Posts in Stock Options

Survivorship Bias and Other Tricks of the Trade

July 21st, 2016 Posted by Economics, Investment Strategy, Investment Vehicles, Investor Behavior, Stock Options 0 thoughts on “Survivorship Bias and Other Tricks of the Trade”

One of the reasons we turn to evidence-based investing is to guide us past the misguided strategies that can otherwise cause an investor’s expected returns to run aground. That said, there is a lot of “evidence” out there. How do we determine which of it comes from sound science and which may steer you wrong?

Survivorship bias is one trick of the trade we must watch for when accepting or rejecting a performance analysis.

What Is Survivorship Bias?

Only the strong survive. This is a familiar adage because it’s often true – especially in our financial markets. That’s why it is important to remember the expression whenever we want to accurately assess a sample of past returns. Examples of a “sample” might be the returns from all actively managed U.S. stock funds during the past decade, or the returns from all global bond funds from 2000–2014.

Survivorship bias occurs when an analysis omits returns from in-sample funds that were closed, merged into other funds, or otherwise died along the way.

How Often Do Funds Go Under?

Some new funds are truly innovative, do well by their investors, and become familiar names. Less-sturdy ones may instead focus on trying to seize and profit from popular trends. For these, the expression “cannon fodder” comes to mind. They may (or may not) soar briefly, only to fizzle fast when popular appeal shifts.

In the competitive capital markets in which we operate, fund managers launch new products and discontinue existing ones all the time. Individual funds probably disappear far more frequently than you might think.

  • A recent S&P Dow Jones Indices analysis found that, for the five-year period ending in December 2015, “nearly 23% of domestic equity funds, 22% of global/international equity funds, and 17% of fixed income funds have been merged or liquidated.”[1]
  • As might be expected, the longer the timeframe, the higher the death rate. A January 2013 Vanguard analysis of survivorship bias looked at a 15-year, 1997–2011 sample of funds identified by Morningstar. The analysis found that 46 percent “were either liquidated or merged, in some cases more than once.”[2]
  • A May 2015 Pensions & Investments (P&I) article reported that Exchange-Traded Products (including ETFs) weren’t immune from the phenomenon either, having just reached the milestone of 500 products closed.[3] According to the “ETF Deathwatch” cited source, this represented a mortality rate of just under 23 percent.[4]
  • The same P&I piece cited Dimensional Fund Advisors and Vanguard analyses that estimated 15-year mortality rates for traditional U.S. mutual funds in the range of a 50/50 coin flip, or worse.[5]
  • A November 2015 article by financial columnist Scott Burns found similar survival rates for the 15-year period ending in 2014. “At the beginning of the period, there were 2,711 funds,” he reported. “At the end of the period, there were 1,139. Only 42 percent of the starting funds had survived.”[6]

Why Does Survivorship Bias Matter?

Why should you care about the returns of funds that no longer exist?

The funds that disappear from view are usually the ones that have underperformed their peers. The aforementioned Vanguard analysis found that, whether a fund was liquidated or merged out of existence, underperformance was the common denominator prior to closure.[7]

If these disregarded data points were athletes on a professional sports team, they’d be the ones bringing down their team’s averages. When assessing a team’s overall performance, it’s important to consider both the wins and the losses, right? Same thing with fund performance.

Instead, an analysis marred by survivorship bias is highly likely to report overly optimistic outcomes for the group being considered. While a degree of optimism can be admirable in many walks of life, basing your investment decisions on artificially inflated numbers is more likely to set you up for future disappointment than to position you for realistic, long-term success.

Moreover, survivorship bias is only one of a number of faults that can weaken seemingly solid reports. One way in which we at OpenCircle strive to add value to investors’ evidence-based investment experience is to help them separate robust data analysis from misleading data trickery. We hope you’ll be in touch if we can assist you with your own strategies and selections in a market that is too often rigged against the individual investor. Please give us a call at 203-985-0448. We look forward to speaking with you.

[1] Aye M. Soe, CFA, “SPIVA® U.S. Scorecard, Year-End 2015,” S&P Dow Jones Indices. Page 2.

[2] “The mutual fund graveyard: An analysis of dead funds,” The Vanguard Group, January 2013. Page 3.

[3] Ari I. Weinberg, “Learning from a walk through the fund graveyard,” Pensions & Investments, May 28, 2015.

[4] Ron Rowland, “500 ETF Closures,” Invest With an Edge, May 19, 2015.

[5] Weinberg, Pensions & Investments, May 28, 2015.

[6] Scott Burns, “The missing bullet holes problem,” The Dallas Morning News, November 13, 2015.

[7] “The mutual fund graveyard,” The Vanguard Group, January 2013. Page 2.

Investing for Retirement Income Part III: Total-Return Investing

March 24th, 2016 Posted by Investment Strategy, Investment Vehicles, Investor Behavior, Retirement Planning, Saving, Stock Options 0 thoughts on “Investing for Retirement Income Part III: Total-Return Investing”

As we’ve discussed in the first two parts of this three-part series, we do not recommend turning to dividend-yielding stocks or high-yield (“junk”) bonds to buttress your retirement income, even in low-yield environments. So what do we recommend? Today we’ll answer that question by describing total-return investing.

Part III: Total-Return Investing for Solid Construction

There are three essential variables that determine the total return on nearly any given investment:

  1. Interest or dividends paid out or reinvested along the way
  2. The increase or decrease in underlying share value: how much you paid per share versus how much those shares are worth now
  3. The damage done by taxes and other expenses

Total-Return Investing, Defined

Instead of seeking to isolate and maximize interest or dividend income – i.e., only one of three possible sources for strengthening your retirement income – total-return investing looks for the best balance among all three, as they apply to your unique financial circumstances. Which strategy is expected to give you the highest total return for the amount of market risk you’re willing to bear? Which is expected to deliver the most bang for your buck, in whatever form it may come?

If you’re thinking this seems like common sense, you’re on the right track. Last we checked, money is money. In the end, who wouldn’t want to choose the outcome that is expected to yield the biggest pot given the necessary risks involved? Why would it matter whether that pot gets filled by dividends, interest, increased share value, or cost savings from tax-wise tactics?

In “Total-return investing: An enduring solution for low yields,” The Vanguard Group describes the strategy as follows: “Many investors focus on the yield or income generated from their investments as the foundation for what they have available to spend. … The challenge today, and going forward, is that yields for most investments are historically low. … We conclude that moving from an income or ‘yield’ focus to a total-return approach may be the better solution.”

And yet, many investors continue to favor generating retirement cash-flow in ways that put them at higher risk for overspending on taxes, chipping away at their net worth and weakening the longevity of their portfolio.

We’re not saying you should entirely avoid dividend-yielding stocks or modestly higher-yielding bonds. With total-return investing, these securities often still play an important role. But they do so in the appropriate context of your wider portfolio management. Let’s take a look at that next.

The Related Role of Portfolio Management

The tool for implementing total-return investing is portfolio-wide investment management. Decades of evidence-based inquiry informs us that there are three ways to manage your portfolio (the sum of your investment parts) to pursue higher expected returns; more stable preservation of existing assets; or, usually, a bit of both. The most powerful strategies in this pursuit include:

  1. Asset allocation – Tilting your investments toward or away from asset classes that are expected to deliver higher returns … but with higher risk to your wealth as the tradeoff
  2. Diversification – Managing for market risks by spreading your holdings across multiple asset classes in domestic and international markets alike
  3. Asset location – Minimizing taxes by placing tax-inefficient holdings in tax-favored accounts, and tax-efficient holdings in taxable accounts

By focusing on these key strategies as the horses that drive the proverbial cart, we can best manage a portfolio’s expected returns. This, in turn, helps us best position the portfolio to generate an efficient cash flow when the time comes.

Your Essential Take-Home

Bottom line, there is no such thing as a crystal ball that will guarantee financial success or a happily-ever-after retirement. But we believe that total-return investing offers the best odds for achieving your retirement-spending goals – more so than pursuing isolated tactics such as chasing dividends or high-yielding bonds without considering their portfolio-wide role.

With that in mind, the next time the market is huffing and puffing and threatening to blow your retirement down, we suggest you throw another log on the fire that fuels your total return investment strategy, shore up your solidly built portfolio, and depend on the structured strength to keep that wolf at bay. Better yet, be in touch with us to lend you a hand.

Investing For Retirement Income Part II: High Yield Bonds

March 17th, 2016 Posted by Investment Strategy, Investment Vehicles, Investor Behavior, Retirement Planning, Saving, Stock Options 0 thoughts on “Investing For Retirement Income Part II: High Yield Bonds”

Part II: High-Yield Bonds – Sticks and Stones Can Break You

In Part I of our three-part series on investing for retirement income in low-rate environments, we explained why we don’t advise bulking up on dividend-yielding stocks as a reliable way to generate retirement cash flow. Like the Three Little Pigs’ straw house, dividend-yielding stocks can disappoint you by exhibiting inherent risks just when you most need dependability instead.

Another popular tactic is to move your retirement reserves into high-yield, low-quality bonds. Here we explain why we don’t typically recommend this approach either.

Part II: High-Yield Bonds – Sticks and Stones Can Break You

We can see why it would be appealing to try to have your bonds pull double-duty when interest rates are low: protecting what you’ve invested and delivering higher yields. The problem is, the more you try to position your fixed income to fulfill two essentially incompatible roles at once, the more likely you will underperform at both.

Risk and Return: The Same, Old Story (Sort of)

In investing and many other walks of life, there’s nothing to be gained when nothing has been ventured. This relationship between risk and expected return is one of the strongest forces driving capital markets. But decades of academic inquiry help us understand that the risks involved when investing in a bond – any bond – are inherently different from those associated with investing in stocks. These subtle differences make a big difference when it comes to combining stocks and bonds into an effective total portfolio.

Because a company’s stock represents an ownership stake, your greatest rewards come when a company’s expected worth continues to improve, so you can eventually sell your stake for more than you paid for it, and/or receive “profit-sharing” dividends along the way. Your biggest risk is that the opposite may occur instead.

A bond is not an ownership stake; it’s a loan with interest, which defines its two biggest risks:

  1. Bond defaults – If all goes well, you get your principal back when the loan comes due. But if the borrower defaults on the loan, you can lose your nest egg entirely.
  2. Market movement – You would like your bond’s interest rate to remain better than, or at least comparable to those available from other, similarly structured bonds. Otherwise, if rates increase, you’re left locked into relatively lower payments until your bond comes due.

As such, two factors contribute to your bond portfolio’s risks and expected returns:

  1. Credit premium – Bonds with low credit ratings (“junk” or “high-yield” bonds) are more likely to go into default. To attract your investment dollars despite the higher risk, they typically offer higher yields.
  2. Term premium – The longer your money is out on loan, the more time there is for the market to shift out from under you, leaving you locked into a lower rate. That’s why bonds with longer terms typically offer higher yields than bonds that come due quickly.

Bond Market Risks and Returns

If you’re connecting the dots we’ve drawn, you may be one step ahead of us in realizing that, just like any other investment, bonds don’t offer higher expected returns without also exposing you to higher risks. So, just as we do with your stock holdings, we must identify the best balance between seeking higher bond yields while keeping a lid on the credit and term risks involved.

With stocks – Taking on added stock market risk has rewarded stalwart investors over time. The evidence is compelling that it will continue to do so moving forward (assuming you adopt a well-planned, “buy, hold and rebalance” approach as a patient, long-term investor).

With bonds – Taking on extra bond market risk is not expected to add more value than could be had by building an appropriately allocated stock portfolio. Moreover, it is expected to detract from your bond holding’s primary role as a stabilizing force in your total portfolio … and it often does so just when you most want to depend on that cushioning stability.

For example, in “Five Myths of Bond Investing,” Wall Street Journal columnist Jason Zweig dispels the myth that “investors who need income must own ‘bond alternatives’” (such as high-yield bonds). He cites our own BAM ALLIANCE Director of Research Larry Swedroe, who observes that “popular bond alternatives … provide extra income in good times – but won’t act like bonds during bad times.”

The Monevator piece (“brief guide to the point of bonds”) we referenced in Part I offers a similar perspective: “[B]onds are meant to be the counter-weight to shares in a portfolio. They are the stabilising influence that tempers the turbulence. Equities are from Mars and bonds are from Venus, if you will. … [Use] Equities to deliver growth, and domestic government bonds to reduce risk.”

Your Essential Take-Home

Given these insights, logic dictates:

If you must accept higher risks in search of higher returns, take those risks on the equity (stock) side of your portfolio; use high-quality fixed income (bonds) to offset the risks.

As we’ve been hinting throughout this series, there is one more critical component to investing for retirement income. Beyond optimizing your bond portfolio with the right kind of bonds (high-quality, short- to mid-term), and avoiding chasing dividend stocks for their pay-offs, among the most important steps you can take with your retirement income is to adopt a portfolio-wide approach to money management, instead of viewing your income and principal as two isolated islands of assets. We’ll explore this subject in Part III.

Investing for Retirement Income: Straw, Sticks or Bricks?

March 9th, 2016 Posted by Investment Strategy, Investment Vehicles, Investor Behavior, Retirement Planning, Saving, Stock Options 0 thoughts on “Investing for Retirement Income: Straw, Sticks or Bricks?”

Part I: Dividend-Yielding Stocks – A Straw Strategy

If ever there were an appropriate analogy for how to invest for retirement, it would be the classic fable of The Three Little Pigs. As you may recall, those three little pigs tried three different structures to protect against the Big Bad Wolf. Similarly, there are at least three kinds of “building materials” that investors typically employ as they try to prevent today’s low interest rates from consuming their sources for retirement income:

  1. Dividend-yielding stocks
  2. High-yield bonds
  3. Total-return investing

In this three-part series, we’ll explore each of these common strategies and explain why the evidence supports building and preserving your retirement reserve through total-return investing. The approach may require a bit more prep work and a little extra explanation, but like solid brick, we believe it offers the most durable and dependable protection when those hungry wolves are huffing and puffing at your retirement-planning door.

Part I: Dividend-Yielding Stocks – A Straw Strategy

We understand why bulking up on dividend-yielding stocks can seem like a tempting way to enhance your retirement income, especially when interest rates are low. You buy into select stocks that have been spinning off dependable dividends at prescribed times. The dividend payments appear to leave your principal intact, while promising better income than a low-yielding short-term government bond has to offer.

Safe, easy money … or so the fable goes. Unfortunately, the reasoning doesn’t hold up as well upon evidence-based inspection. Let’s dive in and take a closer look at that income stream you’re hoping to generate from dividend-yielding stocks.

Dividends Don’t Grow on Trees.

It’s common for investors to mentally account for a dividend payout as if it’s found money that leaves their principal untouched. In reality, a company’s dividends have to come from somewhere. That “somewhere” is either the company’s profits or its capital reserves.

This push-pull relationship between stockholder dividends and company capital has been rigorously studied and empirically assessed. In the 1960s, Nobel laureates Merton Miller and Franco Modigliani published a landmark study on the subject, “Dividend Policy, Growth, and the Valuation of Shares.” In “Capital Ideas”, Peter Bernstein explains one of the study’s key findings: “Stockholders like to receive cash dividends. But dividends paid today shrink the assets of the company and reduce its future earning power.”

Here’s how the MoneySense article, “The income illusion,” explained it: “[I]f a company pays you a $1,000 cash dividend, it must be worth $1,000 less than it was before. That’s why you’ll often see a company’s share price decline a few days before an announced dividend is paid.”

Dividend Income Incurs a Capital Price.

So, yes, you can find stocks or stock funds whose dividend payments are expected to provide a higher income stream than you can earn from an essentially risk-free government bond. But it’s important to be aware of the trade-offs involved.

As described above, rather than thinking about a stock’s dividends and its share value as mutually exclusive sources of return – income versus principal – it’s better to think of them as an interconnected seesaw of income and principal. The combined balance represents the holding’s total worth to you. (If you’re reading closely, you may notice that we’ve just foreshadowed our future discussion about adopting a total-return outlook in your investment strategy.)

“Safe” Stocks? Not so Fast.

In addition, dividend-yielding stocks may not be as sturdy or as appropriate as you might think for generating a reliable retirement cash flow. Even if those stocks have dependably delivered their dividends in the past, assuming they are as secure as a government bond is like assuming that a Big Bad Wolf is harmless because he hasn’t bitten you yet.

The evidence is clear, and it has been for decades: Stocks are a riskier investment than bonds. This in turn has contributed to their higher expected long-term returns, to compensate investors who agree to take on that extra risk.

Dividend stocks may offer a slightly more consistent cash flow than their non-dividend counterparts, but at the end of the day, they are still stocks, with the usual stock risks and expected returns. As the Monevator “brief guide to the point of bonds” describes, “The key to (most) bonds is they aim to pay you a fixed income until a certain date, at which point you get your initial money back. That is very different to equities, which offer no such certainty of income or capital returns.”

In “The Dividend-Fund Dilemma,” Wall Street Journal’s financial columnist Jason Zweig explains it similarly: “When you buy a Treasury, you collect interest and get your money back (not counting inflation) when the bond matures. When you buy a dividend-paying stock, you collect a quarterly payment – but that certainly doesn’t mean the stock price will be stable.”

Nor is there any guarantee that the dividends will flow forever. Zweig described a lesson that many investors learned the hard way during the Great Recession: “In 2007, 29% of the S&P 500’s dividend income came from banks and other financial stocks, according to Howard Silverblatt, senior index analyst at Standard & Poor’s. That didn’t end well. Many banks that had been paying steady income to shareholders suspended their dividends – or even went bust. Their investors suffered.”

Your Essential Take-Home

Our capital markets rarely offer a free ride. If you’re taking stock dividend income today, you’re likely paying for it in the form of lower share value moving forward. And if you’re invested in the stock market, you are exposing your nest egg to all the usual risks (and expected returns) that comes with that exposure. That’s how markets work.

The fixed income bond markets offer their share of risks as well, but in a different form, which tends to make them a better choice for helping you dampen your total risk exposure as you pursue expected market returns. Stretching for high-yield, higher-risk bond income begins to shift your bond holdings away from their most appropriate role in your total portfolio … which will be the subject of our next piece in this three-part series.

[Photo credit: Flickr Akash Malhotra]

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]

The Why and How of Fixed Income

December 15th, 2015 Posted by Economics, Family Finances, Investment Vehicles, Investor Behavior, Saving, Stock Options 0 thoughts on “The Why and How of Fixed Income”

Fixed Income. You read and hear about it in the financial media. You’ve no doubt heard that having some is a good idea, and you may actually have some fixed income holdings. But perhaps you don’t feel as though you have a good grasp of the actual role of fixed income in a balanced investment portfolio. Whether as a reminder or as a learning process, it never hurts to explore the subject in more depth.

First, let’s set the context by reviewing the basic categories of investments:

Stocks – Stocks are the most effective tool for those seeking to accumulate new wealth over time. But along with higher expected returns, they also expose investors to more volatility as well as increased uncertainty about ultimately achieving their goals, due to market fluctuations and risk potential.

Bonds – Bonds are a good tool for dampening volatility and serving as a safety net for when market risks are realized. They can also contribute modestly to a portfolio’s overall expected returns, but we don’t consider this to be their primary role.

Cash – In the face of inflation, cash and cash equivalents are expected to actually lose buying power over time, but they are good to have on hand for near-term spending needs.

Here’s another way of looking at it:

 Expected Long-Term Returns  Highest Purpose
 Stocks (Equity)  Higher Building wealth
 Bonds (Fixed Income)  Lower Preserving wealth
 Cash  Negative (after inflation) Spending wealth

By keeping your attention on these basic principles of stock/bond investing, it becomes easier to recognize that, even when your bond holdings are plodding along compared to the rest of your portfolio, the more important consideration is whether they are fulfilling their highest purpose in your total wealth management.

Bonds Are Safer, But They’re Not Entirely Safe

It may help to understand that bonds, compared to stocks, have historically exhibited lower volatility and market risks, along with commensurate lower returns. But they do exhibit some volatility and some market risk. Because bonds represent a loan rather than an ownership stake, they are subject to two types of risk that don’t apply to stocks:

  • Term premium – Bonds with distant maturities or due dates are riskier, so they have historically returned more than bonds that come due quickly.
  • Credit premium – Bonds with lower credit ratings, such as “junk” bonds, are also riskier, and they have returned more than bonds with higher credit ratings, such as government bonds.

When reading bond market headlines about interest rates, yield curves, credit ratings, etc., these are the two risks and commensurate-return expectations that rise and fall along with the news. But as alarming or exciting as bond market news may become, compared to stocks, the levels of volatility and degrees of risk need not – and really should not – be as extreme as what we must tolerate with equity/stock investing in pursuit of higher expected returns.

The decisions you make about the risks inherent to your bond holdings should be managed according to their distinct role in your portfolio, as we will explore next.

Act On What You Can Control

There are some proactive steps that you, as a long-term investor, can take to appropriately position fixed income investing to withstand varied market conditions.

Are your fixed income holdings the right kind, structured according to your goals?

Just as there are various kinds of stocks, there are various kinds of bonds, with different levels of risk and expected return. Because the main goal for fixed income is to preserve wealth rather than stretch for significant additional yield, we typically recommend turning to high-quality, short-to-medium-term bonds that appropriately manage the term and credit risks described above.

Are you keeping an eye on the costs, including taxes?

One of the most effective actions you can take across all your investments is to manage the costs involved. When investing in bond funds, this means keeping a sharp eye on the expense ratios and seeking relatively low-cost solutions. For individual bonds, it is important to be aware of opaque and potentially onerous “markup” and “markdown” costs. While these costs do not typically show up in the trade report, they are very real, and can detract significantly from your end returns. In choosing an appropriate fixed-income vehicle, it is also important to consider your tax bracket, to ensure that you get the best after-tax returns.

Are your solutions the right ones for the job?

Whether turning to individual bonds, bond funds or similarly structured solutions such as Certificates of Deposit (CDs), your fixed income portfolio should strike a harmonious balance between necessary risks and desired returns – within the context of your own plans and according to the distinct role that fixed income plays within those plans.

To achieve this delicate balance, it can make good sense to seek the assistance of an objective adviser to help you weigh your options, determine a sensible course for your needs, and implement that course efficiently and cost effectively. Your advisor also can help you revisit your plans whenever the markets or your circumstances may cause you to question your resolve. Should you stay the course? Are updates warranted? It can help to have an experienced ally to advise and inform you before making your next moves.

[Photo credit: Flickr user Roger]

Top Tips for the Well Advised Investor Part IV

November 24th, 2015 Posted by Budgeting, Investment Strategy, Investment Vehicles, Investor Behavior, NAPFA, Stock Options 0 thoughts on “Top Tips for the Well Advised Investor Part IV”

Good advice for investors does not need to be complicated. In that spirit, we offer this four-part series on sound investment principles. Including these guidelines in your investment strategy could help you reach your financial goals.

Part IV. – Thoughts on Life and Investing

  1. It is important to understand the difference between “highly improbable” and “impossible”, as well as the difference between “highly likely” and “certain”.

Over almost all periods of 20 years or longer in the United States, stocks have provided higher returns than bonds. So it’s no surprise that investors assume, if their horizon is long enough, stocks will certainly continue to provide higher returns than bonds. Unfortunately, this assumption can lead them to take more risk than they should. It is essential to remember that stocks, like any risky asset, are risky no matter how long the investment horizon is.

  1. The only thing worse than having to pay taxes is not having to pay them.

Taxes are a fact of life – they are not going away anytime soon. Whether we agree with where our tax dollars are, or are not, being spent, we still have to pay our fair share. For many people, not having to pay taxes is a reflection of not having enough income to live on. So in that respect, having to pay taxes is a good thing. But that does not mean we should pay more than we need to.

All of this leads people to try and avoid paying unnecessary taxes. There are smart and not-so-smart ways of approaching the issue. Investors who hold a large amount of stock with a low cost basis often refuse to sell because of the tax bill on capital gains. Sadly, large fortunes have been lost because of this error.

There is a wiser way to make the decision to sell or not to sell. Investors should weigh the present asset allocation of their current holdings against the desired asset allocation that they have defined within a carefully designed investment policy. Then, factors such as tax implications can be considered.

  1. The four most dangerous words are, “This time is different.”

Believing that “this time is different” has caused the investment plans of many individuals to end up in the proverbial trash heap. It is tempting to succumb to the lure, and potential mania, of the “new thing.” This behavior reinforces a time-worn phrase: “The surest way to create a small fortune is to start with a large one.” When the lure beckons, stick to your plan, as described in Part I of this series.

  1. Good advice does not have to be expensive, but bad advice can cost dearly.

Most of us wouldn’t choose the cheapest doctor, the cheapest attorney or the cheapest accountant. Although we should consider the expense against what we can afford, we also know that the value we receive is what ultimately matters.


The principles outlined in this series can provide investors with resolve to stay the course regardless of market events. For investors, creating and sticking to an investment strategy that addresses their long-term financial goals along with their overall ability, need and willingness to take risk, is an advisable approach that can serve them well through bad times as well as good.

[Photo credit: LendingMemo]

Top Tips for the Well Advised Investor Parts II & III

November 16th, 2015 Posted by Budgeting, Investment Strategy, Investment Vehicles, Investor Behavior, NAPFA, Stock Options 0 thoughts on “Top Tips for the Well Advised Investor Parts II & III”

Good advice for investors does not need to be complicated. In that spirit, we offer this four-part series on sound investment principles. Including these guidelines in your investment strategy could help you reach your financial goals. (You may want to refer back to Part I – Investing – The Benefits of a Disciplined Plan.)

Part II – Individual Stocks – Reasons to Avoid Trying to “Beat the Market”

  1. Owning individual stocks and sector funds can be unnecessarily risky.

Owning one large-cap growth stock has the same expected return as owning an index fund of large-cap growth stocks, but it entails far greater risk. (Large-cap refers to companies with a market capitalization of more than about $10 billion, which is calculated by multiplying the number of a company’s shares outstanding by its stock price per share.)

The market compensates investors for risks that cannot be diversified away – such as the risk of investing in stock versus bonds, or corporate bonds versus Treasury bonds. Investors should not expect the market to compensate them for risk that can easily be diversified away – that is, the unique risks related to owning just one stock or one sector fund. Prudent investors understand that it makes sense to only accept the kind of risk which compensates them in the form of higher expected returns.

  1. Each strategy has an associated cost.

To outperform the market, an investor must first identify a mispriced security and then, after the expenses of the effort, be able to exploit the mispricing. Strategies by themselves have no costs, but implementing them does. Many investors have tried to exploit what they believed were (and perhaps really were) mispricings, but found that that the trading and other costs of implementing their strategies exceeded the potential benefits.

  1. It is prudent to avoid investment products with “elite” appeal.

We feel that hedge funds and private equity, including venture capital, appeal to investors by offering them the possibility of achieving superior returns while appearing to extend invitations to an elite group of investors. Recently, however, the hedge fund and private equity industries have lowered their minimums significantly. Furthermore, many of these vehicles turn out to be more expensive than they are expansive for an investor’s portfolio.

Generally, investors should not invest in a security without fully understanding the nature of all of its risks. And they should avoid investing in an investment product purely for the sake of its inherent complexity or exclusive nature. Such products are designed to be sold, not bought; the complexity is likely to be designed in favor of the issuer/seller, not the buyer.

Part III. – Diversification – An Essential in Portfolio Construction

  1. The safest port in a sea of uncertainty is diversification across many asset classes.

It is not possible to properly diversify using only the S&P 500 Index. While there would be a large number of holdings, there would not be enough diversification by asset class. An investor would receive ownership in 500 companies, but many of them belong to the same asset class. Investors need to look further than a single index to achieve appropriate diversification.

  1. Diversification is always working.

Sometimes investors like the results of diversification in their portfolios and sometimes they don’t. Most investors are familiar with the benefits of diversification. Done properly, diversification reduces risk without reducing expected returns.

However, once investors diversify beyond popular indices such as the S&P 500, they must accept the likelihood of being faced with periods of time (even long ones) when a popular benchmark index, reported by the media on a daily basis, outperforms their portfolio.

The media “noise” may test their ability to stick to their investment strategy. Nothing will have changed (diversification will still be the right strategy), yet many investors will make the mistake of confusing strategy with outcome, and abandon their plan. This is a good time to remember the stick-to-it-iveness that we discussed in Part I.

Stay tuned for the fourth and final part of this series: Thoughts on Life and Investing

[Photo credit: Lendingmemo]

Top Tips for the Well Advised Investor

November 10th, 2015 Posted by Budgeting, Investment Strategy, Investment Vehicles, Investor Behavior, NAPFA, Stock Options 0 thoughts on “Top Tips for the Well Advised Investor”

Good advice for investors does not need to be complicated. In that spirit, we offer this four-part series on sound investment principles. Including these guidelines in your investment strategy could help you reach your financial goals.

Part I – Investing – The Benefits of a Disciplined Plan

  1. Have an investment plan and stick with it.

Your plan should be well-developed and comprehensive. Your plan should be the foundation of all the financial decisions you make, especially when the market is fluctuating. A solid strategy will help you keep your head when your emotions threaten to take over.

  1. Determine the appropriate level of risk tolerance.

Be prepared for the unexpected, so that if it occurs, you will be less likely to panic and abandon your plan altogether. When considering risk factors in specific asset allocations, keep in mind whether your investment time frame is short-term or long-term. Also weigh the stability of your income, your ability to deal emotionally with market fluctuations, and the rate of return you are seeking.

  1. Know how to interpret the value of information.

Consider the source. If you learn something through the media or from a broker, it is likely that the market will have incorporated the same information into the current stock price. In other words, much of the information you may be privy to has a good chance of being obsolete. In any case, there are many intelligent and motivated people researching the same stock, so the information is unlikely to give you a competitive advantage.

  1. Don’t ignore the impact that expenses have on your portfolio.

Investing always has associated costs. On paper, a stock may look like it has outperformed the market, but when considered against fees and other expenses, the net result could equate with underperforming the market. And remember, for one investor to outperform the market, another (this could be you) must underperform. You would be well-advised to seek earnings at the market’s rate of return, while incurring lower costs with an evidence-based investment strategy.

  1. Work with an advisor who meets the fiduciary (rather than a mere suitability) standard.

Brokerage firms and their employees are held to a rule of suitability. The service they provide and the products they sell are only required to be suitable for an investor, not necessarily in the investor’s best interests. And a brokerage firm may sell suitable funds with relatively high fees, earning themselves bigger commissions or satisfying particular sales quotas.

Registered Investment Advisors, on the other hand, have a fiduciary obligation that goes above and beyond the basic suitability standard. They must act with the utmost good faith in their clients’ best interests. In fact, the fiduciary standard is generally considered the highest legal duty that one party can have to another.

Furthermore, an advisor can play an important role in ensuring that investors adhere to their well-developed plans when markets fluctuate. This stick-to-it-iveness helps investors avoid the potential financial consequences of reacting to the “noise” of the market. This approach also averts attempts to profit from “bubbles” in the market, which do occur, but are unfortunately quite likely to burst at unpredictable moments.

Stay tuned for the remaining three parts of this series:

II. Individual Stocks

III. Diversification

IV. Thoughts on Life and Investing

[Photo credit: Lendingmemo]

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.