Vanishing Options, Overreactions, and other Stock Market Observations

stock volatilityStocks go up, and then they go down. Or vice versa. Markets generally trend upward over time, but there is definitely volatility over time. We know that this happens, based on historical data.

It is what it is, and things should be simple to understand, right?

Well, the recent volatility in the markets here in the U.S. have garnered some attention in the news lately. After surging forward for much of the year, aside from a few pullbacks here and there, the market had some down days last week. It’s almost as if a game of musical chairs was being played, and the music suddenly stopped. The bull market party was seemingly over – or, at least on hiatus until yet another one-day rally.

What kind of reaction does that cause with people? Well, I think that it depends on who you’re talking to.

Vanishing Options

I was talking to a friend of mine last week, and he’s generally a very financially savvy person. As in, doing very well with his career as well as saving a high percentage of his income and investing it wisely. He’s also smart when it comes to identifying risks. In short, he’s typically someone who is good at thinking about the key personal finance questions that I wrote about previously. Frankly, I have to admit that he’s done better than me in this regard.

However, in this case he had a different take on the market downturn. He was commenting that they had a good number of stock options that ended up losing a ton of value during that week. This was a particular problem because they had apparently earmarked that money for some major updating to their home. Now, this would have to come out of savings. I believe some money had already been spent.

I don’t think he was the main driver behind spending this money; actually, I think it was his wife. Regardless, the excitement over having such funds – on paper – could have driven some of the decision-making in terms of those expenses. Again, that’s just money on paper.

While that may be frustrating, it probably speaks to the bigger point that we should know that markets go up and they also go down. What goes up will ultimately come back down somewhat, at least to a certain level.

So, it’s smart to not get carried away in excitement over big gains!

Panic Selling

I know another person who talked about pulling out of the market entirely. Instead of getting overexcited, he is highly defensive in his orientation toward money. Not defensive in conversational tone, or anything like that. Just very risk-averse.

Now, if someone is closer to retirement age, it makes sense to be more risk-averse. However, being further away from retirement than that, this guy has a ways to go before reaching the finish line. So while capital preservation is important, people in this age range need to count on some growth.

Here’s the thing: it seems like the market’s overall orientation is upward over the long run. True, right? Plus, there are examples of market overreactions to bad events as well.

One example is the sharp stock market decline after the U.S. credit rating downgrade a few years back. Sure enough, stocks more than recovered not long after that. Another example is how Japanese stocks plummeted after the devastating tsunami earlier this decade.  Within weeks, they came back to prior levels at the market level.

In either case, panic selling didn’t accomplish anything over the long run. What goes down, ultimately comes back up – at least in terms of overall markets, that is.

So, it’s not smart to completely panic over market downturns!

Bottom line: Ups and downs happen, in markets and in life. Sometimes it’s how we actually handle the changes, rather than the changes themselves, that can determine our success.

My Questions for You

Have you seen people overreact to market ups and downs?

How do you handle long-term bull markets, or even sudden downturns in the market?

Long-term Returns for Conservative, Average, and Aggressive Portfolios

The following is a guest post from Larry Russell

Conservative, average, and aggressive portfolio asset allocations, long-term compounded returns, and investment costs

This article provides two annualized return charts to help you understanding how various portfolios have fared over many decades:

    1. Gross inflationary and real dollar returns for typical conservative, average, and aggressive portfolios
    2. Conservative, average, and aggressive portfolio returns with investment costs

These charts provide the annualized cumulative or geometric average returns for the past eighty-five years beginning in 1928 just prior to the collapse of U.S. and world stock markets in 1929. These graphics illustrate the gross returns with and without inflation that would have been achieved on various portfolio investments made in 1928. This numbers assume reinvestment of all dividends without taxation over the years and no subsequent additional investments.

This is a bit like measuring the annual growth of the “portfolio beards” of three different Rip Van Winkles (RVW) who fell asleep in 1928 and awoke at the end 2013 without each waking to trim their financial beards in the interim. Given differing cash, bond, and stock asset class rates of return, “average RVW’s” portfolio beard growth was just that — average. In contrast, “conservative RVW’s” portfolio beard growth was slower and “aggressive RVW’s” was faster.

In reality, however, the first chart below shows how the money beards of all three RVWs were each trimmed by 3.03% compounded inflation per year over these 85 years. Inflation is just a change in the value of the unit of reference. Just as the measurement of inches, feet, yards, and meters are time invariant, so should be the measurement of investment portfolios, if we wish to hold the purchasing power of a dollar constant over time.

In contrast, the level of investment costs is a choice that investors make, naively believing they will earn more if they pay more. The research literature indicates the opposite. Investment costs are just a zero sum game and a wealth transfer to the financial industry. Investment costs can be very low, average, or very high.

“Conservative RVW”, “average RVW” and “aggressive RVW” might have selected any level of investment costs before slumbering in 1928. As the second chart below illustrates, with a low return and very high costs, “conservative RVW” might have awoken clean-shaven in 2013 without any investment growth. With very high costs, “aggressive RVW” could also have awoken in 2013 with a fine beard, but did not realize just how many yards of additional beard the financial industry had trimmed away over the years.

Compounded inflationary, real, and total portfolio historical returns for conservative, average, and aggressive portfolios

The chart below displays investor portfolios with different asset allocations. The middle column is for an average investor. A conservative portfolio is measured to the left and an aggressive portfolio is added to the right.AssetAllocation-BarChart_NO-Fees_600x431

The percentages of cash, bond, and stock in the portfolios of the average investor have fluctuated over time, but these holdings have normally been roughly 10% cash, 35% bonds, and 55% stocks. Note that the 10% cash figure is an estimate of cash for investment purposes. The average person tends to hold higher cash balances measured across all their assets, but this extra cash is typically for transactions and emergency reserves rather than investment purposes.

The conservative portfolio is composed of 20% stocks, 60% bonds, and 20%. In contrast, the aggressive portfolio is composed of 80 percent stocks 15% bonds, and 5% cash.

You should note that there are more conservative investors who hold portfolios that have fewer than 20% stocks and there are those more aggressive investors who have portfolios with greater than 80% stocks. Academic investment research supports the idea that even the most conservative investor should hold a minority stock position, and conversely even the most aggressive investor should hold a minority bond position.

In aggregate, a more diversified portfolio with a mixture of stocks, bonds, and cash tends to smooth out somewhat the more extreme fluctuations within asset classes that occur over time. In models where the need to withdraw assets may occur at random times, portfolios with mixed asset classes tended to do better over long periods, when compared to 100% stock or 100% bond portfolios.


Looking at the compounded annual return over 85 years for the conservative portfolio with 60% bonds and 20% cash, you see the real dollar return this much lower risk portfolio was just short of two and a half percent or 2.48%. When you add 3.03% annual inflation back in, then the total annual return has been about five and one-half percent (5.51%). Thus, for the conservative portfolio, about 55% of the total gross compounded annual return was due to inflation (3.03% divided by 5.51% equals 55%).

In contrast for the aggressive portfolio with 80% stocks in the third column, the real dollar return has been about 5.43% annually. When you add back the 3.03% annual inflation, then the total annual return for this higher risk portfolio was 8.46%. Thus, for the more aggressive portfolio, about 36% of the total gross compounded annual return was due to inflation (3.03% divided by 8.46% equals 36%).

Obviously over this extended 85 year period, the higher the portion of stocks in the mix, then the better the return has been. Concurrently, however, stock-heavy portfolios have experienced much greater asset value fluctuations requiring portfolio owners to have significantly more will-power to sustain a buy-and-hold strategy in down markets.

Going back to the Rip Van Winkle analogy, a great advantage that any of these three RVW’s had was that they slept through 85 years of screaming headlines about financial fear and greed. Clearly, after awaking “conservative RVW” would have preferred to have held the portfolio of “aggressive RVW.” However that is not the way investing works, because we are always awake to the latest news. The reason why the conservative portfolio is better for some investors is that it allows them to sleep at night.

Incidentally, I have written a separate article entitled: “Evaluating historical financial asset class returns: cash, bond, and stock market returns by historical periods” that you can find here: Evaluating historical cash, bond, and stock financial asset class returns by historical periods

This other article looks at this historical cash, bond, and stock return data from a different perspective. It breaks down these inflationary and real returns by various periods of time between 1928 and 2013. The article you are reading now uses long-term historical compounded averages, and obviously there have been significant fluctuations over time that are useful to understand.

For example, there have been two periods (during the Great Depression and during the more recent credit crisis and Great Recession) wherein bonds have delivered better returns. In contrast, there have been two long periods when stocks experienced huge appreciation.

While many investors remember that stock appreciation was high during the 1980s and and the 1990s, that period pales in comparison to another. After the end of the Second World War there was a brief recession and inflationary spike period that quickly gave way to a sustained stock market boom, which lasted until the late 1960’s. During this period stock valuess grew at a very strong pace.

Finally, there was another period in the middle during the 1970s and early 1980s when inflation began to spin out of control, which undermined the value of both bonds and stocks. If you read this other article of mine, you will find numerous graphics that allow you to understand this history quickly.

Investment fees and compounded annual portfolio returns for conservative, average, and aggressive portfolios

Now, let’s move on to the second slide. It is the same as the previous slide but also has some total investment cost overlay lines. This slide brings home an extremely important point that many investors overlook — excessive, unjustified, and completely unnecessary investment fees, costs, and taxes. The financial services industry has so many ways of reaching into your pocket to take parts of your annual gross investment return year after year after year …


However, much of the financial services industry has different objectives for investors. Most of the industry wants you to keep hopping and changing things by trying every supposedly wonderful new investment product and new fad that they can dream up. Unfortunately, all this does is add unwarranted fees and costs and make you pay more taxes. None of this activity helps the average investor to earn a higher gross return. Instead, it just redirects a large portion of your gross returns into industry and government coffers. The result is just a lower net return for you to live on.

Look at the dashed investment cost overlay lines on the graphic above and notice that I overlaid them only over the real dollar annual return portions of these conservative, average, and aggressive portfolio returns for these 85 years. While the financial securities industry will always use inflationary dollars, because that makes it appear like fees are a smaller portion of your returns, but this is just a numerical sleigh of hand.

Again, inflation is just another cost that erodes your total return. You should never evaluate investment performance using inflationary dollars in the first place. All that really counts is your ability to maintain and grow the purchasing power of your portfolio in the face of inflation.

Now focusing just on the real dollar compounded annual returns portions of these conservative, average, and aggressive portfolios, it becomes much more clear that the frequently uttered statement by financial advisors that “investment costs are just a few percent” is simply not true. A few percent spent on costs without a higher return turns out to be a huge proportion of the average investor’s real dollar returns year in and year out.

Also, over this history, clearly stocks have done the best job of beating inflation, while cash has barely kept its head above the inflationary waters. Therefore the industry tends to have more ways of milking the returns of stock assets compared to cash and bonds. The industry clearly understands that they must not kill the golden goose with excessive fees, and there is more gold to be extracted from stocks compared to bonds and cash.

By the way, a linchpin of the “minimize your investment costs” argument rests on the contention that the industry does not add value in terms of higher returns. However, “we will deliver higher returns” is the big lie that the financial services industry has been telling in one guise or another forever. The vast body of independent investment research conducted by objective academic analysts is conclusive on this matter.

On average across all investors the costs imposed by the industry far exceed the value delivered and there is no evidence that the financial services industry knows anything about how to deliver superior returns over the long-term. Period. Full stop. The financial services industry cannot identify superior investments beforehand, and neither can amateur investors. Nevertheless, the industry does a fantastic job of fooling the vast body of investors, while it lives perpetually off of their returns.

Average total costs for the average investor are roughly 2% per year. For the average portfolio returning historically 4.22% in real dollar terms, this means that 47% or almost half of the average investor’s gross real dollar returns would be taken by the industry. (2% divided by 4.22% equals 47%).

Perhaps you think that 2% overstates the average total unnecessary and excessive investment fees, costs, and resulting taxes that are effectively charged by the industry. However, the data supports this 2% total cost figure, and many investors pay much more than this.

You can evaluate whether 1%, 2%, or even 3% are realistic estimates of your own experience with industry fees costs and resulting taxes. Consider these investment cost statistics:

    • The average actively managed mutual fund charges about 1.1% in management fees annually. In contrast, low cost index mutual funds cost around 0.1%. That is one whole percentage point of excessive fees paid without any better performance.
    • Active funds have higher turnover, and higher turnover costs about two-thirds of one percent for every 100% of annual portfolio turnover. Active funds spin their wheels, and your net returns spin downward.
    • If you have not yet wised-up to not paying sales loads, then about five cents on a dollar is skimmed off at the beginning to pay your adviser to tell you that the fund is “better.” However, research clearly shows that advisors have no clue about whether a fund will turn out to be superior. If your holding period is 5 years, then amortizing 5% skimmed at the outset will cost you 1% per year.
    • Advisor sales fees do not stop with up-front purchase loads. There are those sneaky little 12b-1 fees of .25% and higher each and every year that many investment funds add. The purpose of these “trailing fees” is to have the advisor keep assuring that you made the correct decision. If, however, performance turns out to be lousy and you complain, that advisor will just sell you another four-star or five-star fund until that one falls behind, as well. (By the way, the “stars” only look backward, and they are completely useless when it comes to identifying funds that will have superior performance in the future.)
    • If you pay a percentage of assets fee to a registered investment advisor or as part of a “wrap fee” or separately managed account, you will usually pay above 1% per year on account balances under one million dollars. Of course, if you pay such fees, you are looking for better results and therefore financial advisors usually will put you into more costly active funds. They hope that the dice turn up in their favor. This game keeps going because investors are lousy at benchmarking their returns net of advisor fees and other costs versus what they would have netted with a low cost passive index fund strategy that buys the entire market.
    • If you are using a brokerage accounts to buy and sell positions, those repeated “only $10” transactions fees will mount up over time. Most investors fail to appreciate the impact these repeated fees have over time. Furthermore, they fail to understand the cost of market orders that consistently give away most of the bid-ask spread to the industry.
    • All this activity leads to higher taxes. The more active a portfolio, the more likely that these transactions will be short-term capital gains, which will get taxed at your current total federal and state marginal income tax rate for ordinary income.
    • Concerning investment fees for cash assets, when your bank account does not pay interest, then obviously you no return and you cannot even try to keep up with inflation. If you are paid interest but it does not cover inflation, then you are still losing. Note that even is better times before the financial crisis, the average money market mutual fund charged management fees that were greater that .5% and some charged management fees above 1%. So even if your returns were close to covering inflation, these money management fees would have wiped out any real dollar gain, given that the long-term historical real dollar return to cash was only .46% annually. (Note that if you read the fine print of money market mutual funds, you will see that over 90% of them have been waiving most of their management fees in the current low interest rate environment, so that they will not be embarrassed by a negative return on cash measured in inflationary dollars, when real dollar returns have been about minus 2%.

This is an incomplete list of excessive and unnecessary fees, costs, and taxes. Wherever you look concerning financial industry products and services (with only a few exceptions), you will find a myriad of fees and costs that shave off some of your returns without any realistic expectation of improving your gross performance.

So what do you think? Have you for years been paying 1%, 2%, or even 3% or higher in unnecessary and avoidable investment fees, costs, and taxes? If so, you have been letting the financial services industry hollow out your portfolio. Sure, you might still have a net gain, but you could have a significantly larger portfolio had you slashed your costs long ago.

Nevertheless, it is never to late to start to cut your investment fees. Millions of other investors have woken up from overly-long Rip Van Winkle slumbers regarding investment costs, and they have slashed their costs. The financial services industry emperor has no clothes, and the dot-com crash and later credit crisis and Great Recession have made that abundantly clear to many investors.

As an independent fee-only financial advisor, the author of this article Lawrence Russell, always suggests to his clients that they invest in the lowest cost, most broadly diversified index mutual funds and ETFs. Doing this reduces costs to a bare minimum and significantly improves net investment returns over the long term. Each quarter Larry updates his low cost ETFs and no load mutual fund list ebooks using rational ETF and mutual fund screening criteria that are supported by the research literature. Investors can save a lot of their money by managing their own investment portfolios without the excessively expensive fees of brokers who really have no idea about how to pick the best noload mutual funds or ETFs.

Millennials Like Cash as a Long-Term Investment. Why?

millennials_prefer_cashCash is king, as the saying goes. That’s a concept that can apply to businesses, and to our own lives as well in many cases. Having money in hand offers less risk, on many dimensions, than having promise or hope for money in the future.

Pay me $100 today, or give me a promise to pay $100 next year, and I’ll take the former. To take money in the future instead of today, there needs to be a premium involved. Loaning $100 can perhaps get me $105 next year – well, not if I give it to the bank in the form of a checking account! Maybe peer lending could offer this and then some. There is risk involved, not to mention inflation.

This can apply to investments in other asset classes too, and one that jumps out is stocks. Sure, there is volatility – and if you need the money soon, stocks might not be the best holding spot if that risk bothers you. And stock returns don’t always beat inflation as one might believe, when you examine the data.

However,  stocks still do offer returns better than stuffing money under a mattress.   Over the long-term, you’ll generally do much better by investing in stocks than holding cash – based on historical performance.

Nevertheless, not everyone feels that way. An interesting study by Bankrate, summarized in a recent write-up on Yahoo!, showed that there are quite a few people that prefer cash as a long-term investment. In fact, according the study, nearly 40% of those between 18 to 29 years of age indicated that cash is their top choice for how to invest money that they won’t need for 10 or more years.

This is interesting, as it seems to be a real difference compared to how others might have seen stocks during that same age range. As a Gen-X person myself, I was squarely focused on stocks as they way to invest for the long-term. It’s definitely worked about better than had I kept all the money in cash.

I wonder why there is such a difference with those that are Millennials. Is it student loan debt, a shaky job market, seeing parents go through issues with jobs? Perhaps the recent housing crisis was a big influence. Or, maybe the market volatility of the 2008-2009 timeframe made a big impression.

There could be a number of reasons.

In some ways, I see a positive here. If people are now entering their working years with a more conservative approach to money, maybe that will mean an evolving attitude toward debt? Goodness knows that the U.S national debt isn’t a model for how people should run personal finance.   So conservatism with money can be a good thing.

Nevertheless, cash simply underperforms stocks over the long run. Let’s just take an example of a 30 year time frame, and say that stocks earned 7% annually on average. We’ll assume 0% earnings on cash. Let’s also assume a $100,000 initial investment in each, and ignore inflation just for this exercise.

After those 30 years, that $100,000 investment in stocks (with compounding) would be worth over $760,000. Holding that $100,000 in straight-up cash would clearly leave you without that $660,000 increase. Yes, rate of return is important for financial success.

So as I see it, I can see why people might be getting more cautious with money – but would rather see this applied to debt instead of long-term investment choices.

My Questions for You

What are your thoughts on this interest in cash as a long-term investment?

Do you agree with my focus on stocks and other investments, or do you like cash long-term?

Also, I’ve given some of my reasons as to why I think there might be a flight to cash by Millennials, but I’m interested in what you think – whether or not you’re a Millennial yourself!

Are 401(k) Lump Sum Matches Going to be the Future?

401k Match

Matches have value, but I prefer those of the 401(k) variety!

Most of us appreciate the benefits of 401(k) plans, and like having them as an option for retirement savings.  The tax deferred nature of them is great, and garners a lot of attention.  But the company match can be pretty nice too, and a great benefit!

This is why recent news of a company switching to a lump sum, end-of-year match garnered some attention from a lot of people.  Apparently, per this piece in the Washington Post, this created a bit of a fuss with a lot of people.  Instead of the match occurring with each paycheck, the match occurred only at the end of the year.

So, the match was not taken away.  Rather, it was just distributed at different intervals.  Not so bad, right?

Well, it depends on one’s perspective.  Having a match is better than not having a match.  So in that regard, it may not be as bad as the alternatives.  However, there are a couple of problems with this:

1) Diminished Power of Compounding

On the one hand, the exact amount of money given as a match might be the same whether given with each paycheck or in a lump sum.  If a person makes $100,000 annually, and gets a 3% match, basic math indicates that the match will be $3,000.  The lump sum at the end of the year would be, of course, $3,000.  If there are 12 monthly pay periods, as an example, there would be a $250 contribution each time.

The issue is that the money set aside earlier in the year has time to grow.  For example, lets say that after the 1s pay period, the stock market increased by 20% through the rest of the year.  That original $250 would end up being worth $300.  This concept could apply to many of the other contributions through the year as well.

By giving the match all at once at the end of the year, the compounding effect is taken away.  Thus, money could be lost.  In a year with increasing stock prices, this means lost opportunity.

Now, a lump sum might end up being better in a year where stock prices plummet.  But on average, stocks tend to go up most years.   So paying all at once is generally not a good attribute.

2)  Losing the Match if You Leave the Job

Aside from the aforementioned considerations with timing and frequency of matches, there is the issue of what happens to the match if the person leaves the job.

Now, people don’t usually join and leave companies on an exact calendar basis.  If someone leaves a company before the end of the plan year (whatever that might be), the match could be lost.  So, in the example above, let’s say that someone was with a company for 8 months of a year, then left.  This means that if there are monthly contributions, $2,000 will have been paid out – but zero if it’s a company with an annual lump sum.

Thus, while in many cases a lump sum could be preferable, this is probably not one of those situations.

Fortunately, in the situation described in the article, the company did reverse course with the lump sum decision.  Credit is deserved for the change in policy!

However, I wonder how many companies in general would feel compelled to make a change back.  What is the motivation?  Frankly, it would seem like there could be a fair amount of savings accruing to companies who make and keep a switch to lump sum payouts.  After all, people leaving before year-end would presumably get nothing.

Think about it.  If you’re interviewing for a job, would you truly turn down a really good opportunity based on the 401(k) match being given in a lump sum?  Or, if you’re working for a company that makes that switch, would it compel you to job search and look elsewhere strictly based on that?

It wouldn’t be surprising to see this happen.

To me, this just looks like a situation where there is not that much downside for companies to implement this.  But, there could be savings generated.  If there was a wave of businesses doing this, I don’t think any one situation would stand out and create an uproar.  This seems like low-hanging fruit.

My Questions for You

What would your reaction be if your employer switched the 401(k) match to a lump sum from a per-pay period contribution?

Do you think this might be the wave of the future?

Company Fixed Deposits Are a Reliable Way to Earn More

When one has a surplus to invest, one must take time to search for the best possible return and security. It may be that a parent starts an investment for their child’s education. They want to start deposits so that inflation does not affect their standard of living when they retire.

There are innumerable ways to chose from the saving accounts. One way is to make a Company Fixed deposit. It is considered a confident deposits (which are rather safe) with a variety of companies for a fixed term. Such deposits carry a prescribed rate of interest called ‘Company Fixed Deposit’ and can be made by financial institutions and non-banking finance companies (NBFCs). Mobilised deposits of this kind are governed by the Companies Act under Section 58A. They are not secured in the sense, that if the company defaults, the investor can’t sell the document to recover the capital. As mentioned earlier, they are considered confident deposits, but are not 100% assured.

There trick to ensure a reasonable and secure return is to select one of the more stable and known institutions dealing with company fixed deposits amongst their activities. As such deposits are governed by law, one may assume that a large or top-rated, publicly known company makes such deposit reasonably sure. In specialized institutions like FundsIndia’s deposit section, the staff may guide the depositors to exactly the kind of option they are looking for, be it industrial, construction, or production.

The rate of interest and the frequency of payment are two most frequently asked questions because not all follow the same rules. The interest may vary from 11% pro anno (PA) to 12% pa according to the length of the tenure. The interest payment is generally done quarterly and can be disbursed or added to the existing fund to create a larger deposit over time.

To choose a good company fixed deposit scheme is not easy for a layman, so it would be advisable to consult a competent person before deciding where and how much to invest. Each investment company has their specific rules and it would be careless not to investigate the reliability and profit before actually engaging in such a deposit, although they generally give better rates of return than common bank fixed deposits (FD).

Some companies would allow a substantial deposit to gain appreciation if the depositor allows certain more risky investments, but it is totally up to the investor to decide if he or she is willing to absorb eventual risk.

The amounts initially deposited may be as low as Rs. 50.000 and may go up to Rs. 25.000 for ordinary investment. A few Government investments may exceed Rs. 2 Lakh (as for example in case of the Kerala Transport Development Finance Corporation Limited). Most deposits will be cumulative and span over a period of 12 months to 15 month and some may have 500 days as maximum.

Then there are Public Issue of 100% secured National Credit Deposits (NCD), which carries interest rates up to 12.52% in effective yield. Employees and shareholders of public institutions may furthermore get 0.25%. An additional benefit is, that there is no tax deduction (TDS) on the interest if the deposits are held in a Demat account.

Selling Stocks In a Bull Market: Interesting Historical Lessons

selling stocks in a bull marketMarkets go up, and they also go down.  Kind of like gravity: if you throw an apple into the air, it will eventually come back down.

Except, that’s not exactly how it goes with markets.  Sure, they do go up and down, but the long-term trend is up.  Even when you consider the impact of inflation on stocks, there’s at least some upward trajectory over time.  When you add in the reality that compounding can be a great benefit, that higher rate of return with stocks is understandably a place that’s appealing to many with long-term time horizons.

So stocks tend to go up over the long-term, and offer rates of return that are pretty good compared to lower risk vehicles.  We know that.  But what about when stocks have been going up for a while? In other words, do stocks get a lot more risky in a bull market?

I thought of this because as of this writing, stocks have reached historical highs here in the U.S.  Naturally, there tend to be a fair number of people who start to get squeamish during protracted bull markets.  In other words, they wonder when the floor will drop from underneath them prices will tumble.

There’s that saying that we should be fearful when others are greedy, and be greedy when others are fearful.  I’m no Oracle from Omaha (far from it!), but maybe we should be careful to avoid being too fearful in bull markets.  Perhaps we can hold onto that greed a little bit.

As I do on occasion here, I pulled and analyzed some historical stock data to figure this out.  In this case, I took historical S&P 500 data for just over 63 years – from January 1950 to November 2013.  Based on this available data, I analyzed the annual yearly change in the market price in the context of bull markets.   Here is what I found:

Finding #1: Stocks tend to follow a strong year with another solid year

How do you define “strong year?”  In this case, I defined it as a year with returns of 20% or more.  Since 1950, there have been 17 such full years.  In the year following a strong bull market year, stocks average a nearly 11% rate of return!

So, if you’re in a year that happens to be very good – where there is a bull market – the following year tends to have strong performance too.  Now, these are averages of course, and there were some subsequent years that were awful.  No streak continues forever!  But some were good, and clearly the average of nearly 11% is very solid

Finding #2: Stocks still don’t automatically fall after a strong 2-year period

So, we talked about one year in the previous finding.  What if we expanded it to 2 strong years?  In this case, we’ll define a strong 2-year period as one with a total increase of 35% over that time frame.  There were 13 such 2-year time periods since 1950.

In the year following 2 years of bull-market performance, stocks average a return of just over 4%.  So, after 2 years of well-above average returns, things tend to come back down to earth.  However, it’s not like a return of around 4% is a total disaster.   There are far worse “safe” alternatives, though it should be pointed out that with stocks there is a range of good and bad years in there.

What are the implications of these 2 findings?  I see this as a lesson to be learned, that just because stocks have gone up quite a bit during the course of 1 or 2 years, it doesn’t mean that they’re ready to start crashing.    Of course, going from 1 strong year to 2 strong years collectively can decrease the odds of subsequent strong returns.  However, clearly there is often longer life to bull markets than might occur to the more risk-averse investor.

As I write this, we are in the midst of a situation that basically fits both of these scenarios above:  1) Annual returns > 20% (YTD through mid-November), and 2) a nearly 2-year return > 35%.

Food for thought, as you consider what type of scenarios might happen next.

My Questions for You

Do you get worried that stocks will fall, after a prolonged bull market?

Do you agree that bull markets have a longer life than one might realize?

What are your current thoughts – positive or worried – about the markets might be headed?

Make My Money Work For Me, Treat it as an Employee!

make my money work for meWe all need an employee that will be there for us for many years, through thick and thin.  Even better is an employee that can directly help us make more money, and perhaps someday do all the work for us while we focus on other things!  The ultimate: the employee won’t ever talk to you, and can be monitored at all times.  The last point was for you controlling types :)

That employee is money!  When somebody says “I want my money to work for me”, it sounds like they’re at least on the right rack with intent.  We can work hard all our lives, and save money without thinking of it as anything more than just that: savings.  It’s a simple approach, but one that can really be costing us.  Stuffing cash under the mattress is still saving, but if it’s not compounding then it’s losing purchasing value in the absence of deflation.

Maybe one way to look at it is that you’re the CEO, and you can’t accomplish your goals by yourself.  You need help, and you need the right mix of employees to help you get where you need to be with your business.  Then, your business can reach its goals and you can bask in the glory of that success!

But first, you need to assemble that team of employees.    In the case of personal finance, those “employees” are like investments and asset classes.  Here are some things to consider:

  • Don’t hire employees who all have the same skills and background.   No business would do that, right?  Just as a business needs some diversity in experiences, you’ll need to diversify your portfolio.  In other words, using this analogy with your money, don’t pull all your eggs in one basket.  Rather, practice effective asset allocation.
  • Look at their work history.  Just as a CEO would take a close look at a potential key new hire’s background in order to gauge potential future success, you need to look at the resume of your financial “employee”  For example, if you’re looking at making an investment, analyze it to see if it’s a good fit for your portfolio. In other words, do your homework when making investment choices.
  • Hire for the right business cycle.  If a business is in growth mode, it can pay to take on some higher risk employees who might be fresh, full of energy and new ideas.  If a business is more mature, not in all out growth mode, and has stockholders or Wall Street to placate, it might get more conservative with its hires.  In other words, translating this to your investments, take more risks when starting out, and fewer risks when closer to retirement.

You get the analogy here.  Just like a business leader assembles the right talent to reach success while managing risks, each can do the same with our money by managing it in a way that entails investing wisely.

Ultimately, the more we put money to work for us and the more effective we are at getting it to work hard, the less we have to work going forward.  If a person had $100k earning 5%, that’s $5k per year.  If that same person had $1 million earning 8%, that’s $80k per year and much less pressure on us.  Which is great, because money is an employee that doesn’t feel pressure :)

Do you ever think about how hard your money is really working for you?

3 Important Financial Numbers for Building Wealth

Important financial numbers for wealth“Math class is tough!”

That’s not me talking.  That’s an infamous quote from a Barbie doll that was offered for sale to the public years ago.  Understandably, that line did not go over well with a lot of people.  We can all be glad that such toys aren’t offered for sale these days, and being a parent with a daughter who excels in math, you can certainly count me in that group!

Hopefully nobody out there is taking a page out of that playbook, and thinking that “personal finance math is tough!”   If they are, they should stop.  It’s not tough.

Yeah, there’s no doubt that math can play a huge role in finance.  This can even extend to personal finance, and it can actually be quite easy.  Big picture, it’s really matter of making more money than you spend, and taking the savings and investing it wisely to build up net worth.

As I think about it, there are actually 3 numbers we can focus on to help us go a long way toward financial success.  Here they are, 3 financial numbers that can help us build wealth:

Number of Years of Saving Money

Most of us have probably seen those examples of how much better off a person can be by starting to save for retirement when really young, compared to waiting a decade.   It can be quite startling.

Let’s say Joe saves $10,000 one year, and then holds it until retirement 20 years later.  Let’s also assume he invests it and earns 8% per year, and this amount compounds over time.  Joe would see his initial investment grow to nearly $47,000 (not inflation-adjusted) by retirement.

Now, let’s suppose his much younger sister Jane saves $10,000 that same year, and holds it until her retirement 30 years later.  All else equal, this amount will grow to over $100,000 by retirement.

So, the time to retirement was just 50% more, but the resulting dollar total was over 100% more.  Clearly, time has value!

Keeping it simple, the more years we have to save and invest, the more financially successful we’ll be.

Rate of Return on Investments

Going back to Jane, suppose she earned 10% on that $10,000 compounded over 30 years, instead of 8% as illustrated in the example above.  In this case, it would result in an amount of nearly $175,000 by retirement with the increased rate of return.

A 25% increase in the percentage points of return (8% to 10%) yields a nearly 75% increase in overall dollar total during the same time period.  Obviously, rate of return makes a big difference!

Keeping it simple, the higher our percentage rate of return on investments, the more financially successful we’ll be.

Percent of Income Saved

Let’s revisit our friend Jane again.  Let’s now suppose that she saved more than $10,000 that year which happened to be 20% of her $50,000 income.  Instead, let’s assume she saved 24% of her income – which would be $12,000.  Over the same 30 year period, that investment would grow to over $120,000.

Basically, that incremental $2,000 in that one year resulted in about $20,000 more at the end of that time period.  Seems like a pretty good return!

Keeping it simple, the higher the percent of income we save, the more financially successful we’ll be.

Bottom line:  sure there are many numbers and metrics we could analyze regarding money, but if we focus on simply increasing these 3 basic numbers, we’ll be going a long way toward putting ourselves in a position to succeed!

My Questions for You

What do you think about these 3 numbers as levers we could pull to grow our net worth?

Which of these are you focusing on to improve your financial picture?

Any other suggestions on simple numbers or metrics we can focus on?


International Diversification with Stocks

When it comes to one’s portfolio, it’s generally important to avoid putting all of your eggs in one basket.  At least, that’s conventional wisdom that’s dispensed to most people.

Frankly, I find it hard to disagree with that conventional wisdom.  For example, keeping one’s entire savings in cash is usually not considered to be smart.  At least, not for someone with many years to retirement.  The rate of return of investments matters, and you’re not likely to get much by keeping money in cash or cash equivalent.  I’m not picking on the obvious asset class here; the notion of not putting everything in one basket can apply elsewhere too :)

So, we keep our funds in different asset classes.  Cash, bonds, real estate, stocks….you get the idea.  With respect to the latter, there can be significant diversification opportunities as well.  We can invest in individual stocks, ETFs, maybe funds.   In terms of companies, we can invest in small companies, mid-size, or large blue chippers.

There is also the opportunity to find investment opportunities in different countries as well.  Sometimes, it might entail buying shares in a multi-national company traded on a specific exchange but doing business in many different markets.  There is some inherent diversification in such companies, as they are managing risk by doing business in different markets.

Other times, there are simply companies that do business in specific markets and are traded on those company’s markets.  It’s possible to buy shares of companies on a variety of different exchanges.  For example, one could purchases shares trades on the NYSE in the U.S. Others following the Australian market might be focused on asx share prices.  Or, perhaps people might buy shares of companies traded on the NIKKEI, which is Japan’s stock exchange.  Whatever the case, stocks are traded on many exchanges globally, and this presents quite a few opportunities for investors to diversify.

That being said, how many people actually look to diversify internationally?  I’ve shared a story about how I attended a going away part for someone retiring years ago, of a full generation older than me.  He enthusiastically encouraged everyone to put their investments fully into the company’s stock!  I couldn’t believe how everyone applauded him for that, when clearly he was making such a ridiculous suggestion.  Sure, it may have worked for him but it was a very risky move that could have really damaged his retirement plans if it was a different company in different market conditions.

So, given that “approach” to diversification, I wonder how many people really focus on international stocks at all.  Investing everything in one’s home country might offer a lot of diversification, but in a global economy could it be somewhat analogous to that guy who put everything in one company’s stock?

Frankly, I don’t focus nearly enough on stocks outside of my own home country.  I’ve talked about it and written about it, but checking my own portfolio, it’s extremely domestic in focus.  Not exclusively, but perhaps too much so now. Maybe it’s time to revisit this?  After all, investment opportunities are in many corners of the world.

My Questions for You

Do you diversify your investments internationally, or do you primarily focus on domestic investments?

If you don’t diversify internationally, what’s your rationale?