Why Diversify?

Given the stellar performance for the U.S. equities in 2019 many are questioning why we diversify. Below is an article by Frederick C Taylor that explains

Why?

Given the media’s trumpeting (OK, Trump himself as well) of the stellar performance of the U.S. market(s) this past year, one might be tempted to ask: why should or do I have any international stock exposure? After all, look how much more I might have made if I were not diversified and only exposed here in the U.S. Moreover, if I am diversified, why should I rebalance my portfolio when I could just keep a larger allocation or even 100% in the “winning” asset class? That is a fair question that demands a factually based answer, so here goes:

Rebalancing a diversified portfolio essentially addresses two very important investment issues:

1. It imposes a discipline on the portfolio of buying “low” and selling “high” and, after all, isn’t that the old Wall Street dictum of how you make money in the market? This isn’t rocket science and just about any individual with an IQ above room temperature knows this. It’s not the knowing part that’s difficult, it’s the discipline to sell someof those better performing ones and buying those that others find unfavorable at this particular time. This, of course is the emotional part of the equation and where the “discipline” comes into play.

2. There was a landmark study as to where portfolio returns came from. I don’t expect most readers to have any familiarity with it (unless you were taking notes at one of my presentations or read my writings very carefully with a fully retentive memory). The study showed that 94% of a portfolio’s return was due to it’s asset allocationpolicy. So, when a portfolio is structured with specific percentages allocated to specific markets or asset classes such as large U.S. companies or small ones or foreign companies or even emerging market ones, when you have a year such as last year or even this last decade, if you do not rebalance, the allocations you determined were appropriate for the level of expected risk and return the portfolio’s allocation will become skewed, which raises it’s level of risk above what was anticipated and ultimately has been shown to impact returns negatively over the long-term in comparison.

If you do not believe this is significant then you only have to look back to the 2000 – 2002 bear market correction of the 90’s tech and dot.com era, which to this day many have not recovered from or 2008 – 2009’s bear market.

Both events found non-diversified and/or non-rebalanced portfolios maximally exposed at the worst possible time     with risk far exceeding even the investors’ most optimistic assumptions with many paying a very dear price for the lack of diversification and discipline having been applied to their portfolios.

The late Nobel Laureate, Merton Miller advised and wrote publicly on many occasions that “diversification is your buddy.” And it is if one follows the dictates of that other Nobel Laureate, Harry Markowitz and his “Modern Portfolio Theory” which tells us that having a rebalanced, non-correlated, diversified portfolio can be expected to provide higher expected rates of return with lower expected risk — over the long-term. 

Diversified doesn’t mean having a lot of “stuff in only one asset class (i.e. lots of large U.S. stocks) but rather including various others, including international — where around (per Vanguard) 45% of all global stocks reside. Others estimate when emerging markets, frontier markets and others are included the total reaches upwards of 2/3’s. Thus, if you do not have any international exposure you’re missing out on a substantial portion of the equity universe and it’s potential.

It is somewhat difficult to give any credence to the idea of investing anywhere other than where the Apples, Amazons and Microsofts reside when one focuses only on recent returns.

It continues to be prudent to own equities…globally diversify…rebalance.

Preparing Your Business For The Future!!

Preparing for the future is as much about identifying market trends and understanding your customer base as it is about knowing where you’ve been. Healthy growth requires experience and a fundamental understanding of the nuances of your business. It’s your baby, after all, and is a reflection of your drive, passion and planning. You hope that each year, the business increases in value so that when it’s time to retire, your nest egg is secure. So then, what’s your business worth?

Knowing the value of your business is the cornerstone and first step in understanding the business’s past performance. An accurate valuation allows you to determine “Where am I today?” and “How do I get to where I want tomorrow?”. The tumultuous nature of the global economic environment is always a factor to consider, and has resonating effects around business operations. Over 170,000 small businesses permanently closed their doors as a result of the Great Recession, and trillions of dollars deteriorated from the US equity markets. One of the biggest hazards for small businesses during bear markets is what’s known as the “Stock Market Effect”. This describes the consumer behavior in response to equity market conditions. As stocks decline, people feel less wealthy and don’t spend as much. Just as this hurts the big companies it really hurts Main Street businesses as well.  Without a proper plan in place, the next bear market may cause the destruction of many hundreds of thousands more businesses and foster an economic environment of stagnation that will have far greater and further reaching effects than the collapse we saw in 2008-2010. Furthermore, after taking into account inflation and the normalization in population growth, the overall market value recovered since 2008 is less than half of that lost. For the 75% of business owners who plan to fund their retirement with the sale of their business, a proper plan in place to preserve capital, protect against suits and promote growth, is absolutely vital or else they will not have the funds necessary to survive let alone thrive.

US equity markets have seen tremendous gains over the last seven years. It has been one of the strongest bull markets in history and has fostered immense global growth as well.  But many argue that we are overextended the question remains, “Can the underlying assets support such lofty valuations?”.

  • The S&P for example has a P/E of 25.22, a valuation not seen since the Credit Crisis in 2008, Tech Bubble in 2001 and The Panic of 1893.
  • April equity valuations were a 76% deviation from the mean. The month prior to the start of the Great Recession, they were 64%. If we experienced a “crash” next month, it would be the second highest deviation from the mean we have seen before a bear market.
  • Consumer confidence in April missed estimates, representing the steepest decline in sentiment in the last 12 months.
  • The first quarter of 2017 grew at the weakest pace in the last 3 years at 0.7%. Compare that to 2.1% in the last quarter in 2016 and 1.1% for the first quarter a year before.

Whether you agree the outlook is bearish or not, you can agree that a solid plan and adequate preparation are absolutely necessary to have in place for every business. Any proper plan includes liquidity, and cash is king.

            A business needs cash to expand. In the public market, obtaining capital is not too challenging but middle markets and closely held companies often have a much more difficult time. Coupled with lingering fear in the banking industry, capital or loan acquisition can be immensely challenging. The catch 22 is that banks are more inclined to give loans to larger companies because it is less risky. Small businesses, however, need cash in order to grow into those middle market companies. Small businesses rely more heavily on bank loans for working capital, whereas bigger companies have a myriad of options to obtain loans from. (The acquisition of a SBA 7(a), or multi-purpose business loan, actually requires a valuation done before it is even considered.) Unnecessary acts of desperation are often taken when cash flow is under pressure. Roughly 16% of business owners have taken equity from their home and used it as collateral to finance their business. After the business value is understood, plans can be put in place to secure funds, prepare the business for a capital acquisition or simply save and build cash reserves for the future. Money buys freedom and gives you, the business owner, leverage when seeking a loan. The point is to always have a plan. Starting with the valuation, understanding what the value is today and laying out a business plan, builds value moving forward.  

             By identifying the value of the business before a bear market, we can identify what the business can withstand, but more importantly, what it cannot. Insurance coverage and capital preservation are two important areas to consider. A lawsuit even in prosperous times can be a big threat to a business. A lawsuit during a recession can be a knock-out punch. You can see where your business is lacking in coverage and fill those gaps before they become an issue. Mishandled Key Man and Buy/Sell agreements can cause shockwaves resonating throughout all facets of the business and operations. Often, such a disturbance permanently shifts the businesses ability to generate the desired benefit stream. Maintaining adequate coverage keeps operations running smoothly and protects against unforeseen circumstances.

Capital preservation is one of the most important aspects for a business to effectively manage. The secret to capital preservation is a lean business model, or one that creates the most value per dollar spent. A simple Google search yields a clear and concise definition: “Simply, lean means creating more value for customers with fewer resources. A lean organization understands customer value and focuses its key processes to continuously increase it. The ultimate goal is to provide perfect value to the customer through a perfect value creation process that has zero waste.” The key is efficiency and leverage, getting the process as smooth as possible while maximizing each dollar spent. Pooling for example, is a great way to lower inventory costs. Speak with competitors who purchase from the same supplier you do. Combine your purchasing power and agreeing to work with a supplier for a set period of time, can dramatically decrease your inventory costs. A full-time employee is valuable but only if they are effectively utilizing their time. Often when business is slow, salaries go toward idle time and not revenue creating activity. By contracting out certain work you make sure to pay only for time worked and often for high quality skillsets that contractors bring to the table. Finally, simple bottom line cognizance and responsibility will help run a lean business. By stressing the importance of cost cutting and waste to the team, along with encouraging the team to bring ideas to the table around how the business can run more cost effectively, waste can be removed leaving more cash in hand. These are just a couple ways to save money but are still vitally important. Frugality is key to making it through a recessionary period and can be the difference between a happy retirement and a boarded up storefront.

Some of the greatest buying opportunities occur when everyone else is running for the hills. As the markets decline, the smart money starts to look for opportunities and undervalued investments they can scoop up for cheap. Opportunities like these don’t come around often and to seize them requires great preparation and foresight. Periods of economic downturn are often some of the greatest periods of merger and acquisition activity and truly distinguish the strong businesses from the weak. Planning ahead and being able to make a position on a failing operation could pay dividends later on. The main purpose of an acquisition is execution of company strategy and to increase the strength of the core business.

I hope that this article has shed light on the importance of knowing your business’s value. It is the most important step in a business owners plan for the future. Deterioration in the US equity markets over the next two years is going to become a headwind for business owners. Without a solid plan in place to account for decreased profits, fewer capital infusions, increased credit risk and growth opportunities, it is unlikely the business will remain profitable and may even cease operations.

NFL Predictors…..

As I do many times prior to watching the Green Bay Packers beat the Seattle Seahawks I was watching the NFL pregame show. Each week the ‘experts’ pick the winners of specific games. These ‘experts’ are made up of Super Bowls winning players as well as coaches. There ‘experts’ should be able to correctly pick the winners of any game each week.

After all there are only 16 games to choose from. These ‘experts’ have access to all the statistics. Who is playing, who is hurt, who is playing well and who is not. Past performance is there only criteria. Given the past these ‘experts’ make their predictions.

Now that we are in the playoffs there are even less choices.

Well Last week Terry Bradshaw, Super Bowl winning quarterback for Pittsburgh Steelers back in the 70s. He was also MVP of 2 Super Bowl(s). These credentials should give him the credibility to pick the winners with ease.

Terry said that the Minnesota Vikings had no chance against the New Orleans Saints.  Terry gave many reasons This was a sure thing.

He was not alone all the ‘experts’ picked New Orleans to win easily. In fact, if you were to keep track, these ‘experts’ have a terrible record.

You can guess what happened. Minnesota won the game easily.

Investors can learn a lesson here. There is no such thing as a sure thing. The equity markets are random and unpredictable. Just like NFL games. Even if you have all the statistics supporting your position. You cannot consistently pick the direction of the equity markets, nor can you consistently pick the stock winners.

If the NFL ‘experts’ cannot pick the winners out of 16 games each week and much less in the playoffs. What makes you think you can pick the right stocks and the direction of the equity markets.

I wonder what the ‘experts’ will predict in the conference championships. I hope they pick against the Packers, especially Terry Bradshaw.

When you build a prudent globally diversified portfolio a correct prediction is not required. Over the long term you will succeed. There will be, however, times when your diversified portfolio will under perform a specific asset class.

Investors need to remain disciplined and maintain their long-term view of the equity markets. Most cannot do this alone.

It will require the help of a fiduciary adviser/investor coach. Your coach will keep you disciplined and remain focused on your long-term goals.

2019..Events That Did NOT Happen..

During 2019 we were worried about several things that would have a negative impact on the financial markets. The financial media made sure you were fully aware of these ‘negative events.’  

After all, the media’s strategy is, if it bleeds it leads.

Given these possible events the stocks around the world had a solid year in 2019.

Many of the people I talk with remain pessimistic about the future. What if this happens or that happens? They ask. I’m not sure what will happen either short or long term. What I do know is that things will change. The only thing that doesn’t change is that things change.

Rather than trying to predict the future, which no one can consistently do, I follow my investment philosophy, which is that markets are efficient.  In that all the knowable information is in the current price of securities. Any predictions made are a guess. The markets going forward are random.

I believe that free markets work. I believe that economies around the world will continue to grow. What I do not know is what sectors or industries or products will grow.

Therefore we must remain diversified and disciplined.

There will always be short term volatility, both up and down. My role as an investor coach is to keep investors focused on the long term. Trying to time the markets or pick the right stocks will lead to poor results, long term.

Your goal as an investor is to reach your long-term goal. This is not done by earning the highest return possible. Earning the highest possible return can be accomplished in the short term, however it cannot be accomplished long term.

UNLESS, you believe that earning the market rate of return is the highest possible return.

The markets may not be perfectly efficient at all times, however they are far too efficient to take advantage of and improve returns.

Let’s reduce your anxiety in 2020 and improve returns, long term.

To succeed long term you must own equities..globally diversify..rebalance.

Too Good To Be True!!

How many get rich quick schemes have you learned over the last 12 months? Many profess that you can get rich quick if you follow their lead. Remember the old trading adage, ‘pigs are led to the trough and hogs are led to slaughter’.

No one can consistently predict the future!!  Because the equity markets are random and unpredictable.

There are no high return/low risk asset categories or investments.  No matter how sound the logic or plausible the story, this just does not exist

Investors want stock market returns with Treasury bill risk. What they end up with is Treasury bill returns and stock market risk.

To reach your long term goals you must diligently save….own equities and high quality short term fixed income….globally diversify…..rebalance.

Market Timing Has Huge Risks!

There are many risks associated with your money. Inflation risk, equity risk, capital risk and others. However, the greatest risk an investor can take on is market timing.

When assets are moved in the portfolio, based on a forecast or prediction about the future, this is market timing.

For example, you’ve become convinced by economic forecasts that the market is heading down over the next twelve months. You decide to sell your stocks and put all of the money into cash. That is market timing!

Market movements are random. No one knows what the market will do tomorrow or over the next twelve months. It bears saying again: Nobody knows with any degree of certainty what the future will bring and if they did they wouldn’t tell you.

Let’s look at another example. Because of a war, you or your stockbroker predict that international stocks are going to lose big, so you move all of your stocks into the United States. Once again, this is market timing.

This doesn’t “feel” like speculating. It often feels like wise stewardship of your assets.

If over the last two years, you have watched your portfolio take large losses in any one asset category, and every news program, investing magazine and stockbroker says this is the time to get out – it feels like prudent investing. Nothing could be further from the truth.

In many cases, if not most, staying disciplined and staying the course is the best thing to do. That assumes that you currently have a prudent mix of assets. This is a huge assumption, because most people don’t.

To keep you disciplined to your strategy, you will need the guidance of an investor coach/fiduciary advisor. In my opinion, this is where your advisor adds the most value. This is why you pay their fees.

To keep emotions out of your investment decisions. Investing is a long-term process and a true advisor will keep you grounded to your plan.

It Is Prediction Season…

This bears repeating as the predictions are coming fast and heavy. They include a service that says based on Elliott wave principles the S&P500 will fall to 2700 soon, currently around 3100. Morgan Stanley predicts the rough 2020. Many investors I talk with are saying the market is high and due for a decline.

A few years ago, John Bogle, inventor of the index fund and past chairman of Vanguard Investments was speaking at an advisor conference. Now 80+ years young, Mr. Bogle, shared the best investing advice he ever got while a young man working as a runner for a brokerage firm, a fellow runner, about the same age as Bogle is now told him the secret ‘Nobody knows anything’.

During his interview Mr. Bogle warned attendees that “we give too much credence to past returns; past is not prologue,” saying instead “it’s the source of the returns” that is more important. He then quoted Samuel Taylor Coleridge that history is like “a lantern on the stern, which shines only on the waves behind us.”

Discussing investing opportunities, Bogle pooh-poohed private equity, saying that there are “a lot of sellers, but not many buyers.” He still believes that “performance chasing” is one of the most deadly of investing sins, that “I grow more concerned about target-date funds every day,” is skeptical about 130/30 funds–“it’s not that easy”–and on exchange traded funds, “my skepticism is increasing,” saying that his reading of the data shows that “ETF investors do badly relative to mutual fund investors.”

The problem is not the product but the investor. They need a coach to guide them through the maze of financial media and hype.

Basically what Mr. Bogle is saying is that stock picking, market timing and performance chasing do not work. Developing a customized portfolio, with regard to your comfortable risk level, using a scientific approach and remaining disciplined will maximize your opportunity for a successful outcome.

Remember at any one time there will be an asset class or stock picker or market timer or hot strategy or……..that is outperforming. Successful investors are not always right. They have an investment philosophy that they believe in and stick to it.

My clients understand this and will succeed in the long run. We must remain diligent and stay focused. Own equities…… globally diversify…..rebalance.

Happy Thanksgiving….2019!!

As we approach the Thanksgiving holiday and the Christmas holiday, we must realize there is much to be thankful for.

The Men and Women Who Sacrifice and Fight for Us.

Friends and Family.

OK the Packers had an embarrassing loss Sunday!

More importantly, we continue to live in the greatest country in the world despite how you feel about the political climate.

No political unrest can change the fact that the free markets work and will overcome. People will continue to believe that hard work, discipline and prudent risk taking will lead to success. Or at least they should.

Remember, during times like these there are increasing amounts of opportunity for all who are willing to look.

We continue to live in a free country one in which YOU determine how much success you desire. You are accountable for the level of success you will realize.

Regardless of the political climate the free markets and free enterprise will overcome.

Be thankful for this freedom, there are many in the world who are envious of the United States of America.

As always, do not empower the Wall Street bullies, to succeed in reaching your long term financial goals you should:

Own equities….globally diversify…..rebalance

Remember returns come from the markets not from a manager.

Be thankful for all you have.

Going Broke Safely!

Recently I overheard some recent retirees discussing where to out their money. The discussion centered around risk free investments, such as, CDs or U.S. Treasury Bills.

The historic “Risk Free Rate” is about 4%.  In fact, the most recent sale of 5-year Treasury Inflation Protected Bonds sold at a negative yield, first time ever. 

The risk-free rate is the historic return on government guaranteed T-bills.  Think of them as CDs issued by Uncle Sam.  They have a very low return but virtually no volatility.

They seem like a sure thing, but after inflation and taxes, the only thing that’s for certain is long-term losses.  It’s the safest way to go broke.

Investors continue to search for the investment that gives stock market returns with Treasury Bill risks. The Wall Street bullies know this and continue to market exactly this. This type of investment comes at a huge cost to the average investor.

 Really because there is no way to offer a product that avoids risk while providing stock market returns.

Owning a globally diversified portfolio at your risk tolerance level will give you the results you seek, long term. To realize these great long term returns, you must deal with the ups and downs of the equity markets.

To accomplish this, in most cases, you hire an investor coach/fiduciary adviser. Your coach will keep you disciplined during market extremes, both up and down.

To succeed long-term you must own equities….globally diversify…rebalance.

Wall Street Bullies Need You!

Every week I look for a subject to discuss what I have heard from clients/prospects. Some are questions, some are comments. This week I am going to discuss ‘The Efficient Market Hypothesis’ written by Dr. Eugene Fama in his Phd. Dissertation. Partly because Dr. Fama won the Nobel Prize in Economics for 2013 and partly because I continue to hear questions on market timing, when to get into and out of the market. I actually had someone ask for the current hot stock(s). YIKES!!

I have mentioned ‘The Efficient Market Hypothesis’ , now Nobel prize winning, many times before. It has also been referred to as Free Markets Work. Dr Fama’s definition of the efficient market is as follows:

“In [a free] market at any point in time the actual price of a security will be a good estimate of its intrinsic value”.

This is just a brief definition because I do not wish to bore you with the entire dissertation. What he is saying is that price of a stock today represents its true value today. It does not represent a forecast of the future, because we all know no one can predict the future. Therefore, all the knowable information is already in the price of the stock (security).

Any future movement of that stock is random and unpredictable.

Given this information we know that if you are trying to use

  • Stock picking
  • Market timing
  • Track record investing

You are gambling and speculating with your money. Anyone who recommends you use these tactics with your investment money should be considered a Wall Street bully.

When my financial services career began in 1992 I found it very curious why not one firm that I worked for recommended using ‘The Efficient Market Hypothesis’ or any other academic study I learned in finance classes in both college and graduate school. The research I learned proved these concepts work and making predictions does not.

What I concluded was the Wall Street bullies need you to continue to gamble and speculate with your money because this generates the most fees for these firms.

It has been proven numerous times that there is zero correlation between a stock pickers/market timers ability to pick the right stocks or correctly time the market in the past and their ability to do so in the future. This means that just because any adviser/agent has a good track record in ‘beating’ the market there is no evidence that they will repeat. It is not impossible but highly unlikely.

If this is true, then why do investors continually seek out the ‘best’ investments for right now?

Why do these same investors look for someone to beat the market?

The markets offer great returns long term why not concentrate your investment money on capturing market returns?

Most of these questions can be answered by the fact that the Wall Street bullies continue to market gambling and speculating.

There will always be someone making predictions about where investments are going. Stop being a victim of the Wall Street bullies. Learn about the most recent Nobel Prize winning concept along with other academic concepts to engineer a portfolio for you.