All Things Financial Planning Blog


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 Better Off Today Than Four Years Ago?

Every day we get bombarded with reminders that we are not better off than we were four years ago. Obviously, if we have been unemployed during some or all of that time then we are not better off than we were four years ago. Having someone close to me in that situation I am able to see first hand how that has played out.

But what about the rest of us? Are we better off than four years ago? As a financial planner, I have opportunities to have that type of discussion frequently with clients or potential clients when we discuss their financial history. I thought I would make this blog a discussion of how some people have responded to this type of discussion or question.

Here is what the big picture is when I ask this question of people I interact with – if it is a recent observation then they probably do not feel good about the way they look at things. If, however, we discuss the issues over the entire four year spectrum, then they start to realize that things are probably better. Let me share how these issues come about.

Things that are better than four years ago:

  • Their mortgage rate is lower because they refinanced and significantly lowered their interest rate – one client went from 6.6% to 5% and the payment was lowered by $1,000 per month.
  • They stayed the course with their investment portfolio during the entire period. One client had $50,000 at the start that dropped to $35,000 and has since grown to $63,000 as the markets recovered. This does not include new money they invested.
  • That same couple continued to contribute to their 401k plans and they see that the per share prices for new contributions were lower in the early part of the four years so they have more total value today than they would have if the market had not recovered as it has.
  • Another couple was able to pay down their credit card debt faster than they have in the past, in part because they had refinanced their mortgage and used the extra money to apply to the outstanding credit card balance.
  • Several clients now had jobs versus being unemployed four years ago. During that time they used up much of their savings but now they had a new job, new career and things looked brighter.

What about the people who do not feel better off today than they were four years ago? In many cases the issues cited were based on more current observations:

  • They use their car a lot and the price of gas is much higher so they are spending a lot more of their weekly paycheck for gas.
  • They had credit card debt that they are struggling to pay off and the interest rates are very high so not much is going to reducing the principal amount owed with each payment.
  • The ones with credit card debt are also not able to get an equity loan on their home or to refinance the first because the first mortgage is higher than the current value of the property. In a few instances, the interest rate on the first mortgage is also higher than what it could be if they refinanced.
  • For some who have been scared off from investing in the stock and bond market, they see no growth in their investments because they have it all in cash. They are very afraid to get back in the market because they in some cases were burned from the earlier downturns in 2000 or thereabouts.

As you review this blog and the issues cited, how have you reacted to the issues in your specific situation? Are you thinking that things are going to be better or worse four years down the road? If you think they are going to be better, has that changed the way you look at how you save and invest for your future goals? If you think they will continue to be worse, does that make you even more conservative in how you invest for those future goals?

I would be interested in hearing from those who read this blog to get your insights.


Francis St. Onge, CFP®
Total Financial Planning, LLC
Brighton, MI


How Sharpe is Your Portfolio?

Whenever I meet with prospective clients, I usually hear the following comment “I want my portfolio to outperform the overall market, but I don’t want to take any risk.” It’s understandable; individuals want their investments to do well when the market is up, but they also don’t want to lose any money when the market is down. Unfortunately, risk and return have a positive relationship: the higher the expected return, the greater the risk. The optimal portfolio earns the maximum return with the least amount of risk, but how does someone create that optimal portfolio? One method used by professional money managers is the eponymous Sharpe Ratio. Created by Nobel Laureate William Sharpe, the Sharpe ratio is a measure of risk-adjusted returns or how good is your investment return given the amount of risk taken. The higher the Sharpe ratio for an investment, the better the risk-adjusted return.

What is Risk
The Sharpe Ratio is simple to compute and is comprised of only three variables: expected return, risk-free rate, and standard deviation. Standard deviation is the most widely used measure for risk in portfolios because it shows the variation of returns from the average return. The greater the standard deviation, the greater the risk. The risk-free rate is a theoretical investment with no-risk and typical proxy is a short-term government bond yield. The Sharpe Ratio is calculated using the formula below.

(Expected Return of Portfolio – Risk Free Rate) / Portfolio Standard Deviation of Portfolio

Apples and Oranges
Assume your portfolio had a 15 percent rate of return last year while the overall market earned only 10 percent. Your initial thought would be that your portfolio is better than the overall market because of your added return. However, even though your return was greater than the overall market, if you take into consideration the risk of your portfolio, calculated using the Sharpe Ratio, you may have assumed much more risk than you thought. Hence, your portfolio was not optimal. Let’s assume that your portfolio had a standard deviation of 13 percent versus 6 percent for the overall market, and the risk-free rate was 2 percent.

Sharpe Ratio for your portfolio: (15 – 2) / 13 = 1.00
Sharpe Ratio for the overall market: (10 – 2) / 6 = 1.33

In this example, we see that while your portfolio earned more than the market, your Sharpe Ratio was significantly less. The market portfolio with a higher Sharpe Ratio was a more optimal portfolio even though the return was less. Therefore, you assumed excess risk without additional compensation. Conversely, the overall market, with the higher Sharpe Ratio, had a higher risk-adjusted return.

Not Everyone Is Normal
One of the biggest advantages of the Sharpe Ratio is also its biggest weakness. The Sharpe Ratio relies on the standard deviation as a measure of risk, however, the standard deviation assumes a normal (bell shaped) distribution whereby the mean, mode, and median are all equal. Recent history has shown us that market returns are not normally distributed in the short-term and that they are actually skewed. In a skewed distribution, the standard deviation becomes meaningless because the mean can be either greater than or less than other measures of central tendency. In addition, when short-term volatility spikes as it has in the last 3 years with large swings in both directions, the standard deviation rises and causes the Sharpe Ratio to be lower.

Why Diversification Matters
Constructing a diversified portfolio actually improves expected returns without increasing risk. The standard deviation of an individual asset is based on that asset’s variability from the mean. Standard deviation of a portfolio (multiple assets combined) is calculated using each asset’s standard deviation, the asset’s weight in the portfolio, and the correlation coefficient among the assets. When two assets have low correlations and they are combined to form a portfolio, the portfolio standard deviation is lower than the sum of the two standard deviations. As a result, the Sharpe Ratio tends to be higher because the denominator of the ratio is lower.

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


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 stocks in the 1990s; Buffett was later vindicated for having avoided the 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


What is Really Driving Your Financial Decisions?

A brain scan was taken just before an individual placed a stock trade. Another brain scan was taken just before someone was given a hit of cocaine. In both cases, the brain was flaring up in anticipation of a gain, and the scans were virtually indistinguishable.

Contrary to what we like to believe, decisions are made with the right side of our brains. This statement is controversial because we generally believe that we are rational people and make most decisions after an objective evaluation.

With respect to our financial decisions, this is even more controversial because as soon as we hear the word “finance,” our left brain springs into action. We have conditioned ourselves to believe that finance and mathematics are inextricably linked, and therefore, we make our financial decisions based on rational thought. In reality, we frequently make decisions before we are consciously aware of them and then attempt to rationalize them before we act. We must not confuse this with rational thought.

The left side of our brain tells us the two scenarios outlined above are different, but our right brain can not tell the difference. The left brain tells us that drugs are bad, and making money is good. The right brain simply knows is that we are about to benefit from something.

One of the things that makes us human is the ability to engage in rational thought. Unfortunately, this often results in bouts of overconfidence in our ability to control our emotions.

The brain scans above outline this phenomenon perfectly. Through rational thought, we have the ability to control our urges by recognizing the inherent danger in certain situations. However, we often neglect to acknowledge that danger when it applies to money (or we greatly underweight it), as we are conditioned to believe we ought to pursue more of it.

We must also recognize the overpowering nature of our emotions in reverse. Rational thought would not have led to so many people’s decision to bail out of the market (or not rebalance their portfolios) in 2009. Rational thought would have prevented millions of homeowners from purchasing homes with little or no money down. Rational thought would result in everyone spending less than they earn and planning more for the inevitable uncertainties in life.

We can not change how we are biologically wired, but we can make consistently better decisions by simply acknowledging how and where they are actually made. Like the deterioration of our bodies as a result of cocaine, the pursuit of short-term financial gain can set us up for long-term financial ruin. We insulate ourselves from the dangers of drugs through avoidance. It would serve us well to do more of the same in our financial lives.

Joe PitzlJoe Pitzl, CFP®
Director of Financial Planning
Intelligent Financial Strategies, LLC
Edina, MN


Why Diversification Matters

Last week a friend and I were catching up on life over lunch. This particular person happens to be an extremely knowledgeable investor, and he generally enjoys trying to pin me down on what may happen with the market, economy, interest rates, and the like.

And while he knows my feelings about predictions, we went on to chat about what is going on in the world; and, what various circumstances may or may not mean for holding different investments.

At one point I asked if he was diversified, or had a plan, for whatever may happen.

“My portfolio is well spread out over ten stocks. I’m diversified.”

And over a great Caesar salad, I heard a familiar story about the value of “placing all of your money in one basket, and watching that basket.” I heard again about investor-extraordinaires who called the last downturn exactly when the market turned, and how Warren Buffett’s Berkshire Hathaway only owns a handful of stocks.

But beyond the same conversation we’ve had several times before, there was something else he wanted to discuss that day; a deeper reason for his needing to know what the market may do next, and I could detect a level of worry that was not always noticeable in our past talks.

You see, my friend is of a normal retirement age, and has been out of the workforce for the last few years. He went back to school to pursue a certificate in an unrelated field; he graduated with flying colors. The conversation we were having began to flow from investments to how his original plans involved his working again to make retirement work.

We went on to discuss that while he isn’t drawing on his portfolio yet, there is an ever growing likelihood he would soon. There are daily worries over any number of things that may cause that to happen; a car engine on its last legs, a furnace that needs replacing. And, while he has his health, that too was another topic of concern.

He knew he had saved a decent amount during his first career, but not as much as he could or should have. Due to anxiety during the downturn, he pulled out of the market close to the bottom, and returned late after the majority of the rebound.

I went on and shared with him how we may have our disagreements when it comes to investments, but no matter what beliefs, ideas, or philosophies an investor has, for people diversification is critical. It was the number one reason for his worries I said to him; his retirement plan had turned into a gamble over what stocks would be success stories, when the odds (and his own history) were not in his favor.

Still unconvinced, he presented his case… and being nervous about loss, he countered all of his own points for me.

  • The commentators are saying bonds are in a bubble and to invest in inflation hedges… but of course there has been no inflation to speak of yet.
  • And, the economy looks like it will continue to do poorly so should I pull out of my stocks… but, the market has had two above average years of growth.
  • Domestic stocks certainly won’t grow compared to foreign companies… but, it is a global economy, and look at the problems they’re having in Europe.

My friend’s answer to his financial dilemmas fell back on getting everything right in the market on an almost daily basis. He was watching his account performance day-by-day because his timeline, or time preference, for needing to cash in his investments may change that quickly.

The money managers he watches on television can have a bad week, month, or year, and can still be tops in their profession. The institutional investors whose research he reads don’t have to worry about unexpected car replacements, or health concerns.

As I thought about what else I could say to help, what came to mind was a simple alternative mindset about his investments. Instead of an all-or-nothing strategy, look at your savings in a ‘multiple portfolio’ approach.

A multiple portfolio approach involves seeing the different needs for your investments within the overall structure. Picture a different bucket for every unique goal you have for your money — an example in this case being a separate portfolio for each year of retirement — with all of the buckets together making up your portfolio.

Knowing for the next four years my friend would need to supplement his income for $5,000 of living expenses, and $3,000 as a gift to pay for a Grandchild’s tuition, he would never invest that combined $32,000 in the market. If his car won’t make it another five years, that’s another goal to add that to the conservative piece as well.

I don’t know if it helped, but it seemed as though there was an ‘ah hah’ moment where the risks he was taking with the portion of his money he needed to have absolute faith would be available for use, when he needed it. And, that is why diversification matters.

robertSchmanskyRobert Schmansky, CFP®
Financial Advisor
Sound Capital, LLC
Royal Oak, MI


Will the Gold Rush Continue, or will Fool’s Gold Rule?

Be Aware of the Risks When Considering Gold in Your Portfolio

Have you heard this one lately? “Gold has returned more than 300 percent over the last decade. How is your IRA doing?”

If you haven’t yet, you almost certainly will. Gold is at all time highs. Concerns about the dollar and the global “flat” currency system (in which currencies are not backed by gold as they once were) have renewed interest in protecting wealth by owning that precious metal.

So, the question of the day is… do you need it in your portfolio?

As with any investment — be it gold, stocks, bonds, mutual funds, etc. — before you jump in, you need to know the answers to these basic questions:

  1. What is its purpose in my portfolio?
  2. How will I make the investment, and at what price?
  3. When will I know it’s time to sell?

If you haven’t already thought these questions through, the driver in your recent interest in gold is likely simply a fear of missing out, perhaps fueled by aggressive advertising by gold dealers. This is normal, but concern about missing the boat often creeps in after the ship has long since sailed.

So, to find out if gold is a fit for your portfolio, let’s cover the basics. First, here are some reasons that gold, as well as real estate and other “hard assets,” may be a sound part of your overall investment strategy:

  1. “Store of value” (inflation protection). You work hard for your money. Gold, since the beginning of recorded history, has been used to ‘store’ the fruits of one’s labor for future consumption in a way that maintains purchasing power. However, the required holding period may be lengthy; over the last several decades, gold has not always kept pace with inflation.
  2. Inflation speculation. One of the reasons for gold’s recent run-up in value is that its buyers speculate in gold not based on recent inflation rates, but on expectations of future inflation rates. During the 1970s, many people expected the period’s high inflation rates would continue well into the future. But when future inflation expectations began to drop, so did the price of gold. 
  3. Diversification. Gold and other commodities tend not to move in the same direction as stocks and bonds. Gold is therefore considered a portfolio diversification tool.

For most of us, the best place to store the fruit of our labor for our emergency needs is cold, hard cash in a federally insured bank which is available when you need it, in a predictable amount. Gold must be considered more of an investment than a cash equivalent, so its place in a portfolio is more appropriate as a longer-term piece of the puzzle, than a substitute for emergency cash.

If you are thinking an investment in the yellow metal makes sense for the long term, here are a few things you should know before diving in:

  • The market for gold is more risky than you might think. It is extremely volatile and often complex. Be aware that there is more nominal value in paper contracts for gold, than physical gold exists to be delivered! And the price of gold does not always move in consistent patterns.
  • Because of the above, particularly if you are worried about protecting yourself from the remote prospect of a meltdown of the financial system; consider owning your gold in the form of the actual metal, instead of the paper alternatives and proxies, like gold mutual funds, exchange-traded funds (ETFs), etc. But keep in mind that you’ll incur storage and convertibility costs when you take delivery of the metal.
  • Gold coins and bullion are considered, for tax purposes, to be a collectible.  That means that gains on the sale of gold, as well as shares of gold exchange traded funds and mutual funds, are taxed at higher capital gains rates than most other investment assets.

Also — for the newly minted ‘gold bugs’ — consider that you may already own some — and not even know it! Several mutual funds own both gold stocks, and even gold (and silver, and other precious metal) bullion. As is often the case, allowing financial professionals to decide when to buy and sell on your behalf may be wiser than trusting your instincts. 

Taking the longer-term view, consider that from its 1983 peak to the 1999 low, gold lost over half of its value. Stocks, bonds, and even ‘mattress cash’ for 16 years all trounced gold holders, as the hedge against inflation theory failed.

The gold enthusiast will rightfully point out that anyone would have preferred the gains in gold over the last 10 years, to the returns on stocks. There’s no denying those with the foresight to buy gold in the past decade will have done well — if they sell at today’s high price and lock in their gains. 

But, how long will it last? Investors 30 years ago who feared that the high inflation of the period could continue on well into the future sought out gold as a buffer. Many bought in at high prices that wouldn’t be seen again for decades. As those investors learned, changing attitudes about the future can turn a gold rush into a popped gold bubble. So if you do invest, don’t grow too emotionally attached to your gold — or any other investment for that matter.

robertSchmanskyRobert Schmansky, CFP®
Financial Advisor
Northern Financial Advisors, Inc
Franklin, MI