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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How to Buy Commodities


You have probably heard that commodities are a great way to protect your portfolio from inflation and offer variety from traditional stocks and bonds; but what are commodities, and how does someone actually invest in them?

Commodities are raw items that are used in the production of goods and are broken up into two segments: hard and soft. Hard commodities are mined (gold, silver, platinum) while soft commodities are consumed (wheat, corn, coffee beans, etc.). There are three ways to own commodities: own the physical commodity itself, buy futures contracts, or buy through a mutual fund or ETF. Owning gold coins is an example of a physical holding, while trading a futures contract is the more advanced investment strategy. However, for most investors, the best way to get exposure to commodities is through a mutual fund or ETF.

Physical Commodities
Buying the tangible commodity is the most cumbersome because you have to figure out where to store it, spoilage (for soft commodities), insurance, and liquidity (ability to sell something quickly). Assume you bought 2,000 bushels of corn to protect against rising food prices and to diversify your portfolio; unless you had a barn (which most of us city-folk do not), you would have to figure out where to store it to protect it from spoiling, and you may even want to buy insurance in case your barn or corn-storage facility burned down. If you decided to sell your corn, you would have to find a buyer that wanted exactly 2,000 bushels of corn and was willing to pay market prices; pretty difficult to do if you are not a farmer. This hassle-full scenario is just for one commodity! Imagine if you wanted to diversify among several commodities, which is the financial sound strategy. All these factors make owning physical commodities too cost and time prohibitive.

Futures Contracts
Futures contracts make it easier to invest in a very specific commodity with minimal cost and without the limitations of owning the physical asset. A futures contract is a standardized agreement between two parties to exchange an asset for a set price and quantity, and on a given day. Futures contracts are traded on the Chicago Mercantile Exchange (CME) and are all standardized. For example, 1 corn futures contract equals 5,000 bushels of corn; 1 coffee contract controls 37,500 pounds of coffee, and 1 gold contract equals 100 troy ounces of gold. Continuing with the corn example from above, you would buy 1 corn futures contract on the CME to protect against rising food prices. If corn prices do rise, your futures contract increases in value; but if corn prices decline, your futures contract decreases in value. At the end of the contract term, you either have to take possession of underlying commodity (rarely occurs) or take an offsetting position in your futures contract. Trading futures is a very advanced investing strategy not suitable for most investors.

Mutual Fund or ETF
Mutual funds and ETFs are the best way for the average investor to gain exposure to a broad basket of commodities, without incurring the risks described with owning the physical asset or buying a futures contract. Mutual funds and ETFs can be easily bought or sold and can also be held in your regular investment accounts (IRAs, some 401ks, or brokerage accounts). Most commodity mutual funds and ETFs are structured as partnerships, which means they require additional tax reporting if held in a taxable account; therefore, investors should carefully review the structure of the commodity mutual fund or ETFs before investing to decide which account it should be invested in to minimize tax consequences.

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


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Don’t Put All Your Apples in One Basket


Despite its recent declines, Apple stock is still up 543 percent since the market low of March 9, 2009. Even if you bought Apple last year, you still made a hefty 40 percent return. There is no denying that Apple has been a fantastic investment. Maybe you didn’t purchase any Apple stock, so you think you missed out on a great opportunity. But whether you bought the stock or not, unbeknownst to you, you may actually own much more of that famous fruit than you think. Be careful, too many bites of Apple could make your financial stomach (portfolio) hurt if the stock continues to slide.

Watch Your Weight

Most investors use mutual funds to diversify and gain exposure to well known indexes such as the S&P 500 or NASDAQ. Nearly all large cap funds boast having Apple as one of their top 10 holdings. It is true that these indexes offer the opportunity for diversification because of their broad based holdings, but because these indexes are market-cap weighted, their exposure (and your risk) to Apple grows every time Apple stock rises. Indexes are created in one of three ways: price weighted, market-cap weighted, or equal weighted. A price weighted index (i.e. Dow Jones Industrial Average) is heavily influenced by the highest priced stock in the index; a market-cap weighted index is heavily influenced by the largest company in that index; and an equal weighted index is adjusted periodically so that each component has an equal weight.

Many mutual funds and Exchange Traded Funds (ETF) that track the S&P 500 or NASDAQ have seen their exposure to Apple grow over time because most are market-cap weighted. For example, the Fidelity Contrafund (FCNTX) has seen its exposure to Apple grow from 6.9 percent in 2011 to 9.4 percent in 2012; the SPDR S&P 500 (SPY) went from having 2.7 percent of its assets in Apple to 4.4 percent in 2012; and PowerShares NASDAQ (QQQ) has nearly 18 percent of its assets in Apple, up from 15 percent in 2011. If you think you have sufficiently diversified by owning these large cap funds and have a few shares of Apple on the side, you may have too many Apples in your proverbial basket.

Don’t Follow the Herd

Investors and actively managed mutual fund managers alike are known to follow the herd. Fund managers that do not have Apple stock in their top 10 holdings saw their judgment questioned by the fund’s shareholders, similar to when Warren Buffett was questioned by shareholders as to why he would not buy dot.com stocks in the 1990s; Buffett was later vindicated for having avoided the dot.com bubble. During the dot-com era, it seemed everyone was investing in internet stocks. It wasn’t uncommon to hear everyday investors at cocktail parties brag about their investments in Cisco, Lucent, AOL, and other venerable companies that subsequently lost tremendous value when the market collapsed. The people who lost the most in their retirement and investment accounts were those who became overly concentrated in a single sector or stock and failed to diversify out of those positions. They only realized after the fact that they were overexposed to technology stocks. Fast forward a few years, and these same individuals migrated to the next hottest investment – real estate. Many wrongly assumed that real estate would never lose value. After that came the gold craze, and most recently the Apple sensation. What’s next? Facebook?

Use the 5% Rule

While it’s a great feeling to see one of your stock picks skyrocket like Apple has, the reality is that not all of your stocks will be future winners. I always recommend that clients keep no more than 5 percent of their total portfolio in individual stocks because, while individual stocks can have tremendous growth potential, one bad stock can ruin your entire portfolio, especially if that one stock is a large part of your portfolio. No one expected such giant companies like Enron, Fannie Mae, General Motors, Lehman Brothers, AIG, Circuit City, Global Crossing, WorldCom, UAL Corp (parent of United Airlines), AOL, Lucent, etc. to either go bankrupt or completely wipe out their shareholders, but they did, and many people lost their entire life savings. Do not let yourself become overly exposed to one stock or sector of the market.

I am not attempting to predict the future price of Apple or advising against owning individual stocks altogether. I am simply reminding investors of the clear, but sometimes not-so-easy decision to review your portfolio periodically. Make sure you are not overly exposed to any segment of the market, and that you’re not taking on more risk than you can handle.

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


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What to Invest In Today


I meet with individuals on a daily basis that have different perceptions of the world, and how they should react with their portfolio:

  •  I’m worried about what’s going on in the world, I want to sell out of international stocks.
  • International stocks have been down more than domestic, I feel like it’s a great time to buy.

Both clients have valid reasons to think what they do. So, who is right and who is wrong?

I don’t know enough about the market to tell them what will happen with stocks over the next week, month, or year. I do know however that the above messages include underlying perceptions of investing that are rarely productive, and never consider an individuals goals.

In a recent TED talk titled Perspective is Everything (warning: an instance of foul language is used), advertising guru Rory Sutherland discussed this idea of perception, and specifically how economists (and likely the ones my above clients take their cues from) have the wrong perception of how to assist people in making the best decisions. He points to an often ignored school of economic thought (economics of the Austrian school) that instead of studying mathematical models, places its focus on psychology to determine why people act in order to find solutions to economic problems.

Most investors have bought into an investing paradigm that involves beating something or someone (neighbors, family, etc.), or maximizing yield. It makes sense why so many people equate this idea to investing since this is the exact paradigm they hear from so called ‘experts’ of investment management – “I best the markets.” The piece of their reasoning that doesn’t always translate is that they need to beat the markets to justify their jobs; that doesn’t mean what they offer is what you need.

As an advisor I rarely talk to clients about performance or winning investing as if it is a game. While it may be in an investment managers interests to take gambles with your money, it is not in yours.

Rather, I encourage investors to focus on the reasons for investing, and pick the best investments that meet those objectives, rather than starting with the objective of ‘winning.’ I use the acronym GPS to describe the starting point investors should have to qualify an investments usefulness.

Growth. All investors seek growth, and historically growth is best achieved by participating in the profits earned by successful businesses.

But, while most stock mutual funds fail to beat the markets, most investors with a ‘win at all costs’ mentality get burned, or waste countless hours jumping from one hot fund to the next in search of an extra percent return. The activity of buying into one hot fund at a high, and moving out of it after it falls on tough times often leads to a significantly lower portfolio returns than what would have been achieved by staying put.

Stability. Investors also want safety, but the question they rarely ask is – “How safe is this investment?” I hear far more often – “How much does it earn?”

The rule to remember here is don’t sacrifice safety for yield. Instead of thinking about what often amounts to a few extra dollars a year, ask yourself – “What are the chance of this money being there for me when I need it?”

Principal preservation is another goal of investors; to have their money not only stay stable, but increase as prices rise. I typically talk about it out of GPS order because a combination of Growth and Stable investments may provide the right mix to achieve a portfolio that keeps up with inflation. These may be real assets like real estate, precious metals, currency, or real goods. Think about these investments as providing diversification benefits first over providing winning returns.

Instead of pouring over funds and worrying about what fund or investment will outperform the others, a less stressful and far more productive strategy for individuals is to figure out how much you need to have invested for each category, select investments based on how well they match category criteria and not on returns, monitor those investments, and control the factors you can (avoid investing with companies with poor stewardship, poor performance, and excessive costs). This activity of determining how much you need in each category aligns your investment selection to your individual goals.

Invest today in a changed perception, from trying to win the highest return, to following a purposeful investment selection plan which will ease your stress, align your portfolio with your personal goals, and likely increase your returns.

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


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October: A Trick or Treat for Investors


“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” This is a great quote from Mark Twain. As the message states, not only may October be a dangerous month to speculate in stocks, every month carries risk.

What makes the month of October so worrisome for investors is their knowledge of the great stock market crashes that occurred. The crash in late October 1929 was a catalyst behind the Great Depression and the October 1987 crash still lingers in the minds of most investors.

So does the month of October deserve such a bad reputation? The statistical answer is no. A quick look at the historic monthly average returns of the Dow Jones Industrial Average (DJIA) since 1900 shows October does not deserve its bad rap. The award for the worst performing month goes to September whose average monthly return over that period is down 1.1%. October’s average return over that time frame is up 0.1%. The best month: December which was up 72% on average with a positive monthly return of 1.5%.

So why should investors look for a treat instead of a trick in October? By looking at the historic monthly returns of the stock market, an interesting pattern develops. There appears to be a seasonal tendency for the stock market to perform better over successive months than other months. 

The seasonal tendency is straight forward. Split a year into two distinct investment time frames, 5 months and 7 months. With the first time frame, $10,000 is invested in May 1950 and is sold in September 1950; the cash is held until May 1951 when the proceeds are reinvested in the same manner. The other portfolio invests $10,000 in October 1950 and is sold in April 1951, with cash similarly held until reinvested in October 1951. If the pattern of two distinct investment time frames is repeated year after year for 60-years, a dramatic difference in values surfaces.

The $10,000 invested in the 5 months between May and September would have grown to $12,436. Not a great return for 60-years of work. The $10,000 invested in 7 months between October and April would have grown to $606,806. These numbers do not take into account taxes or investment expenses which would lower the overall totals. But with a 4,700% difference in returns between the two investment time frames, it is a pattern worth noting.

So where’s the catch? Not every time frame has worked. The most recent example is the period from October 2007-April 2008 which whould have resulted in a 9% loss and the October 2008-April 2008 would have resulted in a 25% loss. 

While seasonality may give us a “tip” on how the stock market may have performed in the past, remember that any investment involving stocks may be “peculiarly dangerous” at any time.

Ed GjertsenEdward Gjertsen II, CFP®
President
Mack Investment Securities, Inc.
Glenview, IL


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Is OSU a Buy, Sell or Hold?


My alma matter has been a frequent story in the news lately. The coach has resigned and the top player won’t be coming back. So naturally what I’ve been wondering is if the program is a bargain buy yet?

Granted, it’s had some major setbacks. But, it has a great history. There should be value in the program and my season tickets at some level. Maybe they won’t grant me a good bowl trip this year, but who knows, they may surprise us all.

Would you own OSU today? And, what is even more interesting is would you have bought them six months or a year ago?

  • In early January, ESPN had them in their top 10 teams for 2011. Certainly that could be construed as a big buy signal from a knowledgeable analyst.
  • Rivals.com ranked the Buckeyes with a good recruiting class of freshmen for 2011, and the top class in the Big 10.

And what about a year ago? Who wouldn’t have wanted to own OSU going into the 2010 season? Most of the season they held one of the top two spots in the rankings, stayed within the top 10, and won a top-tier bowl.

But what if you had bought back then, what would the value be today? And what do you do today? Sell before they have a down year or two? Or hold on for the chance they surprise us all with a bounce back? When exactly was the time you should have sold, and, more importantly, did you?

Clearly, this analogy isn’t meant to be literal, but an illustration of how many investors think about stocks. And the message is probably clear: Despite what you knew about a sports program at the time, you really didn’t know enough to gamble on it going forward.

Fifteen years ago, you would have been wise to own Buckeye rival Michigan, though they have had hard times in the last several seasons. Maybe this is a good point to own them again with the momentum and excitement a new coach is bringing to the upcoming season.

But who could have known when the momentum would turn?

Which is exactly why individual stock picking is gambling. The market and corporate structure is far more complex and involves many more actors than a college sports program. At least with college student athletes the motivations are pretty cut and dry!

Investing involves being in it for the long-term, not gambling for the next year or several. Think about who we hold the most respect for in the markets and in sports: Warren Buffett, Joe Paterno. Did they achieve their status by focusing on one year in the market, one season on the field? Not likely.

It also is wise not to place all your chips on one team, but to ‘own’ them all. We had no idea what would happen with OSU football six months ago, however we do know college football is going to continue to do just fine.

But why stop at football? You could benefit from owning a little more of the sports universe. Add a little bit of an emerging sport for higher growth potential (my pick would be lacrosse). And we all know the great foreign story behind what the rest of the world knows as ‘football.’

So, as you contemplate and weigh what changes and short-term gambles you think you need to make in your portfolio, think about what may go wrong because of those variables you don’t know. And then ask yourself if it’s worthwhile to be a gambler at all, or if you would be happier spending your free time enjoying whatever it is you enjoy… perhaps a few more sporting events.

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