Last year was a tough one for disciplined investors. Disciplined investors know that diversification is a key element of successful portfolio management. But investors who stayed the course and remained diversified were punished for it in 2014, at least in the short term.
Disciplined investors will continue to be taunted over the coming weeks and months by headlines touting the success of “the market” in 2014. “Which market is that?” many of them will ask.
Well, “the market” we hear about most often is the Dow Jones Industrial Average, which represents only 30 of the largest U.S. companies trading on the New York Stock Exchange. A slightly broader barometer of “the market” is the S&P 500 index, a benchmark tracking 500 of the largest U.S. stocks. In this case, “the market” could more accurately be translated as “the U.S. large-cap stock market.”
What is “the market”? It’s actually a host of different markets in reality. Pundits may entertain us with their prognostications, but one glance at this asset class quilt makes it abundantly clear that attempts to pick the next winner are in vain–or worse yet, counterproductive.
With markets entering a period of significant volatility this past week, CNBC was curious what type of discussions I’m having with clients. I told them, in short, that I’m talking about ways that we, as investors, can benefit from market losses.
||October 17, 2014
||Gaining Through Market Losses – CNBC
||Street Signs on CNBC
Even if you get your daily news from one of those celebrity tabloid shows, you have probably still heard that the market has been more than a little crazy in recent weeks.
Indeed, the typically overstated “surge” and “plunge” headlines have been less hyperbolic of late, as the Dow Jones Industrial Average burps out daily gains and losses in the hundreds of points. But over the past several trading days, the results have been all red, and since Sept. 18, the market has taken back more than 6% of what it’s given so far this year.
Is this volatility the precursor to another market gutting? Or perhaps it’s just a momentary ebb in advance of a continued upward flow?
The answer is yes.
The market is in the business of rising and falling, and of making fools of those who attempt to predict which it will do next. But be sure that we will feel both the pain of another big drop—perhaps sooner rather than later—and the euphoria of another unprecedented gain.
Whether this very recent pullback happens to be the beginning or the end of something, most investors have already lost enough to benefit from it.
Benefit? Yes, you did read that correctly. Here are three ways to gain from market losses:
Exchange-traded funds—commonly referred to as ETFs—are all the rage. While there are several excellent reasons to use an ETF over the seemingly archaic traditional mutual fund, they are not a universally preferable solution.
First, to be fair, let’s review a few reasons why ETFs can be a better solution than mutual funds.
ETFs generally have lower associated costs than comparable mutual funds. This isn’t news, I know, but since costs are one of the few variables over which we have control as investors, I don’t mind flogging this deceased ungulate.
The expense ratio is the most obvious cost reduction. For example, the legendarily inexpensive Vanguard 500 Index Fund has an expense ratio of 0.17 percent, while Vanguard’s S&P 500 ETF has a barely noticeable expense ratio of 0.05 percent. This makes ETFs an ideal choice for investors making a sizable, broadly-based, one-and-done purchase.
As if PIMCO needed any more bad press, The Wall Street Journal reported this week that the Securities and Exchange Commission is investigating whether the bond giant “artificially boosted the returns of a popular fund aimed at small investors.” While we should all be attentive to the results of this probe—because I’d bet my lunch money that its implications will be felt beyond just PIMCO—there is an even deeper issue to consider. And this issue has a more direct impact on our individual portfolios and money management choices. The real danger in overstating returns, and indeed the root of most financial missteps, is self-deception.
“How’s your portfolio?”
Who among us wants to feel like a failure? We’ll generally avoid experiencing this sensation at all costs. So, absent conspicuous success, we permit ourselves to believe that we’ve at least not failed, frequently through self-deception.
As kids head back to school, adults spanning several generations set their sites on getting their financial house back in order. What are the most important financial planning considerations in three major demographics—Millennials, Generation X and Empty Nesters?
Millennials: First things first – Before making any big financial commitments, like buying a house, figure out what you want life to look like.
- Are you in a relationship and looking to “settle down,” or do you highly value freedom and flexibility? If the latter, you shouldn’t be buying a house or committing to a job that is geographically tethered.
- If you’re in your twenties, the primary factor that will influence your financial success is how well you establish yourself in a career. Invest in yourself, and that will likely help you invest more money in the future.
- Save as much as you can in tax-qualified retirement accounts at this phase of life, because once you get settled down and have kids, your expenses will rise dramatically.
- Don’t default to 100% equity portfolios just because you’re young. After getting burned by the market crash of 2008, many Millennials got scared away and didn’t benefit from the subsequent market rise. Your portfolio should likely be predominantly stocks at this age, but consider some fixed income exposure to keep from losing your shirt (and abandoning your strategy) in a downturn.
There is no shortage of receptacles clamoring for your money each day. No matter how much money you have or make, it could never keep up with all the seemingly urgent invitations to part with it.
Separating true financial priorities from flash impulses is an increasing challenge, even when you’re trying to do the right thing with your moola — like saving for the future, insuring against catastrophic risks and otherwise improving your financial standing. And while every individual and household is in some way unique, the following list of financial priorities for your next available dollar is a reliable guide for most.
Once you’ve spent the money necessary to cover your fixed and variable living expenses (and yes, I realize that’s no easy task for many) consider spending your additional dollars in this order:
I always enjoy talking to Tyler Mathisen and Susie Gharib on PBS’ Nightly Business Report. They ask important questions well, like, “What are the hidden risks in target date funds?”
“I was wrong.”
There are few words strung together that possess such power to free us. In less than a second, we’re able to reconcile the inconsistency between our previous conviction and the apparent truth. Humbling, yes, but also strangely euphoric.
Well, I’ve earned the opportunity to claim said euphoria, as I must confess that I had bought into the most prevalent myth du jour surrounding bond investing. You’ll forgive me, I hope, because this misconception—like all of the most powerful ones—is especially deceptive because it’s grounded in half-truth.
Let’s be quite clear: Rising rates simply do not guarantee negative bond returns.