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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How the Fed Sets Interest Rates

The role of the US Federal Reserve, referred to most as “the Fed,” and how it determines interest rates remains a mystery for many people. One of the many functions of the Fed is setting short-term interest rates. During my nearly 10 years at the Fed as a Bank Examiner, bankers frequently asked me whether the Fed was going to raise or lower rates. My response always included the same disclaimer: the Fed analyzes and makes decisions based on the same economic indicators that everyone else has access to.

So, what factors impact whether the Fed decides to intervene to stabilize the markets? The Fed sifts through huge amounts of data (known as economic indicators) from various government and non-government sources, which are used to determine the current “health” of the economy. The Fed relies on three types of economic indicators: leading, lagging, and coincident. Leading indicators are used to predict future economic events while lagging indicators are events that have already occurred, but are still important to consider. Coincident indicators measure changes in the economy as they are taking place. Below are some of the key economic indicators commonly used by the Fed to determine interest rates:

  • Consumer Price Index (CPI): The Department of Labor’s Bureau of Labor Statistics produces the CPI, which accounts for the change in prices of many goods and services. It is also the most widely accepted measure of inflation and plays a large role in setting and adjusting incomes and other payments. For example, cost of living adjustments, Social Security benefit adjustments, and many other government payments are all based on the CPI. The CPI is published monthly and is considered a lagging indicator because it is based on past events.
  • Gross Domestic Product (GDP): The Department of Commerce’s Bureau of Economic Analysis compiles GDP, which measures the value of all the goods and services produced by a given country. It is similar to a person’s annual salary and is used to gauge a nation’s economic power and wealth. GDP numbers are closely monitored by the Fed because GDP value dictates whether a country is in recession or expansion. GDP numbers can also have a big impact on the health of the stock market. Curious how the US GDP compares to other nations? In 2011, the US GDP was $15 trillion whereas the GDP of Russia and China were $1.86 trillion and $7.3 trillion, respectively. GDP is published quarterly and is also considered a lagging indicator.
  • Unemployment: Every month the Bureau of Labor Statistics conducts the Current Employment Statistics (CES) survey to assess employment in the US. The Fed keeps a close eye on unemployment figures to measure the impact of their policies. If unemployment remains high, the Fed may decide to initiate more stimulus.
  • Stock Market: To the Fed, the stock market is one of the most telling indicators because stock prices are based on future earnings of a company, not its current or past performance. Some economists believe the stock market is an indicator of how the economy will behave six months hence. Trends in the stock market can also provide clues on consumer spending behaviors, as well as, business investments.

There are a multitude of other key indicators, such as retail sales, consumer confidence, new building permits, etc., that factor into the Fed’s assessment of the US economy. In fact, there was a recent Bloomberg news article about how aggregate Google searches can also be used as a leading economic indicator because it represents current hot topics. The Fed considers all these factors (excluding Google searches) when deciding how to set interest rates.

Despite some criticism of how the Fed reacted to the most recent Great Recession, I think Ben Bernanke, current head of the Fed, deserves credit for his commitment to transparency and communicating the reasoning behind the Fed’s actions. Bernanke’s predecessor, Alan Greenspan, was notoriously confusing and often frustrated the public with cryptic speeches, secretive actions (remember Long Term Capital Management?), and infamous buzzwords like “irrational exuberance.” During the Greenspan era, experts were typically interviewed after every Greenspan testimony (the Fed didn’t give press conferences at this point) to decipher his remarks. Sometimes it seemed that Greenspan went out of his way to leave people scratching their heads.

Whether you agree with Bernanke and the Fed’s response to the Great Recession or not, we should all agree that Greenspan’s habits of addressing today’s problems with backdoor deals and obtuse speeches that rattle markets, are a welcome thing of the past.

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


Defining Diversification

In the top few responses most people give when you ask what they know about investing, “it’s important to be diversified” is right up there with “buy low, sell high”. Both statements are true and very important components of investing. My concern is that we hear and say these things so often, we lose sight of what they actually mean. defines Diversification as “a risk management technique that mixes a wide variety of investments within a portfolio.” True, but what the heck does that mean? Can it be any mix of investments? What does it really hope to accomplish? Is my portfolio diverse?

Today my goal is not to sell you on a particular investment strategy or convince you that there is any one way to properly diversify. My hope is to provide some key educational points to enhance your understanding of this important rule of thumb.

As the last several years have shown, investing in the stock market can be a volatile experience. If you invest in stock in one or even a small handful of companies, the value of your portfolio can shift wildly, often it seems for no logical reason. The primary purpose to diversify your investments is to decrease these and other risks.

How does one increase a portfolio’s diversity? Let’s look at a portfolio strictly invested in stocks. The simple answer is to buy a higher number of stocks. The better answer is to buy a higher number of different kinds of stocks. Suppose you own General Motors. Buying Ford might technically make you more diverse, but only slightly so. You still own just two companies, both large, US automakers. Instead, you should look at a vast array of companies differing in size, location and type.

This means expanding your portfolio to large and small companies of all types (often called sectors) all across the globe, avoiding the urge to own more companies in the U.S. than in other parts of the world. U.S. companies make up just 40-50% of global market share. By focusing solely on the U.S., you cut off the opportunity to better diversify and participate in the opportunity for growth in more than 50% of the world’s companies.

I want to stress that none of this is a blueprint for any type of investment strategy. It is simply an effort to help you understand what diversification means. How much diversification, in what areas, and the blend or allocation of different types of assets is a decision that should be made with careful thought and, in most cases, professional advice based on your goals and ability to tolerate risk.

As you approach your personal financial planning and goals, it’s important to obtain at least a basic grasp on the essentials in order to make the most educated decisions possible. There are lots of trusted professionals there to help, but knowledge is always a worthwhile investment.

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

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Mutual Accountability

Business CoachWe talk a lot at the financial planning firm I work for about mutual accountability. In fact, it is part of our vision statement. What it means to us is that there are responsibilities for both the advisor and client in maintaining a healthy relationship designed to successfully meet our clients’ goals.

For advisors, that means being diligent and putting together sound advice and plans that serve the best interest of the clients and families we gratefully spend our careers serving.

But, we must also expect clients to be accountable for carrying out those plans and letting us know when goals or situations are in flux. Without proper execution, the advice we offer will never amount to much. Despite what many think, long term success occurs less in the swings of the stock market and more in the mundane financial decisions we make every day.

So what happens when we deviate from those plans?

See if this analogy hits close to home. You’re making an ongoing effort to eat less. Maybe you’ve consulted with a dietician, attended a Weight Watchers meeting or sought advice on the Internet. You put a plan together designed to meet your goals. Then, one night you decide to splurge. It might be a trip to the fridge for an extra bite of leftovers or a quick cookie in the pantry.

Do you own up that you’re making a conscious choice to go off plan? Or, do you “sneak” the quick indulgence? Hide it from a spouse or your children? Claim ignorance at your next meeting as to why the pounds aren’t melting away?

Have you ever thought about why?

It’s ridiculous, really. That cookie isn’t adding calories to anyone else’s diet. It isn’t breaking their rules. The person you’re really hiding from is yourself. You’re avoiding accountability.

Are these types of indulgences the end of the world? It depends. Does one cookie become a whole sleeve? Does twice a month become a nightly ritual? How badly are you willing to sabotage your long term goals for short term enjoyment?

The same is true with our personal finances. We all have places we turn for financial planning and advice. Financial planners, investment managers, and sources like this blog or other Internet resources can be full of valuable, insightful information. Either way, we might receive some useful advice or read a particularly relevant article and decide to commit to making a change in our financial lives, just like with our diets.

What happens next is crucial. Do we carry it out? Do we save a little more? Spend a little less? Or do we quickly find ourselves back at square one after too many instances of whatever the financial equivalent is to an extra bite of cheesecake when no one’s looking?

Unfortunately, like our waistlines, accountability will eventually rear its ugly head. We can spend that extra dollar when no one’s looking and cheat our responsibility to our future selves all we like. In the end, we will have no one else to answer to when important goals go unmet. No one has the kind of stake in your future that you do.

There are wonderful advisors and tools out there to help you build a path to meet your lifetime goals, but the path is really all they can show you. The decision to walk down the path is yours. Sure, you’re going to stray from time to time, just don’t get so far off course that you can’t find your way back. Keeping those diversions to a minimum and letting your trusted sources know when they occur will help ensure the needed corrections will be relatively minor.

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

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No Substitute

If advertising trends are any indication, more and more of us are experiencing increased levels of what I’ll call “yield fatigue”. New advertisements and articles appear everyday about where to go to earn something on those dollars otherwise sitting in savings accounts, money markets, CDs and the like. We enjoy the safety these type of vehicles offer, but are growing exceedingly tired of earning nothing or near nothing while the cost of gas, health care, tuition and other goods continues to rise. We have to do something. Right?

It’s no secret that our relationship with money has always and likely will always revolve around fear and greed, risk and reward. It is frustrating to scrimp and save only to see no short term fruit born for our efforts. That all said, it seems that, in our quest to earn a bit more of our hard-earned dollars, some are starting to get a little loose with the definition of the word substitute.

Suggesting moving some of your cash or short-term, high quality bonds to dividend paying stocks, high-yield (a.k.a. junk) bonds or emerging market bonds may sound promising at first glance. I’d argue that’s the greed side of the equation playing with your mind. That’s not to say that there aren’t situations where taking more risk to earn higher returns than cash is currently offering don’t exist, they certainly do. The irresponsible part is anyone proclaiming, or any investor believing, that this is a “substitution” for cash or cash like investments.

No, the equation hasn’t changed. If you wish to earn an expected return greater than that being offered in cash, you must accept the additional corresponding risk. In other words, moving some of your safety net into riskier investments, even if only slightly so, should be carefully evaluated, preferably with a trusted advisor. Everyone has different long term needs, wants, wishes and abilities to tolerate risk. Some may be able to stay on track sitting on their current cash reserves through this continuing low-rate environment while others are falling further behind on their hopes to meet their goals. If you do choose to make some adjustments and go it alone, make sure, at a minimum, you at least . . .

  1. Maintain your emergency fund in cash. Make your first savings priority to have at least six months of living expenses available in cash, possibly more if you’re self-employed or a single income home.
  2. Avoid investing in anything other than cash and short term, high quality bonds for any cash you might need in the next five years. The stock market is a place for long term investing. If you’re going to need the money soon or there’s a high probability you might, leave it on the sidelines.
  3. Dividends are nice, but so is preserving your capital. There’s nothing wrong with making dividend paying investments part of your investment strategy. Just make sure you understand how volatile they can be to your principal. Also keep in mind that when the value of a stock goes down, so might the amount of dividend you receive. When the market went south in 2008 and 2009, many companies suspended dividends right when their stock values are at their lowest. Can you afford to have your income stream and the value of your portfolio impacted that dramatically all at once?

With some thoughtful strategizing, your plan can include all the safety and security you need in the short term, with an eye towards growth with those investments slated for the long term. Just make sure you aren’t moving things from one category to another without understanding the risk. Often times when it comes to cash, there’s just no substitute.

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


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


Invest Outside the Box

Most people consider the Morningstar Style Box, the ubiquitous 9 square grid seen all over financial publications, as the entire spectrum of investible assets. These same individuals consider stocks, bonds, and real estate to be the only acceptable forms of investments (aka: asset classes). While these certainly are the primary investment vehicles used by most, and granularity within these sectors allows further diversification, they do not represent the whole spectrum of investment options. Building a well diversified portfolio entails combining assets that compliment each other and reduce risk; in finance parlance, they have low correlations. During times of stress, correlations tend to be high, which means assets move in tandem; this explains why even the most diversified stock and bond portfolios sometimes lose value in a down market, albeit not as much as the overall market. However, there are many asset classes that are often overlooked, despite their low correlations.

  • Become a venture capitalist
    Venture capitalists provide early stage financing, either through debt or equity, to companies they believe will be profitable. Unfortunately, not all good companies have access to venture capital because of their size, and not all companies are good investments. Given the current economic climate, even good small businesses are having a very difficult time obtaining bank financing. Do you know someone who recently started a company or is thinking of expanding their existing profitable business, but is unable to obtain financing? If you believe in this person and their product/service, then consider investing in their company by lending money at a reasonable market rate, buying shares in their firm, or both. Your investment in their firm will be less tied to the stock market, give you diversification, and of course help a small business; all good things.
  • Invest in consumption
    Another way investors can enhance their portfolio returns and minimize risk is by investing in commodities. Many people think of commodities as just gold or silver. However, commodities are a much broader category than just these two metals. Commodities are divided into two categories: Hard and soft. Hard commodities are those that are mined such as gold and silver, while soft commodities are grown and consumed. Commodities are not only a good hedge against anticipated inflation, but they also have a low correlation with the stock market. A more recent trend in commodities investing is in water rights. Water is a scarce resource and some experts predict that in the future, territorial conflicts will shift from energy to water rights. If this prediction-theory is correct, investing in water rights may be lucrative.
  • Collect something
    Collectibles such as stamps, art, wine, coins, vintage car collections, etc. are usually considered hobbies, but they are all forms of diversifiable investments. The mere existence of large auction houses validates the significance of the collectibles market. Many famous entrepreneurs and entertainers from Bill Gates to Elton John have invested in art and collectibles. In 2006, famed entertainment mogul David Geffen, purportedly auctioned off a painting by American painter Jackson Pollock for $140 million, the highest single amount paid for a work of art. Beyond collectibles, some people buy and sell websites. According to a recent Bloomberg Businessweek article, an investor bought in 1995 for $150,000, and sold it four years later for $7.5 million. The most important rule of investing in collectibles is to buy what you know and love. Don’t buy baseball cards just because you think they will go up in value someday, buy cards because you understand and love the game.

The aforementioned investments are not risk free, and require a tremendous amount of due-diligence prior to making a commitment, which is why their payoffs are so great. Therefore, it is important to know what you are investing in before committing your hard-earned funds. Investors should also keep in mind that such investments are often illiquid, do not generate cash, require a long time horizon, and may have unique tax consequences. Whether you decide to lend capital to your best friend from high school for her new ultra-hip restaurant, or buy stock in your college roommate’s medical device company, it is always a good idea to draft the appropriate legal documents to protect both parties. Lastly, as with any asset class, determine an appropriate and strategic percentage of your portfolio to allocate to such investments which are based on your goals and risk tolerance. Remember to always remain within that range; do not overexpose yourself to any investment. And as always, an informed investor is a successful investor.

By Ara Oghoorian, CFP®, CFA
Special to FPA