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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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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Beware Barnyard Rules Investing


In early grade school, my next door neighbor and best friend Mike and I were absolutely inseparable. Any free time you could find us engaged in all varieties of physical games — from basketball, football, to roller hockey. You name the sport, and we could be seen trying to make a one-on-one game of it in our parents’ yards.

Often, Mike’s older brother would challenge us to a game, any game, of two-against-one. Inevitably, when the tide turned against him, anyone within a hundred yard radius could hear a shout of “Barnyard Rules!”  This was our warning that the accepted rules of the game were off. The law of the jungle prevailed.

Having grown up in the suburbs of Detroit without a farm within miles, to this day I can’t fathom where he came up with the term, Barnyard Rules. To me, it has always meant using whatever advantage you have to get the job done in the short-term, ignoring the principles (the rules) of the game, and the consequences (generally physical injuries) of breaking them. 

Barnyard Rules has come to mean even more to me as I’ve read Dr. Stephen Covey’s books on principles. He frequently uses the example of life on the farm to describe what principled living means. Farmers do not simply declare ‘Barnyard Rules’, and harvest a higher yield of crop. Principles might best be described as things that are, simply because they are.

Likewise, a principled investing plan requires accepting the fundamental truths of markets, your role as an investor, and the knowledge that speculative investments that would tempt us out of greed, or fear, to ‘win’ the game, are simply the ‘barnyard rules’ seeking to gain hold.  

Reacting to the downturn, many investors have shed principles. They believe they are adjusting to ‘new realities.’ But in truth, they are ignoring — consciously or not — time-tested sound investment principles. Those include seeking higher returns and yet ignoring the risk, giving into fear or greed and pursuing speculative investments, and not maintaining investments whose purpose is to provide safety and stability, despite their yield. It is true that we have endured a far worse than expected investing “season.” And yes, systematic economic and financial threats, just like hurricanes or droughts, could always bring hard times to the farm again.

But, ask yourself:  Is your objective in the new strategy investing for sustainable crop yields, year in and year out? Or are you trying to scratch out a little more yield this year, to next year’s detriment? Or are you running for cover because the sky looks threatening?

Interestingly, I see many investors beginning to ask the same questions that burned them before the downturn — where can I get the most yield; what investment will generate the highest return; should I buy a risky stock; who has the advantage — and how can I get a part of it?

Thanks to Morningstar’s monitoring of investor returns, we can see the consequences of this line of thinking.

For example, one of the best performing domestic mutual funds over the last 10 years, CGM Focus Fund (CGMFX), has a 10 year average annual return (through 11/30/09) of 18.79 percent — handily beating the S&P 500. However, due to the nature of many investors that such performance attracts — i.e. those impatient investors looking for spectacular returns — the average investor in the fund fared dramatically worse. Specifically, the average CGM Focus Fund investor lost an average of 11 percent over the same time period.

On the farm there are no shortcuts for long-term success. Shortcuts — failing to invest in proper equipment maintenance — only create long-term problems. The Barnyard Rules always end in pain and loss. Farms would not produce if their farmers dumped principles. Investors that continuously leave investing principles for the latest pitch or product likewise should be concerned about their prospects for achieving their long-term goals.

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