All Things Financial Planning Blog


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Young Investors Key to Beating the Market


Invest Outside the BoxWant to know how to beat the market? “Sure,” you may say, “it’s possible. If I spent my every waking hour researching undervalued companies.”

But, what if I told you I had a fool proof way for those with time to spare to win against the market, without searching rummage shops for discarded crystal balls, or trusting in your uncle’s stock advice? And on top of that, even the most novice investor can use this strategy and win?

Impossible? Read on.

The way to beat the market isn’t by finding the next hot mutual fund manager or dedicating yourself to becoming the next Warren Buffett, it’s simply how you manage your tilt.

Your “tilt” is how your portfolio is invested in the market. You hopefully are diversified over the universe of stocks, but your tilt tells your holdings of large or mega companies versus small or medium sized firms. It also tells if you tend to invest in companies trading at premiums or discounts to the overall market.

More often than not, most retirement investors I meet are “top heavy,” investing in a mix that doesn’t stray too far from the market represented to a higher degree by largest companies, or a mix that resembles the S&P 500 (most people refer to this as the market). This is often the case if you’re investing in a Target Retirement Date fund, or any other fund or funds, or have a managed account.

However, is this the best mix when you’re young and have time to take risks?

By shifting the weights of your portfolio towards areas of the market that tend to have higher degrees of return (and volatility), you may supercharge your retirement accounts when starting out, specifically by using a greater share than the market of smaller companies with more room to grow, and stocks that are trading at a discount to the market (value stocks).

How much better can you do than the S&P 500 by including more small and value in your mix?
The S&P 500 averaged 9.5% per year since 1928. One can not invest in an index, but if you could and had invested $1 in the S&P 500 way back then, you would have had $3,530 at the end of 2012.

Using a similar strategy of owning the stock market, but by shifting the tilt to include more small, and more value, a portfolio that tracks Dimensional Fund Advisors US Adjusted Market Value Index would have averaged 11.7% during the same period. An investment of $1 would have grown to $11,998.

A strategy of tilting more towards small and value stocks will be more volatile than the market, so don’t think this approach will only lead to gains; you still have to master the skill of not watching your accounts rise and fall in the short run. However, while you’re accumulating and have a long time horizon, volatility can be your friend.

robertSchmanskyRobert Schmansky, CFP®
Financial Advisor
Clear Financial Advisors, LLC
Royal Oak, MI


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Are You an Investor or Speculator?


A Worthwhile Financial Market DiagnosisHow can you tell if you are you an investor or a speculator? Many casual investors buy stocks and assume they are investing, but in reality, they are actually speculating. True investing entails conducting a thorough analysis of a company, determining whether the current price is justified, deciding whether the stock would be a good addition to your portfolio, and repeating the process periodically; speculation is simply buying a stock because you think it’s a good company or you heard a good tip, but you really don’t know how the company makes money, who its competitors are, or in some cases, even what it does. Most people would say they are an investor, but unless you are employing the fundamental analysis discussed below, you may actually be a speculator.

Top-Down

Suppose you believe that the new Affordable Care Act will benefit pharmaceutical companies and you want to capitalize on that potential gain. In a top-down approach, you would first generate a list of all the publicly traded pharmaceutical companies. Then you would compare them among each other using that industry’s metric. If any of the companies are non-US companies, then you need to translate the company’s currency to the US dollar for an equal comparison. Some common comparison metrics include: profit margins, sales, market capitalization, market penetration, debt/equity, etc. In addition, each industry has its own unique metric. For example, airlines use (revenues per passenger miles) and hotels use (average daily rate). Once you have identified the best stock within your filtered list, then you can determine whether the stock price is cheap or expensive versus its competitors.

Bottom-Up

Suppose you are an avid Facebook user and want to invest in the stock. In a bottom-up approach, you would first obtain financial information for Facebook to understand how it makes money. What are its income sources: advertising, selling products, partnerships? How much of their income comes from each source? Who are its competitors and what do their numbers look like? Keep in mind, just because a company makes a ton of money, it still doesn’t make it a good investment. Facebook made $5 billion in 2012 while Microsoft made $74 billion in 2012, yet Facebook stock trades at almost 143 times the value of Microsoft.

Research Reports

Some investors prefer to rely on research reports prepared by prominent analysts at investment banks. One of the many lessons the recent financial crisis taught us is that investment banks have countless conflicts of interest. There is no shortage of headlines where an investment bank issued research reports where they also did investment banking for the company in question. Unless the research is truly independent and neither the analyst nor their firms have a vested interest in the companies they cover, their assessment of a company is tainted by their firm’s relationship with the company being reviewed.

As you can see, researching individual stocks is very labor intensive whether you use the top-down or bottom-up approach. The analysis doesn’t stop when you buy the stock, you must continue to monitor the company (not just the stock price) to ensure it still meets your criteria. It’s ok to invest in stocks, but investors must recognize that unless they conduct ongoing and thorough analysis, they are merely gambling.

Ara OghoorianAra Oghoorian, CFP®, CFA
Founder and President
ACap Asset Management
Los Angeles, CA


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How Do Options Work?


The Economics of FearWhat if you had had a hunch that Microsoft stock would skyrocket when it introduced Windows 8? Would you have risked purchasing Microsoft stock on just a hunch? Or what if you owned a hundred shares of Apple but wanted to protect yourself from the stock’s recent declines? Well you can do both through options. An option is a standardized contract to either buy or sell a stock at a pre-determined price within a specific date. The key word is option; if you buy an option contract, you have the option, not the obligation, to exercise your contract if it makes financial sense for you at that future date. Option trading has been around for thousands of years and is widely used by many people to either protect the value of an existing investment or speculate on the future movement of an asset. There are two types of option contracts: calls and puts. A call option gives the owner the option to buy a stock at a set price in the future, whereas a put option gives the owner the option to sell a stock at a set price in the future. Let’s see how each one works.

Example of a Put Option:

A put option grants you the right to sell a stock at a set price. An investor buys a put option if she feels the price of a stock is going to decline and wants to lock-in a particular price. Let’s look at a specific example: It is March, and you own 100 shares of Apple stock (symbol: AAPL) that you bought for $400. You think that the price of Apple will decline from its current price of $457 in the coming months and you want to protect your gains. Each option controls 100 shares of the underlying stock, so 1 put option would give you the protection you seek. You could buy a $450 put option that expires in 3 months (May). If the price of Apple goes below $450 between now and May, you can exercise your option and sell your shares at $450. If the price of Apple doesn’t get that low, then you would keep your shares and simply let your option expire.

Example of a Call Option:

A call option grants you the right to buy a stock at a specific price. You would buy a call option if you think the price of a stock will rise within a given time and you wanted to benefit from the expected rise. Continuing with our Apple example, assume you don’t own the stock, but you think that Apple stock will rise in the next couple of months. You could buy an option that expires in May that allows you to buy Apple stock at $500. If the price of Apple rises above $500, you could exercise your call option and buy the stock at $500. Again, if the price of Apple does not rise by the May expiration date, you simply let your option expire.

As you can imagine, options can be useful for certain investors who are interested in: protecting a large gain; benefiting from a stock’s rise/fall without actually owning the stock; and in some cases, diversifying. While there are only two types of options (calls and puts), there are a multitude of strategies an investor can employ by combining calls and puts.

Though it may seem that options as part of your portfolio is a no-brainer, this article is simply an introduction to options. It is important to understand that options are quite complicated and can be rather risky. Options should only be used by experienced investors who really understand the mechanics of options – note, there is no easy money in trading options. Some people brag about making a lot of money in options, but be careful because option prices move very quickly, and while you can quickly make a lot of money, you can also easily lose a lot of money in just a single day.

Ara OghoorianAra Oghoorian, CFP®, CFA
Founder and President
ACap Asset Management
Los Angeles, CA


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Headlines vs. Markets – A Case Study


Bad-IdeaThe media’s job is ultimately to make money by selling advertising. How much advertisers are willing to pay depends on how widely their message will be distributed. That is measured by how well a television network, magazine or newspaper does at maintaining eyes on the screen or sales at the newsstand. Unfortunately, that often means the more negative a story or the more fear a topic instills, the more exposure it’s likely to receive. This is a common complaint, yet we keep watching.

Going back to my blog from last month, an investor’s job is to earn a return on the money they invest in line with the risk taken. Despite some volatility based on truly unforeseen headlines, the market is much less sensitive to the media and much more concerned with what is actually going on in the companies that comprise a given marketplace than the average investor.

In other words, to get a true sense at what’s going on at the markets, look at the markets, not the guy on TV keeping you glued until the next commercial break.

One quarter does not an investment lifetime make, but I’d like to use the fourth quarter of 2012 as a brief case study in lending some credence to the above point.

Going into the fourth quarter of 2012, it was hard to find much optimism. Most Americans had grown tired of an intensely divided election, Superstorm Sandy devastated the East coast and the fiscal cliff was looming on the horizon. In fact, I’ve spoken with many people who still believe that 2012 was a bad one for the markets.

Let’s look at some of the crises that many “just knew” would sink the markets to end the year and what wound up occurring in reality . . .

  1. Europe’s unemployment rate hits 11.6% signaling more problems for international investors:
    International developed markets were up 5.93% just in the 4th quarter of 2012 (represented by the MSCI World ex USA Index (net dividends))
  2. Greece’s debt and budget woes would continue to keep drag down developed market returns:
    Greece, for the second quarter in a row, led developed markets with a return of 17.87% for the fourth quarter (represented by MSCI All County World IMI Index)
  3. China’s slowing economy meant that emerging markets were in trouble to end the year:
    Emerging markets stocks were up 5.58% for the 4th quarter of 2012 (represented by the MSCI Emerging Markets Index (net dividends))
  4. An Obama re-election spelled doom for the U.S. market:
    The S&P 500 Index finished 2012 up 16% for the year
  5. Those fearing the doom and gloom should take refuge in commodities, specifically gold:
    Commodities ended the quarter down -6.33% with Gold down -5.65%. Commodities overall wound up down -1.06% for 2012 (All represented by the Dow Jones-UBS Commodity Index Total Return)

I want to stress again that this is just a one quarter snapshot. It’s not to suggest that anyone should have invested or sold any of their investments based on the above information. It simply illustrates how strongly our emotions can be pulled by headlines when what actually occurs in reality is a much, much different story.

So, what is an investor to do with this information? Not as much as you might think. It’s less about action and more about awareness. Have a plan, stick to it, be aware of the world around you, but careful of the motivations of those telling the story. Try to separate your concern for local, national and world events from your long term investing strategy.

Chip Workman, CFP®, MBA
Lead Advisor
The Asset Advisory Group
Cincinnati, OH


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When Investing Isn’t


I recently received a “March Madness” promotional offer from an industry publication that involves picking mutual funds which are then put into a bracket similar to the format for the NCAA Men’s basketball tournament. Once you select funds, they are monitored over the same six weeks as the NCAA tournament and a winner is ultimately determined based on the funds’ performance during that timeframe.

Now, I’m no prude. I enjoy March Madness, filling out brackets and watching student athletes leave everything on the court as they strive to make the next round in search of a championship. It’s one of the most exciting events in all of sport and something I look forward to every year.

I also understand different industries wanting to get in on the act and borrow from that kind of excitement to generate excitement of their own. It is relatively harmless fun to pick a few mutual funds and see how they do over a short period of time.

The difference is far too many would describe this as an “investment game.”  In fact, this has absolutely NOTHING to do with investing. It can be argued what kind of time horizon is justified to analyze the return of various investments, but six weeks certainly isn’t sufficient.

Investing, at least as far as the stock market goes, is committing your money to a business with the expectation of obtaining a fair return over time. This return can come from dividends paid out by the business or in appreciation of the value of your stock based on the company’s growth. This stems from the business using your (and other investors) money to hire people, innovate and develop new products and improve operations. This takes time and certainly comes at a risk. The company could lose money or go out of business entirely leaving you with nothing. In fact, the relationship of how risky the business you invest in might be directly relates to how much return you might expect from your investment.

Speculation in the stock market, on the other hand, is attempting to guess about the future movements of a company, a sector or the market at large. In other words, it’s more of a way of placing bets on what you think might happen. The risk here is clear, you could be wrong. In fact, most studies show that our ability to make these guesses (when to get into an investment and when to get out) correctly over and over again is much, much less productive than just choosing a broadly diversified portfolio of investments and then staying invested according to whatever mix of stocks, bonds and cash fits our risk tolerance and goals over the long run.

If the goal is to have some fun with a non-basketball “bet” during March Madness and seeing what a spin of the market wheel gets you over a six week period, I hope all involved enjoy. What I want to make sure the average investor out there is crystal clear on, however, is to not recognize an entertaining, speculative game for the true benefit of the capital markets, which is to enjoy a long term return equivalent to the amount of risk being taken.

Speculation can be fun. Investing should be reserved for helping us meet our long term goals. Knowing the difference can be the key to a successful experience with either.

Chip Workman, CFP®, MBA
Lead Advisor
The Asset Advisory Group
Cincinnati, OH


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Location, location, location


You have probably heard the old real estate adage – location, location, location – meaning the location of your house has a great impact on price. The same theory holds true for other investments. Where you hold your assets is almost as important as the assets themselves. Investments grow through interest, dividends, and/or capital gains. In general, interest is paid on bonds and savings accounts; dividends are paid on stocks; and capital gain is the profit you earn when you sell an asset for more than you paid for it. Unfortunately, interest, dividends, and capital gains are each taxed differently, so ensuring investments are held in the proper accounts can maximize your after-tax return. In short, interest earning assets should be in tax-efficient accounts while capital assets in taxable accounts.

Take Control of Your Tax
Currently, long-term capital gains are taxed at a maximum rate of 15 percent for the highest tax brackets and zero for the lowest two tax brackets. Conversely, interest and some dividends are taxed at ordinary tax rates which are higher. You cannot control when a bond pays interest or when a stock pays a dividend, so the tax liability is out of your control; however, you do choose when to sell a stock and thus incur capital gains. Therefore, you can control your tax liability by holding capital assets such as non-dividend paying stocks in your taxable accounts and income producing assets, such as bonds and dividend paying stocks, in your retirement accounts.

Keep It Simple
If you own commodities, as any well diversified investor should, you most likely own them through a mutual fund or ETF; if you own physical commodities, see section on Make Your Gold Shine. Most commodity funds are structured as partnerships, which means that at the end of the year, you will receive a K-1 statement from the partnership showing your share of the partnership’s profits/losses. The K-1 must be entered into your tax returns and can increase your tax preparation costs and complication. One way to avoid having to report a K-1 and still own commodities is to buy them in your retirement accounts. You will still get a K-1 at the end of the year, but there will be no tax ramifications.

Make Your Gold Shine
If you invest in gold, silver, or other similar assets (i.e., stamps, wine, rugs, etc.), the IRS considers these collectible items. The tax rate for these collectibles is a flat 28 percent if held long term and at your ordinary rate if held less than a year. These unique tax rates still apply even if you hold these investments in an ETF. Since such investments have less favorable tax rates, it would be wise to hold them in an IRA instead of a taxable account.

Be Tax Efficient
REITs are required to distribute 90 percent of their taxable income to shareholders, which means they generate a high yield; therefore, REITs are more appropriate in a retirement account. In addition, some interest, like those on certain municipal bonds, are exempt from state and federal income taxes, thus making them ideal to hold in a taxable account. Recognizing the type of income received (interest, dividends, or capital gains) and how it is taxed will help you determine where to hold those investments to ensure the most tax efficiency.

Ara OghoorianAra Oghoorian, CFP®, CFA
Founder and President
ACap Asset Management
Los Angeles, CA