Embrace Low-Frequency Trading

I love Michael Lewis’ writing, but I have some surprisingly good news to share about the high-frequency trading scandal revealed in his new book:

High-frequency trading is not likely to hurt disciplined, long-term, low-frequency-trading investors. In fact, it might even help.  bondpit

Yes, it is almost impressive that Wall Street has managed to produce yet another scandal, even under the ever more watchful eye of regulators and the media since the financial industry imploded in 2008.

And no, I don’t favor high-frequency trading or especially its less-sophisticated cousin, day trading. I thought former hedge fund manager James Altucher put it best when answering the question, “Should I day trade?”

“Only if you are also willing to take all of your money, rip it into tiny pieces, make cupcakes with one piece of money inside each cupcake and then eat all of the cupcakes.”

However, high-frequency trading, this scandal du jour, seems to actually push trading costs and bid/ask spreads (effectively, the net cost of purchasing a security) down for investors. High-frequency traders aren’t doing it out of the kindness of their heart, mind you, but it’s the large number of medium-frequency active managers who are losing out, not disciplined low-frequency investors. Wall Street’s movement toward high-frequency trading is only making a stronger case for passive asset class management—a major component of which is low-frequency trading.

The primary benefits of low-frequency trading are the reduction of trading costs, the minimization of taxable events and, especially, the avoidance of falling prey to what financial writer and artist Carl Richards calls “the behavior gap”—the difference between what the average investment returned and what the average investor earned. Sadly, investors have earned meaningfully less than the investments they buy simply because they don’t hold them.

I’m not talking about pure indexing, although you could do much worse than establishing a diversified portfolio with Vanguard index funds and/or exchange-traded funds.

I’m also not talking about pure white-knuckle passivity.

I’m talking about combining the art and science of investing in the form of evidence-based investing—creating a portfolio that is broadly diversified, combining the asset classes that have historically given you the most return for your risk with the asset classes that have tempered portfolio volatility enough to stick with your plan.

Evidence-Based Investing: 101

The fundamental aim of investing is not to actually make money--but to have a better life.

The primary objective of investing in stocks, however, is to make money. The point of investing in bonds, then, is to help you stay invested in stocks when the waters get choppy. The net effect should be adding value to your life, in accordance with your values and working toward your goals.

Evidence-based investing forces us to submit all of our opinions and informed guesses to actual peer-reviewed evidence. The evidence shows, after all, that it is nearly impossible to “beat the market.”

There is adequate evidence, however, that certain asset classes—slices of the market—have outperformed others. For example, you already know that stocks have historically outperformed bonds. Additionally, small-cap stocks have outperformed large-cap stocks and value stocks have historically outperformed growth stocks.

Of course, those asset classes that have historically produced outsized returns have also required an iron stomach at times in order to reap your reward. Their highs are higher, but their lows are also lower.

The objective, then, is to orchestrate a portfolio that accepts the risk you can withstand, and then blend that risk with the proper stabilizing agents to lessen the volatility, helping ensure that you stick with the plan.

Can You Expect More Return With Less Risk?

In short—yes, because a truly diversified portfolio is indeed greater than the sum of its parts . There are two ways to reduce overall portfolio volatility:

1)   Own less volatile asset classes.

2)   Own less correlated asset classes.

The foremost portfolio stabilizing agent is fixed income, and since the primary reason we hold fixed income is to stabilize, it only makes sense to hold the most stable of the stable—FDIC-insured CDs, Treasuries, agencies and, only if you’re in a high tax bracket, AAA-rated municipal bonds.

Yes, I omitted corporate bonds from that list as well as high-yield “junk” bonds, because these varietals tend to exhibit more equity-like risk characteristics. If you’re going to take risk, you may as well do it in an asset class that rewards you better—stocks.

But as Larry Swedroe, author of Think, Act, and Invest Like Warren Buffett, shows, it’s possible to add an equally or more volatile asset class and see the overall volatility go down .

He compares the traditional 60/40 portfolio—60% S&P 500 (stocks) and 40% five-year Treasury notes (fixed income)—to a flip-flopped portfolio with 60% in Treasuries, but a vastly more diversified 40% in equities, skewed in the small, value and international directions (and away from the broader market).  The results?

In short, the 40/60 portfolio with diversified equity holdings outperformed the 60/40 portfolio with substantially less risk. (By the way, I’m not recommending that you should have a 40/60 portfolio—I’m simply demonstrating the benefits of thoughtful diversification.)

The only way this works is if you join the low-frequency trading club. Don’t set it and forget it. Set it, calibrate it when necessary through rebalancing, and only make more meaningful changes when your ability, willingness or need to take risk changes.

If you enjoyed this post, please let me know on Twitter, @TimMaurer.

 

What You Can Learn From Bill Gross And PIMCO’s Troubles

“Trouble. Trouble, trouble, trouble, trouble.” Reading all the news about Bill Gross and PIMCO, I keep hearing that Ray LaMontagne song in my head. (Go ahead—give it a listen while you read this, just for fun.) EGO

The king of bonds isn’t yet abdicating the throne, but it’s been a rough stretch since PIMCO came down from the mountain to translate the etchings on the “New Normal” tablets. It was, of course, hard to argue the logic in 2009, that U.S. markets would struggle under the weight of a sluggish economy hampered by high unemployment and systemic government debt. But as it often does in the face of supposed certainty, the market defied man’s expectations.

Following the new normal playbook, PIMCO bet against Treasurys in 2011, when its flagship fund, Total Return, captured only 53% of the Barclays U.S. Aggregate Bond index return for that year. In 2013, the fund barely beat the Barclays index, but it lost money for the first time since 1999—accelerating a trend of fund outflows.

Then things started to reflect daytime television, when Gross’ heir apparent, Mohamed El-Erian, departed in the midst of rumors of dissent at the top of the organization. Those rumors were confirmed when The Wall Street Journal published an article based on reports by unnamed inside sources, accusing Gross of comparing himself publicly to the unbeatable racehorse, Secretariat. Then Morningstar downgraded PIMCO’s “stewardship grade” to C from B.

Beyond the tabloid fodder, however, there is a vital investing lesson to take away from this still-evolving story:

Pride goeth before a fall.

Ego and ignorance are at the core of nearly every investment blunder. As un-shocked as most of us were to find that an investment management bigwig making $200 million a year had an ego problem, ego is at the core of the PIMCO dilemma.

(Click HERE to see me discussing concerns about Bill Gross' ego on CNBC's "Street Signs.")

Ego, then, often leads to an interesting form of ignorance. While none of us would dispute Gross’ intellectual brilliance, his presumption of preeminence might be his downfall.

When everything goes right for an extended period of time, we often mistakenly allow ourselves to believe that our success is disproportionately attributable to us and not outside forces. It’s called the fundamental attribution error. We attribute our success to our innate traits and our mistakes to external circumstances while assuming that the errors of others are due to internal shortfalls, like a lack of character or intelligence.

It’s a blind spot. Unfortunately, the financial industry seems to be full of them. Everybody thinks they’re smarter than everybody else—and the market, even though the overwhelming evidence stands in opposition.

Déjà vu all over again?

Remember the story of the fabled fund formerly known as the Legg Mason Value Trust? Bill Miller had beaten the market for so many years that he forgot it was possible for him to not beat the market. When he lost to the S&P 500 for the first time in his tenure with the fund in 2006 and 2007 — and then very badly in 2008, betting he could will the financials out of their downward spiral — everything started to become clearer: The fund had returned more than the broader market largely because it was taking on more risk than the market—then, it simply lost more than the market because it was taking on more risk than the market.

Almost two decades of apparent outperformance were undone in a single year.

Or go back even further to explore the life of Jesse Livermore in the fictional account based on his life in Reminiscences of a Stock Operator. Some Wall Street firms still offer this as a securities trading handbook, even though Livermore lost his fortune more times than he was able to make it and ended his life by his own hand, in poverty and disgrace.

The Bottom Line:

The market rewards humility over hubris, discipline over gut feelings and proactivity over reactivity. By acknowledging that you’re not omniscient, you free yourself to compose an investment strategy grounded in evidence that makes up for its lack of sex appeal with its elegant simplicity—and most important, its effectiveness. You can choose to stop chasing the market and build a portfolio designed to get everything the market has to offer.

More on that next week.

If you enjoyed this post, please let me know on Twitter, @TimMaurer.

 

 

Allocating Your Most Valuable Asset—You

What is your most valuable asset? Your home? Not likely, even back in 2006. Your 401(k)? Doubtful, even when it was 2007. No, if you’re not yet glimpsing your retirement years, it’s likely that your biggest asset is you—and not just metaphorically.

Let’s say you’re only 30, with a degree or two and some experience under your belt. You’re making $70,000 per year. If you only get 3% cost-of-living-adjustment raises, you will crest a million in aggregate earnings in just the next 13 years.

Over the course of the next 40 years, over which you’ll almost surely continue working, you’ll earn more than $5.2 million.

Or maybe you’ve just celebrated your 40th birthday—the new 30—and you’re hitting your stride professionally, making $150,000 per annum. With only 3% raises, you’ll make more than $2.1 million in just the next dozen years.

(How’s that 401(k) looking again?)

You are your biggest asset.  It’s called labor capital, and it’s an asset all too often underestimated by financial advisors and their clients.

Labor Capital Curve

While your financial assets start small and hopefully grow over time, compounding through disciplined saving and wise investing, your labor capital brims with potential before descending later in your career.

What would it look like if we treated labor capital with the respect it deserves throughout the financial planning process?

First, we’d invest purposefully in our labor capital. Yes, this means pursuing education, but it also means cultivating our earning potential through mentoring and coaching.

It also means pursuing a job that we enjoy so we don’t feel boxed in if it’s necessary or desired to extend the longevity of our career—and our labor capital.

Second, we’d adjust the rest of our financial plan—especially our investment plan—to accommodate for our labor capital. Moshe Milevsky asks the important but rarely asked question, “Are you a stock or a bond?” in his book of the same name.

If your work offers a high reward but also high risk—let’s say you’re self-employed or you work in a cyclical boom/bust business—you’re a stock. If you enjoy the stability of your position as a tenured professor, but gripe with your colleagues about your unremarkable pay raises, you’re a bond.  "An investor’s ability to take risk is impacted by the stability of their earned income," says Larry Swedroe in The Only Guide You'll Ever Need for the Right Financial Plan, co-authored with Kevin Grogan and Tiya Lim.

If your labor capital acts like a stock, even if you have the intestinal fortitude to endure risk, you should likely be skewing your financial assets more conservatively. Whereas, if your income is more representative of the tortoise than the hare, you may consider infusing your portfolio with a little Usain Bolt.  "[E]ffective diversification of the client’s entire household balance sheet may entail using financial capital to counterbalance against the risks of human capital," says planning guru, Michael Kitces.

Lastly, we’d ensure that our moneymaker is adequately insured. If you work for a well-established company, it likely pays for a base level of disability income (DI). But for most, this isn’t enough, for at least two reasons:

If your company pays the premiums on your group DI policy, the benefits to you will be taxable. Most group policies cover 60% of your salary compensation (although typically not your bonus or incentive comp). If you didn’t have to worry about paying taxes, that wouldn’t be so bad, but after taxes, you’d be lucky to walk away with 40% of your gross pay—while enduring higher medical expenses on the home front.

Additionally, most group DI policies only cover your “own occupation” for two years, at which time you must be medically incapable of performing the material duties of any occupation. (Intending no offense to the gracious folks at the entrance of a Wal-Mart, this means that if you can’t pin a smiley face sticker on the front of someone’s shirt, you ain’t gettin’ your disability checks.)

To make up for either or both of these shortfalls, it makes sense for many—if not most—of us to explore the acquisition of a supplemental long-term disability income insurance policy to stack on top of your insufficient group policy. And if you’re self-employed or otherwise uncovered by a group policy, you’re entirely exposed to the risk of losing your most valuable asset. Private policies aren’t cheap and have too many moving pieces, so you’ll want to educate yourself further. But ignore this very real risk at your own peril.

BOTTOM LINE: Discussions of labor capital can be a great encouragement to those just starting their occupational journey—or those who’ve fallen behind on the accumulation of financial assets—but integrating our labor capital into our financial plan only helps if we allocate our income well.  This means spending money on the most important things in life, saving money for a time when our labor capital is exhausted, and ultimately giving money to the people and causes dearest to us.

If you enjoyed this post, let me know on Twitter @TimMaurer.

The chances are good that your 401(k) isn’t.

We need not look far to learn that 401(k) plans are imperfect or worse, so instead of lumping on more criticism about how you and your employer have botched your 401(k), let’s discuss how to make the most of a not-so-great situation.401k-Plan

Step 1: Don’t blame shift. There is a time for criticism, so keep reading, but too many people use the imperfections in, or a lack of understanding of, their retirement plan to feed the self-deceptive siren’s call to inaction.

Yes, it’s true that there is systemic as well as plan-specific dysfunction in many 401(k)s—and 403(b)s, TSAs, TSPs, SIMPLEs, 457s and whatever other “defined contribution” retirement plan you might have at work.

Yes, it’s true that 401(k) plans are often needlessly complex and confusing, often filled with a seemingly endless array of choices, designed more for plan sponsors than for participants.

Yes, it’s true that 401(k) investment options are notoriously poor and over-weighted with fees.

Yes, it’s true that defined benefit pension plans—when the company you dedicated yourself to for many years would continue to pay a stream of income through your retirement—were helpful but are now largely extinct.

Yes, it’s true that Social Security benefits will likely provide less—or at least less value—for future generations than for present and past, putting even more pressure on our own ability to save for retirement.

But 401(k) and equivalent vehicles are still the best way for most Americans to create a tax-privileged reserve that is designed to generate future income when we’re no longer capable of doing so. Even justifiable criticism shouldn’t be an allowance for negligence on our part.

Step 2: Control what you can. Despite the many maladies likely infecting your 401(k) plan, we still have control over the elements that determine our investing success the most—the amount we contribute and the allocation of the portfolio.

You’ve heard the grandfatherly wisdom of saving 10%. Well, as it turns out, it just might work. A crude calculation suggests that if you save 10% of your income right out of college through retirement age, you’ll likely have saved enough to generate approximately 66% of your pre-retirement income in retirement. If you add Social Security benefits and subtract your annual savings, you’ll likely have more disposable income than in your last day of work.*

If you are able to increase your annual contribution amount to 15%, you’d have enough to generate 99% of your pre-retirement income, so anything you get from Social Security would be a travel bonus.

But life is not a linear Excel calculation. Life changes and tends to get more expensive in the middle when we’re supporting the 2.5 kids, yellow lab and the picket fence. Therefore, you’ll likely need to save more at the front end when you have fewer expenses and on the back end after the kids have moved out, so consider the 10% rule of thumb as less of a cap and more of a floor.

Saving more helps reduce the risk of falling short of your goals.  Saving more enables you to take less equity risk, thereby reducing the stress of bear markets, allowing you to sleep better and stick with your strategy.

Regarding the optimal portfolio allocation, the weight of evidence suggests that the bulk of our long-term returns are attributable to proper asset allocation, not security selection. That is, the proportionate arrangement of your mutual funds is more important than the funds themselves. And since the vast majority of actively managed mutual funds get beaten by the index they’re chasing, you’ll have probability working for you if you use passively managed index funds if they’re available.

Here’s a generic example of a model portfolio from Bill Schultheis’ Coffeehouse Investor model. Neither Bill nor I would suggest that this should be your portfolio, but it helps illustrate the concept of diversification through asset allocation.  Coffeehouse

Your portfolio should be customized based on your abilitywillingness and need to take risk and will likely include more or less exposure to these and other asset classes.

In the book The Only Guide You’ll Ever Need for the Right Financial Plan, co-authors Larry Swedroe, Kevin Grogan and Tiya Lim instruct that an investor’s ability to assume risk is largely determined by time horizon—when will you likely need the money? Your willingness to accept risk involves “the fortitude and discipline to stick with your predetermined investment strategy when the going gets rough,” while the need to bear risk “is determined by the rate of return required to achieve the investor’s financial objectives.”

Often, however, we are not the best suited to gauge our own ability, willingness and need to take risk. Instead, consider using risk tolerance tools available through your 401(k) plan, or better yet, talk to a financial advisor who doesn’t have a stake in the outcome of your risk analysis.

Once you have determined an optimal allocation for your 401(k) portfolio, it’s time to put the plan on autopilot, thereby reducing your personal tracking error. Adjust both your current allocation and your future contributions, and if you have an automatic rebalancing feature that will periodically bring your portfolio back into alignment with your new allocation, use it. If not, rebalance manually, selling high and buying low.

Step 3: Talk to your human resources department. Once you have done all that is within your power to make the most of your 401(k), it’s time to talk to company leadership about making the plan even better. If yours is one of the majority of plans that has high expenses, low transparency and poor investment options, suggest they consider a change. You might not think your opinion will carry any weight, but you’re unlikely to see the plan improve unless people like you are questioning its effectiveness.

Imperfect though they are, even bad 401(k)s can be made into an excellent tool for wealth accumulation by those who dedicate themselves to making the most of this foremost retirement planning vehicle.

If you enjoyed this post, let me know on Twitter @TimMaurer.

 

*Assumes saving 10% per year on a $50,000 beginning salary at age 22 that increases with inflation at 3% earning 8% per year before retirement at age 67 (Social Security full retirement age) and 5% thereafter.

Study Reveals Investing Is Hazardous To Your Health

Investing Hazard-01I don’t need to inform you that investing is dangerous business.  You already know in your gut what Joseph Engelberg and Christopher Parsons at U.C. San Diego found in their new study, that there is a noticeable correlation between market gyrations and our mental and physical health.

But when do you think the financial industry will get the point?

Shortly after I became a financial advisor, I was given a book to commit to memory.  It told me what my role in life would be: To make a very good living helping approximately 250 families stay in the stock market.

The text insisted that regardless of my client’s age or risk temperament, it would be in their best interest to be—and stay—in stocks, exclusively and forevermore.  I was the doctor; they were the patients.  I was the ark-builder; they were the—you get the point.

The book might even be right.

But…

The Behavior Gap

My friend and New York Times contributor, Carl Richards, has been drawing a particular picture for years.  He’s struck by the research acknowledging the noticeable difference between investment rates of return and what investors actually make in the markets.  (Investors make materially less.)

Investors, it appears, allow emotions to drive their investing decisions.  A desire to make more money causes them to choose aggressive portfolios when times are good, but a gripping fear leads them to abandon the cause in down markets, missing the next upward cycle.

Investors buy high and sell low.

Well-meaning advisors, then, including the author of the book I referenced, have claimed their collective calling to be the buffer between their clients’ money and their emotions.  Unfortunately, it’s not working.

Maybe it’s because the intangible elements of life are so tightly woven into the tangible that we can’t optimally segregate them.

Maybe it’s because we’re not actually supposed to forcibly detach our emotions from our rational thought.

Maybe it’s because financial advisors and investing gurus should focus less on blowing the doors off the benchmark du jour and more on generating solid long-term gains from portfolios designed to be lived with.

Livable portfolios.

Portfolios designed to help clients stay in the game.

Portfolios designed to help clients (and advisors) avoid falling prey to the behavior gap.

Portfolios calibrated with a higher emphasis on capital preservation.

How much less money do you make, anyway, when you dial up a portfolio’s conservatism?

The Same Return With Less Risk

In his book, How to Think, Act, and Invest Like Warren Buffett, index-investing aficionado, Larry Swedroe, writes, “Instead of trying to increase returns without proportionally increasing risk, we can try to achieve the same return while lowering the risk of the portfolio.”

Using indexing data from 1975 to 2011, Swedroe begins with a standard 60/40 model—60% S&P 500 Index and 40% Five-Year Treasury Notes.  It has an annualized rate of return of 10.6% over that stretch and a standard deviation (a measurement of volatility—portfolio ups and downs.) of 10.8%.

Next, Swedroe begins stealing from the S&P 500 slice of the pie to diversify the portfolio with a bias toward small cap, value and international exposure (with a pinch of commodities).  The annualized return is boosted to 12.1% while the standard deviation rises proportionately less, to 11.2%.  (Remember, this is still a 60/40 portfolio with 40% in five-year treasuries.)

But here’s where Swedroe pulls the rabbit out of the hat:  He re-engineers the portfolio, flipping to a 40/60 portfolio, proportionately reducing all of his equity allocations and boosting his T-notes to 60% of the portfolio.  The net result is a portfolio with a 10.9% annualized rate of return—slightly higher than the original 60/40 portfolio—with a drastically lower standard deviation of 7.9%

Same return.  Less Risk.

This, of course, is all hypothetical.  This happened in the past, and for many reasons, it may not happen again.  These illustrations are not a recommended course of action for you or your advisor, but instead a demonstration that it is possible—and worth the effort—to work to this end.

Because we can’t keep hiding from the following logical thread:

1)   Volatile markets increase investor stress (even to the point of physical illness).

2)   Heightened investor stress leads to bad decisions—by both investors and advisors—that reduce investor returns.

3)   Market analysis suggests that portfolios can be engineered to maintain healthy long-term gains, while at the same time dramatically reducing the intensity of market gyrations.

How could we not, then, conclude that more investors would suffer less stress, thereby reducing (hopefully eliminating) their behavior gap, thereby allowing investors to hold on to more of their returns?

Isn’t that the point?

If you enjoyed this post, please let me know on Twitter @TimMaurer, and if you’d like to receive my weekly Forbes installment via email, click HERE.

Don’t Bet Your Portfolio On The Twitter IPO

Twitter Announces Plan To Float On Stock MarketConsider keeping your social media activity on your computer, phone or tablet—and out of your portfolio.

People seem to either love or hate Facebook and Twitter, with emotions ranging high, like rooting for our favorite sports teams.  Personally, I’m unlikely to win any football or basketball office pools because I’m so biased toward my favorite teams.

We can also suffer from some of these polarizing bias issues with individual stock selections—and especially social media stocks bearing the names of the most recognizable thumbnail icons of our time.

There will be winners and losers with Twitter, as with any stock, but I’m content to be an observer.  This is for a couple specific reasons:

1)     I am biased.  Unlike Facebook, which I dumped as a personal social media outlet (for seven reasons that were important to me), I really like Twitter.  I hope Twitter continues to do well so that those of us who are fans will continue to benefit from its many uses well into the future.  In other words, I’m biased.  I’m vested, and that detracts from my ability to be the best investor.

2)     Another reason that I’m tentative about this whole Twitter IPO business is that, well, the company has never made a profit.  One of the reasons for its cult following is that you don’t get slapped in the face by endless ads hunting for the content you seek (unlike some other social media platforms).  You don’t have to be a stock picker to know that Twitter will have to access “as-yet-untouched monetization levers,” according to Jeff Bercovici at Forbes, in order to reach the upper end of its anticipated price range.  That means they’ll have to find new ways to sell us, and if you’re anything like me, you’re probably hoping to be an untouchable monetization lever.

This is not investment advice—it’s gambling advice, because at this stage of the game, it’s anyone’s guess whether or not Twitter is going to successfully remake its loyal followers into a money-printing machine, 140 characters at a time.

TWEETABLE: Consider keeping your social media activity on your computer, phone or tablet--and out of your portfolio. #TwitterIPO

If you enjoyed this post, please let me know on Twitter @TimMaurer, and if you’d like to receive my weekly Forbes installment via email, click HERE.

Life Is Not An All-Star Game And Investing Is Not A Home Run Derby

MLB: All Star Game-Home Run Derby162.  That’s how many games are played in the regular season of Major League Baseball.  There’s only one All-Star Game—in the middle of the season, played last night—and it’s rightly referred to as a break for the sport that requires more endurance than any other.

Life has come to look too much like an all-star game, with our greatest hits trotted out on LinkedIn, Facebook, Twitter, Instagram and more.  And while social media has made it easier to craft perception, we’re often putting the face on just the same at networking events, church (especially church) and family parties.

Façade creation is expensive.  It’s inherently limited to the external, the material, and almost always comes with a price tag.  It also tends to degrade, both in appearance and value.  How much time, effort and money do you expend on your perception engine?

No, life is not an all-star game.  It’s grinded out over long and arduous seasons, filled with many highs and lows and sleepless nights spent picking fiberglass-laden tobacco out of our teeth contemplating an oh-for-five game, imagining how we can do better next time.

The highlight for many of the All-Star break, however, is the Home Run Derby, where the game’s biggest sluggers do their worst to cream-puffs tossed by coaches.  It’s like batting practice on steroids (pun intended), complete with no fewer than 47 “Back, back, back…and it’s gone!” calls from the Swami himself, Chris Berman.  Quite the spectacle.

Too many investors, however, emulate home run derby strategies in their process, swinging for the fences on every pitch.  This is problematic for at least two reasons: First, the market’s not pitching balls at half-speed right down the middle.  There simply aren’t any no-brainers (Apple) or sure things (real estate).  The second reason concentrating your investing on the long-ball is a bad idea is that, well, you’re probably not an all-star.  I mean no offense—neither am I.  But I’ve been around the business long enough to see (brilliant) grown men brought to tears, exasperated by the apparent futility of their efforts.  I know enough to know that I don’t know enough to be a big-league stock picker, and I’m ok with that.

Unfortunately, many on Wall Street have a tendency to overestimate both the power of their swing and their knowledge of the game, and I’m not just talking about the overwhelming majority of mutual funds that underperform their benchmark.  Bill Miller, manager of the once-vaunted Legg Mason Value Trust (LMVTX) struck out at the plate so many times in 2008 (most notably in his all-in bet on Bear Sterns) that he inflicted systemic damage to the fund and the very firm he helped put on the map. As investing success persists, it seems, hubris inflates, making these minted sluggers ever more likely to end up walking back to the dugout with their heads hung low.

I’m not just talking about stocks, bonds and mutual funds as investments, either.  It’s even easier to deceive ourselves into thinking that an expensive degree or a home priced out of our reach are worthy of a home run swing.  Let’s, instead, make a practice of getting on base repeatedly, and allowing someone else’s luck or error to drive us home.

Chris Davis leads the major leagues in home runs with 37 only half-way into the season, but he admitted that it wasn’t actually Oriole Magic (or steroids for you haters).  “It was more about consistently putting the bat on the ball, not swinging at balls 14 feet out of the strike zone.”  That’s good advice, for baseball and investing.

If you enjoyed this post, let me know on Twitter @TimMaurer, and if you’d like to receive my weekly post via email, click HERE.

Excessive Trading Leads To Death

Actually, the headlines on Friday, November 29th, 1940 read, “Livermore, Wall St. Wonder, Dead.”[i]  I was recently re-acquainted with Jesse Livermore’s story—that of a self-made trading savant whose early-life exploits were regaled in a series of articles turned classic work of historical fiction, Reminiscences of a Stock Operator, by Edwin Lefevre[ii]. The volume is still handed out as a guide book to new traders every year, an ironic tradition considering the book was written as a cautionary tale.

It was first published in 1923, after Livermore had won and lost a couple fortunes already, but prior to his biggest take when he shorted the market in the Great Depression, increasing his net worth to a stunning $100 million.  Livermore subsequently went bankrupt—not for the first time—and was suspended as a member of the Chicago Board of Trade in 1934.  So why do we continue to romanticize the story of an investor who lost as much money as he ever made?  Why do we glorify the existence of a man who, thrice married, deemed his life’s work an abject failure?

The story’s remarkable appeal should not surprise us—regardless of the futility of sustainable success in the business of gambling, the allure of the quick or easy fortune seems a siren’s song that will forever be sung, heard and followed.  Maybe the appeal of Livermore’s sad story is that he did not follow his own rules, by his own admission, and that if we can manage to do so, we might be able to make the equivalent fortune without losing it.

Don’t bet on it.  When attending to the business of fooling the market, we almost invariably end up fooling ourselves.  And while one of the first stages of grief for the newly penniless may be blaming our failure on the market, like many others, Livermore eventually placed the blame where it rightly lay—on himself—and sadly took his own life at the age of 63.

Unfortunately, it’s not a stretch to suggest that dedicating ourselves wholly to the pursuit of money and riches often leads to death—literally for some but figuratively for many, many more.  Relinquish the claim to overnight riches in favor of lifetime investing.  You have a favorable probability of generating comfortable wealth through a lifetime of dedicated investing, but even the most disciplined gamblers eventually learn this sad truth—the house always wins.


[i] “The Daily News Record,” Harrisonburg, Virginia, November 29th, 1940

[ii] I highly recommend the edition published by John Wiley & Sons in 2010, newly and informatively annotated by Jon D. Markman.

Annuity Audit App

This is the 10th exercise in a series designed to walk you through an entire financial plan.  The exercise is embedded in an Excel spreadsheet you can download and save for personal use.  You can read the backdrop for the exercise HERE, or just jump right in with the instructions given below:

It is my hope that this is an extremely brief exercise for you, but many people who have long-term relationships with folks in the insurance, brokerage, or banking industries have a lifetime of annuities built up.  If that is your scenario, it is very important that you do this exercise to get a handle on where your money is and what it is doing (or not doing).

When you did your Personal Balance Sheet or Mutual Fund Audit App, you probably pulled together the statements for any annuities you own.  These statements often lack the information you’ll need for this exercise, so I also want you to pull together each of the contracts you received at the inception of your annuity policies as well.  Then, using the App (link below), fill in the information cataloging the following: owner[i], annuitant[ii], beneficiary[iii], contract value, surrender value, cost basis (the sum of your contributions), and the surrender schedule.  Some of this will be on your statement, but the remainder will be in your policy contract. You may have to do some digging.

Once you’ve collected the information, the analysis should start with a diagnosis of the investment value.  If it is a fixed annuity, you’ll know very quickly if the rate is competitive with today’s rates.  If it is a variable annuity, examine how it has performed versus the various benchmark indices.  If it is an equity indexed annuity, the chances are very good that it is not a phenomenal investment, but it also probably has a very long and steep surrender charge which may make it prohibitive to move at this time.

If you determine you’d prefer to be out of an annuity contract, here are the questions to ask:

  • What, if any, surrender charge exists?
  • Is the surrender charge cost prohibitive?
  • How much longer will the surrender charge last?
  • How much have you contributed (what is your cost basis)?
  • How substantial would the tax impact be (would you have to pay a lot in taxes)?
  • Is there a gain on which you would have to pay a penalty if you are under age 59½?

Again, remember to make these decisions slowly because there are many moving pieces with annuities.  It is best to speak with a fee-only Certified Financial Planner™ practitioner AND a Certified Public Accountant prior to making any final decisions.

Click HERE to access the Annuity Audit app!


[i] The person who made the investment in the annuity

[ii] The person upon whose life the actuarial calculations in the annuity policy were based (this is often the same person as the owner)

[iii] The person or people to whom any annuity proceeds will be directed upon the death of the annuitant

Mutual Fund Audit App

This is the ninth exercise in a series designed to walk you through an entire financial plan.  The exercise is embedded in an Excel spreadsheet you can download and save for personal use.  You can read the backdrop for the exercise HERE, or just jump right in with the instructions given below:

Most of the information you’ll need to complete this exercise should already be together from the Personal Balance Sheet exercise earlier in this series, but if not, pull together the most recent holdings information that you have for your various investment accounts.  If you have online access to these accounts, it will be as easy as printing out the page with your current holdings.  If not, pull together each of the most recent statements for all of your investment accounts.

Aggregate your holdings using the form we’ve made available for this exercise online.  Segregate them between investments that are inside of retirement accounts (like your 401ks, 403bs, IRAs, etc.) and nonretirement accounts (there is a tab for each on the spreadsheet).  For any mutual funds, you’ll want to have the name of the fund and the five-letter symbol.

Now, navigate your web browser to www.morningstar.com.  With the tools here, you’ll be able to use that final column of your Investment Audit to fill in the Manager Category column.  (You can examine your mutual fund managers with the tools on Morningstar using the basic service at no cost.  Another good, free resource for the analysis of stocks and mutual funds is Yahoo’s Finance web site http://finance.yahoo.com/.)

Plug the symbol of each of your mutual funds into the “Quotes” field on Morningstar.  The main page for each fund will show you a 10-year chart with a graphical depiction of your fund’s performance alongside its benchmark.  Just below the chart, you’ll see a tool that will allow you to click and drag the timeline backwards to see a longer fund history if it’s
available.  You can also hit the “Performance” tab and select the “Expanded View” to see even more detail about the fund’s numerical performance.

Using the tips in this post, you should now be able to classify each of your funds.  In the Action column on the right hand side of the worksheet, check any of the Return Chasers and Index Huggers for additional review.  Again, Return Chasers should be well understood, carefully monitored, and dumped if misunderstood.  Index Huggers should be replaced.

Click HERE to access the Mutual Fund Audit app!