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The Patient Investor

Written by Eric Hutchens on .

Topic #9 – Eight Wealth Strategies During the Coronavirus

“The utility of living consists not in the length of days, but in the use of time.” Michel de Montaigne

For better or worse, many of us have had more time than usual to engage in new or different pursuits in 2020. Even if you're as busy as ever, you may well be revisiting routines you have long taken for granted. Let's cover eight ways—some effective and others ineffective—to spend your time shoring up your financial well-being in the time of the coronavirus.

1. A Best Practice: Stay the Course

Many investment habits remain the same as ones we've been advising all along. Build a low-cost, globally diversified investment portfolio with the money you've got earmarked for future spending. Structure it to represent your best shot at achieving your financial goals by maintaining an appropriate balance between risks and expected returns. Stick with it, in good times and bad.

2. A Top Time-Waster: Market-Timing and Stock-Picking

Why have stock markets been ratcheting upward during socioeconomic turmoil? Market theory provides several rational explanations. Mostly, market prices continuously reset according to "What's next?" expectations, while the economy is all about "What's now?" realities. If you're trying to keep up with the market's manic moves ... we recommend that you stop doing that. You're wasting your time.

3. A Best Practice: Revisit Your Rainy-Day Fund

How is your rainy-day fund doing? Right now, you may be realizing how helpful it's been to have one, and/or how unnerving it is to not have enough. Use this top-of-mind time to establish a disciplined process for replenishing or adding to your rainy-day fund. Set up an "auto-payment" to yourself, such as a monthly direct deposit from your paycheck into your cash reserves.

4. A Top Time-Waster: Stretching for Yield

Instead of focusing on establishing adequate cash reserves, some investors try to shift their "safety net" positions to holdings that promise higher yields for similar levels of risk. Unfortunately, this strategy ignores the overwhelming evidence that risk and expected return are closely related. Stretching for extra yield  out of your stable holdings inevitably renders them riskier than intended for their role. As personal finance columnist Jason Zweig observes in a recent article  about one such yield-stretching fund, "Whenever you hear an investment pitch that talks up returns and downplays risks, just say no."

5. A Best Practice: Evidence-Based Portfolio Management

When it comes to investing, we suggest reserving your energy for harnessing the evidence-based strategies most likely to deliver the returns you seek, while minimizing the risks involved. This includes: Creating a mix of stock and bond asset classes that makes sense for you; periodically rebalancing your prescribed mix (or "asset allocation") to keep it on target; and/or adjusting your allocations if your personal goals have changed. It also includes structuring your portfolio for tax efficiency, and identifying ideal holdings for achieving all of the above.

6. A Top Time-Waster: Playing the Market

Some individuals have instead been pursuing "get rich quick" schemes with active bets and speculative ventures. The Wall Street Journal has reported on young, do-it-yourself investors exhibiting increased interest in opportunistic day-trading, and alternatives such as stock options  and volatility markets. Evidence suggests you're better off patiently participating in efficient markets as described above, rather than trying to "beat" them through risky, concentrated bets. Over time, playing the market is expected to be a losing strategy for the core of your wealth.

7. A Best Practice: Plenty of Personalized Financial Planning

There is never a bad time to tend to your personal wealth, but it can be especially important—and comforting—when life has thrown you for a loop. Focus on strengthening your own financial well-being rather than fixating on the greater uncontrollable world around us. To name a few possibilities, we've continued to proactively assist clients this year with their portfolio management, retirement planning, tax-planning, stock options, business successions, estate plans and beneficiary designations, insurance coverage, college savings plans, and more.

8. A Top Time-Waster: Fleeing the Market

On the flip side of younger investors "playing" the market, retirees may be tempted to abandon it altogether. This move carries its own risks. If you've planned to augment your retirement income with inflation-busting market returns, the best way to expect to earn them is to stick to your plan. What about getting out until the coast seems clear? Unfortunately, many of the market's best returns come when we're least expecting them. This year's strong rallies amidst gloomy economic news illustrates the point well. Plus, selling stock positions early in retirement adds an extra sequence risk   drag on your future expected returns.

Could you use even more insights on how to effectively invest any extra time you may have these days? Please reach out to us any time. We'd be delighted to suggest additional financial practices tailored to your particular circumstances.

Stay patient, my friends.

 

The information provided is for educational purposes only and is not intended to be, and should not be construed as, investment, legal or tax advice. Allodium makes no warranties with regard to the information or results obtained by its use and disclaim any liability arising out of your use of or reliance on the information. It should not be construed as an offer, solicitation or recommendation to make an investment. The information is subject to change and, although based upon information that Allodium considers reliable, is not guaranteed as to accuracy or completeness. Past performance is not a guarantee or a predictor of future results of either the indices or any particular investment.

 

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The Patient Investor

Written by Eric Hutchens on .

Topic #8 –Why Diversify When It Doesn't Seem To Be Working?

Over the last several decades, we’ve seen strong returns from large U.S. companies and a question that many clients have asked is: “Why continue to diversify? Couldn’t we just buy an S&P 500 index fund and get better returns?”

What Diversification Feels Like

Dimensional Fund Advisors (DFA) recently posted a terrific blog entitled "A Tale ofTwo Decades: Lessons for Long-Term Investors" that shares some very insightful data that sheds some light on these important questions.

First, let's look at the numbers over the last decade ... in the chart below, you can see that the S&P 500 (U.S. large cap stocks) had a cumulative return from 2010-2019 that was more than double any of the other listed asset classes. Furthermore, some evidence-based investment managers we use (such as DFA), favor value ("cheap") stocks over growth ("expensive") stocks, as value stocks have been shown to provide excess returns over time. As you can see in the chart below, it wasn't a great decade for value stocks either as the indexes with a value-tilt trailed the market-cap indexes.

graph 1

So why continue to diversify? Let's broaden our perspective and take a longer term view, looking at the prior decade of 2000-2009 as an example. That timeframe has been called the "lost decade" for U.S. investors for a good reason as large U.S. stocks had a negative total return, while other asset classes did better. If all your money was invested in an S&P 500 index fund over that time, you may have very well thrown in the towel at that point, deciding in your mind that U.S. stocks are a terrible investment.

 graph 2

So, how did these asset classes do over the 20 years combined? As you can see, every asset class did well, though during different periods. And interestingly enough, even though U.S. large cap stocks did great during the recent decade, they were in the middle of the pack when looking at 20 year cumulative returns.  

graph 3-1

So, is it time to abandon diversification and buy an S&P 500 index fund? Hopefully this research helps demonstrate why we believe diversification is as important (if not more important) than ever before. Will U.S. large cap stocks continue to outperform over the coming decade? Possibly, but no one knows what the futre holds. From a valuation perspective, a case could be made that asset classes like small-cap, international and value stocks may be primed for a period of relative outperformance over U.S. large-cap stocks. 

When investors try to outguess the market or bet on one area of the market, they typically get it wrong. We are wired to instinctively look for perceived patterns whether real or not (“pattern recognition” bias) and gravitate toward what’s done the best recently (“recency bias”). These behavioral biases can cause investors to chase hot trends, often right before the trend reverses. 

between-you-and-the-big-mistake

Part of our job as advisors is to help clients maintain a longer-term perspective and make decisions that give them better odds of financial success over their lifetime. The good news is, you don’t need to pick winners or avoid losers to be successful. Owning all of the asset classes does work over time and help reduce the risk of making a big mistake. As Nobel Prize winner Harry Markovitz has famously said, “diversification is the only free lunch in finance.” We agree. You can learn more about how we approach diversification here: Smart diversification.

Stay patient, my friends.

Additional resources:

1  Dimensional Fund Advisors, Returns Web.
    Indexes shown:

  • Large U.S. stocks – S&P 500 Index
  • International stocks - MSCI World ex USA Index (net dividends)
  • International value stocks - MSCI World ex USA Value Index (net dividends)
  • International small-cap stocks - MSCI World ex USA Small Cap Index (net dividends)
  • Emerging market stocks - MSCI Emerging Markets Index (net dividends.)
  • Emerging market value stocks - MSCI Emerging Markets Value Index (net dividends

The information provided is for educational purposes only and is not intended to be, and should not be construed as, investment, legal or tax advice. Allodium makes no warranties with regard to the information or results obtained by its use and disclaim any liability arising out of your use of or reliance on the information. It should not be construed as an offer, solicitation or recommendation to make an investment. The information is subject to change and, although based upon information that Allodium considers reliable, is not guaranteed as to accuracy or completeness. Past performance is not a guarantee or a predictor of future results of either the indices or any particular investment.

 

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The Patient Investor

Written by Eric Hutchens on .

“You can outsource expertise but never your understanding, especially when it comes to your finances.”    Ben Carlson, Don't Fall For It

Topic #7 –How To Be Positively Skeptical Part 4: Check the Facts Before You Act

As we covered in the most recent installment in our “How To Be Positively Skeptical” series, there are only so many hours in the day to do all the fact-checking you’d like to when deciding who and what to believe.

How do you approach this never-ending challenge? We suggest conducting your due diligence like a tournament. First, eliminate the weakest contenders, then conduct deeper due diligence on the finalists.

Truths and Dares

This does NOT mean you should disregard all opposing viewpoints. As you may recall from our last piece, confirmation bias causes us to favor information that supports our beliefs and ignore that which contradicts them. But what if your beliefs are mistaken? One of our goals is to combat confirmation bias by considering any reasoned argument that:

  1. Is well-informed, with an objective perspective and minimal conflicts of interest
  2. Prioritizes judicious decision-making over strident calls to immediate action
  3. Inspires a thoughtful approach to touchy topics, instead of feeding fervent fires

In other words, when considering whether a claim is credible, it doesn’t matter whether or not you agree with it. What matters is whether it represents a genuine pursuit of the truth.

Be particularly wary when you come across startling information – good or bad – filled with superlatives. As this Wall Street Journal article reports, we are all subject to extremity bias, or “our tendency to share the most extreme version of any story, to keep our listeners rapt.” Thus, even if a provocative claim contains an element of truth, it may be overblown.

Once you’ve eliminated the weakest claims, you can fact-check the rest.

Start With a Reality Check

Does a claim make you wonder, “Really?” Especially if it’s a relatively extreme position, a good first step is to refer to one or more fact-checking resources, such as Snopes, Vote Smart, or FactCheck.org. While none of these are infallible, you should be able to at least filter out any flagrantly false claims before sharing them with others or acting on them yourself.

Just Google It

Next, use your favorite search engine to learn more. Don’t just depend on the most popular hits. Just as you wouldn’t turn to tabloids to tell you whether aliens really exist, you should avoid the tabloids’ virtual equivalents and turn to reputable sources offering educated insights.

Examples of more robust sources include academic and similar philanthropic institutions, respected journalists, government publications, quality trade organizations, and subject matter experts with appropriate credentials.

As we’ve covered before, be sure to consider the source’s dominant motivations, their depth of experience, and their thoughtful vs. emotional approach. Ideally, identify multiple credible sources to substantiate, strengthen, and/or clarify any given claim.

Seek the Source

Merely stating a fact does not make it so! When sharing facts and figures, the author should explain how they came up with them, and/or cite a reputable source. Beware if it’s instead left unclear just where the claim came from.

Whenever possible, take the time to verify and confirm the validity of original sources. If the author has not provided the links, an Internet search often uncovers them. By the way, don’t be too daunted to read through academic studies or similar reports. Like any skill, it gets easier over time. Plus, cited information is often found in the study’s abstract, introduction, or conclusion.

Academically Speaking

While we’re on the subject of academic research, let’s take a closer look at its use, and potential abuse. At least in theory, academics are motivated by discovering and publishing their most objective findings. As such, their findings are typically the gold standard for evidence-based understanding.

That said, even academics are human. They are subject to the same biases and misjudgments as the rest of us. Highest priority should be given to studies that exhibit a disinterested outlook; are based on robust data sets; can be reproduced by others and repeated across multiple environments; and have been published and rigorously peer-reviewed.

That last point is important, since an academic’s peers are best positioned to spot any flaws the author(s) may have overlooked. Consider this Scientific American report, describing how a set of psychologists peer-reviewed a series of studies on how social media impacts our youth. While it may be headline-grabbing to publish evidence suggesting smartphones are bad for children, this peer review suggested that misleading data analyses and overstated results needed to be replaced with “a much more nuanced story.”

The Advisor’s Essential Role: Separating Fact from Fiction

If we’ve not made it clear by now throughout this series, our own and others’ behavioral biases present among your greatest hurdles in separating fact from fiction.

As information consumers, we’re inherently susceptible to falling for fake news (especially when we’re tired, by the way). Our challenge is further aggravated by the droves of information out there that is unwittingly or deliberately false.

We hope this series has strengthened your “B.S. detector” as you make your way in the world. At least when it relates to financial planning and investment management, we also consider it among our greatest roles as a financial advisor to help families strengthen their financial literacy, see past their factual blind spots, and separate wealth-building facts from fantasy.

Please let us know if we can help you with the same.

Stay patient, my friends.

 

The information provided is for educational purposes only and is not intended to be, and should not be construed as, investment, legal or tax advice. Allodium makes no warranties with regard to the information or results obtained by its use and disclaim any liability arising out of your use of or reliance on the information. It should not be construed as an offer, solicitation or recommendation to make an investment. The information is subject to change and, although based upon information that Allodium considers reliable, is not guaranteed as to accuracy or completeness. Past performance is not a guarantee or a predictor of future results of either the indices or any particular investment.

 

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The Patient Investor

Written by Eric Hutchens on .

“All media shares one thing: Someone created it. And it was created for a reason. Understanding that reason is the basis of media literacy.” — Common Sense Media

Topic #6 –How To Be Positively Skeptical Part 3: How Do You Do Your Due Diligence?

In previous installments of our “How To Be Positively Skeptical” series, we covered the many forces that tease us into falling for misinformation. Bottom line, our brains are hardwired to lead with fight-or-flight instincts ahead of rational resolve. As such, our critical thinking often plays second-fiddle to rash reactions such as fear, excitement, overconfidence, and regret.

In the financial jungle, it’s essential to look before you leap at emotion-triggering misinformation. Here are five “dos” and “don’ts” for doing your best fact-finding due diligence.

1. Do be positively skeptical. In the courthouse, a defendant is presumed innocent until proven guilty. When managing information overload, we recommend you default to exactly the opposite: When in doubt, remain in doubt until you’ve done your due diligence.

Also watch out for confirmation bias. If you want something to be true, you’ll be more inclined to believe it is. Likewise, if you wish something weren’t so, you’ll assume it probably isn’t.

2. Do question the motives. As suggested above, everything you see, hear, or read is driven by someone’s incentive for sharing it. This helpful Life Kit Comic from National Public Radio describes at least four potential motivations: self-interest, malicious intent, financial gain, and/or genuine altruism. Determining which motivations are most likely at play suggests how readily to accept a claim as the whole truth, and nothing but.

Also watch out for familiarity bias. We take mental shortcuts to more quickly trust people who are familiar to us, whether or not our trust is well-placed.

3. Do consider the source. Motivation aside, does the source actually know what they’re talking about? If they’re sharing their own insights, do they have the credentials and/or experience to be accurate and objective about the subject matter? If they’re reporting others’ insights, have they first done their own due diligence? Is their “evidence” fact-based, first-hand, and objectively considered? Or is it opinionated, emotionally charged, and largely circumstantial?

Also watch out for blind spot bias. We can more objectively spot others’ behavioral biases than we can recognize our own. This is one reason why even a well-intended individual may be unaware of their own misperceptions.

4. Don’t let repetition replace reality. Believe it or not, simply repeating a lie can make it more believable. Citing a pair of studies from the Journal of Experimental Psychology, this Wall Street Journal columnist reported, “When people hear a false claim repeated even just once, they are more likely to let it override their prior knowledge on the subject and believe it.” This all too real “illusory truth effect” explains how effective marketing campaigns often work. It also explains how we can fall for fast-moving falsities, whether unwittingly or intentionally repeated.

Also watch out for hindsight bias. Hindsight bias tricks us into altering our memories to reflect current reality. In other words, once you decide to believe a repeated claim, you may forget you didn’t believe it the first time.

5. Don’t rush. Especially in money management, anything that is important today will still be important tomorrow. Take your time, ask critical questions, and ensure you understand the ramifications before you make any move. The same applies when sharing tantalizing social media posts. If something strikes you as either outrageous or too good to be true, avoid getting caught up in the heat of a moment, lest you accidentally fan the flames of an illusory truth.

Also watch out for herd mentality. Herd mentality intensifies our greedy or fearful reactions to breaking news. We are prone to run in whatever direction everyone else is headed.

How Do You Do Your Due Diligence?

Of course, nobody can research every claim they come across. There are only so many hours in the day! So, what are some practical steps for efficiently differentiating fact from fiction? We’ll cover that in our next, and final installment in our “How To Be Positively Skeptical” series.

Stay patient, my friends.

The information provided is for educational purposes only and is not intended to be, and should not be construed as, investment, legal or tax advice. Allodium makes no warranties with regard to the information or results obtained by its use and disclaim any liability arising out of your use of or reliance on the information. It should not be construed as an offer, solicitation or recommendation to make an investment. The information is subject to change and, although based upon information that Allodium considers reliable, is not guaranteed as to accuracy or completeness. Past performance is not a guarantee or a predictor of future results of either the indices or any particular investment.

 

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The Patient Investor

Written by Eric Hutchens on .

“The challenge for all investors is to consume the news without being consumed by it.”  — Jason Zweig

Topic #5 –How To Be Positively Skeptical Part 2: Understanding Your Emotions

In a recent post, we introduced our multipart series on the importance of separating fact from fiction—as an investor, as well as in your everyday life. Today, let’s talk about your emotional reaction to unfolding news, and the impact that can have on your financial well-being.

The Usual Emotions in Unusual Times

If anything, current events have made this series even more important. Thoughtful, sober answers to our most pressing questions must now compete against a deluge of emotional misinformation that can almost be as virulent as the ailment itself.

First of all, there’s nothing wrong with having emotions—even strong ones.

For example, many of us may be grieving the loss of the “normal” life we used to have just a few months ago. It’s important to acknowledge these feelings. In a recent National Public Radio piece, behavioral counselor Sonya Lott explains how unattended grief can impair “every aspect of our being—physically, cognitively, emotionally spiritually …” and financially, we might add. Lott says, “We can’t heal what we don’t have an awareness of.”

In other words, emotions are not only unavoidable, they’re essential. But remember:

When you put your feelings in the financial driver’s seat, they will steer you toward what your instincts would prefer, rather than what reason might dictate.

Behavioral Finance and Emotional Investing

There is an extensive field of study dedicated to understanding how our instincts and emotions often interfere with our ability to make rational financial decisions. This study is called behavioral finance. We have written and posted a white paper on this topic called The ABCs of Behavioral Biases on our website.

Suffice it to say here, every investor faces strong, hardwired temptations to:

  • Chase illusory trends
  • Fear the very investment risks that are expected to generate our greatest rewards
  • Regret even our most sensible decisions in the face of minor setbacks
  • Disregard the most durable data
  • Overreact to breaking news and emotion-triggering language

On that last point, words alone can create a potent brew of emotions. Guns, abortion, climate change, and immigration probably generate a rise out of you, one way or the other. The same goes for financial catchwords: crashing, soaring, crisis, and opportunity.

Strong feelings, while natural, WILL create cognitive blind spots in your reasoning. Add the speed and omnipresence of the Internet, and it becomes even easier to lead with your emotions.

“There’s no room for facts when our minds are occupied by fear.”  Hans Rosling, Factfulness

Emotional Marketing for Better and for Worse

The power of people’s emotional response is so strong, academics like Wharton School’s Jonah Berger have written books on how marketing teams can appeal to them – for better or worse.

In his book “Contagious,” Berger describes six triggers companies can use to amplify their marketing messages, including playing to your emotions. In this podcast , he observes: “Companies recognize, ‘Hey, if we can get people to feel emotional, we’ll get them to talk and share.’ … You need to design content that’s like a Trojan horse. There’s an exterior to it that’s really exciting, remarkable and has social currency or practical value. But inside, you hide the brand or the benefit.”

Emotion-triggering communications aren’t inherently wrong or bad. Your favorite causes use them to nudge you into giving more generously. We ourselves use them in messages just like this one, to encourage you to embrace your own best investment interests. You may not realize it, but you probably use them as well, to advance your own heartfelt beliefs.

Unfortunately, not every application is as well-intended. Profit-hungry wolves on Wall Street won’t think twice about preying on your hopes and fears. Popular and social media alike are forever awash in fervent calls to action. Identity thieves are the ultimate masters of emotional trickery in their quest to rob you of your wealth.

Powering Past Your Emotions

So, as an evidence-based investor, how do you navigate past these and many other emotional traps? It can help to have an objective advisor point out your own behavioral blind spots. But you can help yourself as well.

Has something you’ve seen, heard, or read left you “stirred up”? Again, we’re not suggesting you should repress every feeling. But the more aggressively an appeal tugs at your emotions – in fear, anger, excitement, or elation – the more important it is to avoid being consumed by it.

Especially if it involves your financial well-being, we strongly recommend hitting the pause button before making any next move. Take your emotional “temperature.” Wait for the heat to subside. Most importantly, take some time to conduct extra due diligence before taking the bait.

What kind of due diligence? That’s what we’ll cover in part 3 of this series.

Stay patient, my friends.

 

The information provided is for educational purposes only and is not intended to be, and should not be construed as, investment, legal or tax advice. Allodium makes no warranties with regard to the information or results obtained by its use and disclaim any liability arising out of your use of or reliance on the information. It should not be construed as an offer, solicitation or recommendation to make an investment. The information is subject to change and, although based upon information that Allodium considers reliable, is not guaranteed as to accuracy or completeness. Past performance is not a guarantee or a predictor of future results of either the indices or any particular investment.

 

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