s talk about that.

While the outcome of the Brexit referendum is certainly new and different, its impact on the market is old hat. These are the sorts of events we have in mind when we prepare and manage our clients and their portfolios. Using global diversification, effective asset allocation and careful cost management, the goal has been – and remains – the same. Our aim is to expose our clients to the market risks and expected returns they need for building or preserving their wealth, while minimizing over-concentration in any one holding. That way, they are best positioned to avoid bearing the “Ground Zero” worst of it when market crises do occur.

Even so, the unfolding events may cause some people to realize that they aren’t as keen as they thought they were on bearing market risk. Real life is very different from theoretical exercise.

If this is the case, we get that too. Still, we would strongly suggest that this is no time to act on those insights. In fact, it’s likely to be the worst time to do a “GMO.” First, it is likely to incur significant avoidable financial loss. Plus, while it may temporarily feel better to have “done something,” it leaves you with no plan for the future. That can generate more chronic unhappiness than it briefly relieves. Life is too short for that!

If you have a solid plan, but are still having your doubts, consider your current feelings an important and valuable insight about yourself, but please, please sit tight for now. Do give us a call right away, though, and we’ll explore how best to ratchet down your investment risk sensibly and deliberately. And if you are not our client and don’t believe you have a solid plan, give us a call about that, too.

In short, as an advisor, we’re all about safeguarding our clients’ best financial interests. We remain here for them as always. We hope you’ll let us know how you are holding up, and what questions we can answer about the unfolding news. Market analyses aside, we are living in “interesting” times, and would love to chat further with you about them, one on one. We look forward to hearing from you at 203-985-0448.

How to Respond to China’s Impact on Global Markets

January 7th, 2016 Posted by Economics, Foreign Investing, Investment Strategy, Investor Behavior, Sectors 0 thoughts on “How to Respond to China’s Impact on Global Markets”

Events in China have had an impact on the beginning of the New Year, and we’re not talking about fireworks. There has been concern for months about China’s economy, as we have watched a slowing down of growth. And just as we rang in 2016, there was some media drama around China’s stock market plunge and the negative reaction that was evident in our own US markets. Now, even as China’s government takes steps to stabilize the situation, people are wondering how they should respond individually, if at all.

The simple answer is, as always, stay calm. We have talked previously about having a well-thought-out financial plan and sticking to it. This mindset is as valid as ever.

Back in August of 2015, CNBC ran a piece by Jim Pavia about market volatility amid doubts about China. In it he interviewed Manisha Thakor, a member of CNBC’s Financial Advisor Council. As our Director of Wealth Strategies for Women via the BAM Alliance, she always talks to our clients about being prepared for market fluctuations.

“I explain how the money [clients] have in stocks is, by definition, money they don’t need to spend in the near term,” Manisha said in the August piece. “If they needed to spend it near-term, we would never have put it in stocks to begin with; it would have been allocated to high-quality fixed income.”

Manisha is also a member of the Wall Street Journal’s Wealth Experts’ Panel. On December 18, 2015, the WSJ posted Manisha’s article, “What Investors Should Have Learned from Recent Market Volatility.” The article is still so relevant that it could have been written yesterday. For your convenience, we are sharing excerpts here:

For me, the biggest lesson of 2015 was the vital importance of having a written investment policy statement. During August, I noticed that individuals who had a clear, concise and documented plan were least likely to have a knee-jerk (and all too often ill-timed) reaction to wild market movements….

I suspect investors with an investment policy statement were more likely to stay the course because they had a deep understanding of, and comfort with, the risk they were taking in their portfolios.

Developing this understanding before a period of volatility hits is the key. Just as the time to network is before you need to utilize a connection, the time to understand why your portfolio is constructed in the way that it is comes before that construction gets put through an inevitable patch of volatility.

What will 2016 hold? As my colleague, Larry Swedroe, says, “Ignore all forecasts. All crystal balls are cloudy.” He means that no living person on the planet knows with certainty what will happen in the future. That said, as we head into 2016, we’ll be watching and preparing for events that may include:

– Interest-rate hikes

– A rising dollar

– Recession in non-U.S. developed markets

– Falling commodity prices negatively impacting emerging markets

– The one thing we can always expect–the unexpected

Against this backdrop, it is likely that the VIX (a measure of the volatility of the market) will continue to rise and investors’ convictions in their investment plans will continue to be tested. So, if [recent events] made your stomach plunge along with the markets, it’s time for you to create or revisit your written investment policy statement.

You can read more about Manisha Thakor on our website.

To learn more about creating or reviewing your own written investment policy, please give us a call at OpenCircle, 203-985-0448.

[Photo credit: Flickr user John Keogh]