I’m New Here

Our summer intern turned part-time associate Dan McKenna wrote a great piece about his experience being new to the biz that I thought was worth sharing.

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I’m new here.  

The best word I can think of for explaining the experience of being a freshly-graduated analyst entering this market is… baffling.  Every week I read the news that markets are hitting new all time highs, that we have shaken off the effects of the global financial crisis and that excellent Q2 earnings reports are the catalyst that will push stocks higher.  There is almost a weekly reminder that markets do not die from old age.  Yesterday, the Dow climbed back above 22000 as investor fears retreated.

On the other hand, every week I also read articles from investors screaming that the end is near, markets cannot possibly keep up with their current pace, P/E ratios are outlandish and we need to be paring back risk.  For example, a month ago, the co-founder and chief executive officer of DoubleLine Capital LP, Jeffrey Gundlach, said that risky assets are overvalued and that investors should be “moving toward the exits.”  Since then, markets have pushed even higher.

No wonder the average client is looking to their advisor with a look of complete confusion and truthfully, a fair amount of fear.  In times like these, the words of my graduate-school mentor (one of the most brilliant finance professionals I know) often ring in my ears.  He always reminded me of a piece of wisdom I want to share with you:

Nobody knows anything in this field.

By that he means… nobody knows for certain what is going to happen.  If we truly did know the future, we’d never have to work again.  We could all leverage up, pick the winners, and make so much money our eyes would glaze over.  But we don’t know the future.  That’s why we spend so much time crafting diversified portfolios and picking the right amount of risk for each individual’s unique tolerance.  Face it: you’re probably not going to achieve your daydream of being the protagonist of The Big Short who calls the financial crisis before it happens.

We have to understand that the difference of opinion is what makes a market exist.  Don’t forget that there is an incremental seller for each and every buyer in the market.  Right when you’re convinced to buy a security, someone else is convinced to sell.  That is just how it works.  

The simplest thing to do is to remain calm and stick to your plan.  At Sherman Wealth Management, we use broad-based financial planning that is designed around your unique risk tolerance and your goals.  Unless it directly affects your financial plan, ignore the noise in the markets and that nagging voice in the back of your mind that screams sell every time you read a negative piece of news.  

I might be new here, but I can predict the future just as well as the next guy.  

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

The Problem with “Buy Low, Sell High” Advice

Buy Low Sell High

Of the many common sayings in the finance industry, the most popular is undoubtedly “buy low and sell high.” While it sounds simple enough, it’s actually significantly more complex than it seems.

Not Following the Herd

Buying low comes from an investment philosophy known as value investing. The basic concept of value investing is to buy investment instruments when they are “on sale.” That means buying when everyone else is selling (and prices are down) and vice versa. A bargain-hunting value investor looks for what they consider to be healthy companies that are – for whatever reason – severely undervalued. A smart value investor buys low, then patiently waits for the “herd” to catch up. Unfortunately, most investors tend to do the exact opposite. We tend to chase trends and follow the herd. (For more, see: Don’t Let Emotions Hinder Your Investing Goals.)

Sounds Easy. So Why is it Hard?

A huge part of smart investing is psychological and this chart illustrates of one of the many psychological roadblocks we have as investors.

We may want to buy low and sell high, but that goes against our instincts and biases. When a stock is falling, we dump it. When a stock is rising, we buy it. We sell a company when the price is falling because we are afraid of losing more money; we buy a stock when it is rising because we have a fear of missing out. To compound the problem, most investors are not experts at realizing when something high or low “enough.”

At times, investing can feel like quicksand: the more you do and the harder you try, the more you sink. It requires effort to overcome the psychological biases that often prevent us from acting in our own best interest. It is human nature, for instance, to continue to make the same mistake over and over again, or to not let go of stocks when we should through either familiarity bias or disposition effect.

Goals and Risk Tolerance

So what can you do to avoid to avoid the pitfalls of trying to buy low and sell high?

  1. Understand your goals and risk tolerance: before you get started investing, it is critically important to understand what it is you are trying to accomplish and how much risk you are comfortable taking. Once you have that figured out, you can create an investment plan that is appropriate for you and comfortable enough to keep you from impulse buying high and panic selling low.
  2. Avoid market timing: instead of trying to time investments perfectly and squeeze every last cent out of each one, focus on building a diversified portfolio of stocks and bonds that give you the greatest chance to succeed over the long term.
  3. Leverage your resources: having a great financial plan and a diversified portfolio is irrelevant if you don’t follow through and stick to it. Becoming self-aware of the pitfalls is a great first step. Having a good financial advisor is a good step too. Just make sure that they are a fee-only fiduciary, so that they have your best interests in mind at all times.

Think about it: if it were easy – if everyone bought low and sold high – there would be no high or low because the market prices would be continually correcting. Bargains do exist and sometimes the wisest choice is to lock in earnings. The safest financial plan for the long run, however, is to understand your goals and risk tolerance, then work to create an investment plan that builds on gains over the long term, rather than continually outguess the market.

(For more, see: Which Investor Personality Best Describes You?)

This article was originally published on Investopedia.com

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions, please Contact Us.

Why Playing It Safe Could Hurt Your Retirement

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A new survey from Bankrate indicates that many Americans hold quite a low view of the stock market. In answering what was the best way to invest money unneeded for at least 10 years, real estate (25%) and cash (23%) took the top spots, followed by the stock market and gold (16% each) in a tie for third. This comes on the heels of Bank of America finding that cash levels in portfolios are at their highest since November 2001.

In a time of volatility in the market, many Americans, particularly those who are young and/or without a huge amount of money to invest, are hesitant. They prefer the certainty of a house or even cash under the mattress to the unpredictability and seeming inaccessibility of the public markets. On the surface, this seems like the safer option, and we understand why many people feel this way. Loss aversion is countered by having a tangible stack of cash that will always be there.

Unfortunately, it’s wrong and can be dangerous in the long term.

What many cash-focused savers don’t realize is that because of inflation, the value of cash fluctuates over time—just like a stock. As Alex Gurevich, CIO of HonTE Investments, points out, that means that cash is subject to bubbles similar to tech in 2000 or the mortgage crisis. Moreover, saving only cash eliminates access to the market’s long-term returns; $10,000 invested in the S&P 500 in 1980 would yield $166,600 at year-end 2015, adjusted for inflation. Even with the ups and downs, in the long run the stock market remains the best place to invest for retirement. (For related reading, see: Why Investors Can Be Their Own Worst Enemy)

Saving cash is still important for short-term emergency funds. But if simply stockpiling cash is your long-term plan for retirement, you probably have no shot unless you’re very wealthy.

Many people may avoid the stock market out of a fear of the bad days when the market tumbles. Some people panic when the market dips (for example, in the event of a major world event like Brexit) and sell most or even all of their stock. Besides the fallacy of panic-selling at play here (you’d be selling low rather than buying low and selling high), by withdrawing from the stock market you miss out on the good days as the price of shielding yourself from the bad. Reporter Spencer Jakab points out in the Wall Street Journal that a couple good days a year produce the entire year’s returns, on average. (For related reading, see: Behavioral Finance: 8 Common Investor Biases That Impact Investment Decisions)

“Investors sit out on some really good days by trying to avoid bad ones,” Jakab writes. “Nearly all of those happen around scary episodes such as October 1929, October 1987 and in 2008 following the collapse of Lehman Brothers. Pretend, for example, that you took your money out of the market following the choppiest episodes over the last 20 years and wound up missing the epic rebounds that made up the 40 best days. You actually would lose money.”

The stock market can be threatening and, sometimes, punishing. But the solution isn’t total withdrawal; on the contrary, find an advisor you trust and create a plan that makes you more comfortable about investing. As Ben Carlson writes, “The alternative for stepping out into the unknown is the known of never building your wealth.”

This article was originally published on Investopedia.com

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Don’t Expect to Win With Actively Managed Funds

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This article was originally published on NerdWallet.com

Trying to pick individual stocks is a losing game, and this doesn’t just apply to individual investors. It’s also true for professionally run, actively managed mutual funds.

Actively managed funds are tasked with picking a collection of stocks and bonds that will outperform market indices, or benchmarks, such as the S&P 500 or the Dow. They’re armed with Ph.D. analysts, hundreds of interns, and tools and research to which very few of us have access — but they can’t consistently beat their benchmarks by enough to justify their costs.

Long-term underperformance

Eighty-six percent of actively managed funds failed to beat their benchmarks in 2014, according to the S&P Dow Jones Indices scorecard. “So what?” you may say, “That’s only one year.” But 89% of funds failed to beat their benchmarks during the past five years; 82% failed to do so during the last decade.

The following data help illustrate how unlikely it is for active managers to beat the market over longer periods. During a one-year period, a high percentage of active managers in some categories may outperform their benchmarks. But over five- and 10-year periods, fewer active managers outperform.

Percentage of Actively Managed Funds That Outperform Benchmarks

1 YEAR 5 YEARS 10 YEARS
Source: 2015 Morningstar data
Large-cap value 36.5 19.6 33.7
Large-cap core 28.7 16.7 16.6
Large-cap growth 49.3 11.9 12.2
Mid-cap value 53.5 22.7 42.3
Mid-cap core 42.1 27.7 11.0
Mid-cap growth 41.6 26.0 32.4
Small-cap value 66.7 38.0 38.3
Small-cap core 44.7 32.8 23.1
Small-cap growth 22.2 20.5 23.1

Some managers do outperform the market, but picking a winning manager is as tricky as picking winning stocks. If you still think you can find “a good manager” who is the exception, consider this widely accepted Wall Street rule of thumb: Past performance doesn’t guarantee future performance. A manager who outperformed last year may not do it again this year.

Reasons for underperformance

There are a few main reasons actively managed funds underperform, aside from picking the wrong investments:

FEES

Many actively managed funds charge 1% to 2% per year in management fees, while a passively managed exchange-traded fund could charge as little as 0.1% to 0.2% per year. And many actively managed mutual funds are loaded funds, which means you’ll pay a sales charge, typically between 4% to 8% of your investment, when you buy or sell the fund — though the fee may decrease the longer you stay invested. Compounded over time, these higher fees can eat up a lot of gain, reducing overall returns.

TAXES

Because actively managed funds try to time the market and pick winners, they buy and sell positions frequently. These transaction costs reduce the fund’s returns, and all the buying and selling can also create taxable gain. Fund managers have no incentive to avoid this because they simply pass those taxable gains on to you, the shareholder.

MARKET EFFICIENCY

Some argue that markets are becoming more efficient, making it difficult to identify overvalued or undervalued stocks. The efficient market hypothesis states that stocks are constantly adjusting to news and information, and thus their share prices reflect their “fair value.” In simpler language, other than in the very short term, there are no undervalued stocks to buy or inflated stocks to sell. This makes it virtually impossible to outperform the market through individual stock selection and market timing.

An unsustainable approach

Whether active management can outperform is a controversial topic. Many experts dismiss the science and say that they can indeed beat the market. Some of them may even do so for a year or two, or even five, but what about over the long run? It’s simply not sustainable, and to think otherwise is dangerous.

If the data shows that the vast majority of the brightest and most well-equipped professional investors can’t beat their benchmarks, why should you believe anyone who says they can?

This story also appears on Nasdaq.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

How Diversified is your Diversification?

Eggs

In November yet another firm fell victim to the growing Valeant fallout as Tiger Ratan Capital Fund LP fell 33% over the past three months, wiping out gains for 2015.

Those losses stemmed from the fact that Valeant accounted for 20% of TRC’s U.S. holdings. But they weren’t alone. Many well-respected funds, including the mighty Sequoia Fund, and hedge fund manager Bill Ackman’s Pershing Capital also had extensive exposure to long time Wall Street darling Valeant and suffered losses not only of value – but of face as well.

The dramatic losses came as quite a shock to many of the investors who own these – and other affected – funds, and who assumed that the funds were diversified – when in fact they weren’t. By going out on a limb and investing too much of their allocation in what has been one of Wall Street’s hottest stocks for years, many respected “hedge” funds experienced huge capital losses that it will take years to recover from.

In fact, of the 1,000 hedge funds tracked by Symmetric.IO, approximately 12% had a position in Valeant. A startling 32% of Valeant’s shares were held by hedge funds.

When Diversification isn’t Diversification

Having 20% of your portfolio in one stock is a huge risk for anyone. You never know when the next Enron or Worldcom may be and, because of accusations of unorthodox practices, it may very well be Valeant.

On the other hand, Valeant could still turn out to be a home run and deliver big time. No one really knows, which is why diversification is so key.

Many investors diversify with ETFs and mutual funds. But how many investors are absolutely certain that the mutual funds they are counting on to provide diversification, are, in fact, properly diversified themselves?

When that Hot Stock is Too Much of a Good Thing

When a “hot stock” or fund keeps climbing, it’s tempting to want to jump on the bandwagon, and the same is true for a hot sector. That’s no doubt why so many otherwise experienced fund managers over-exposed themselves to Valeant and to the health sector in general.

But while a portfolio with correlated assets that tend to do well together, is also a portfolio with assets that can tend to do poorly together when the winds shift. As Ben Carlson put it in a recent blog post: “Diversification requires finding the right balance between eliminating unsystematic risk (risk that’s specific to single securities or industries) and di-worsification by adding too many overlapping funds.”

Put another way: it’s not enough to put your eggs in different baskets, the eggs themselves need to be diversified, some plain, some speckled, and the speckled ones should be speckled in different ways.

A properly diversified mutual fund or ETF allow you to invest in a sector or a “hot stock” while mitigating risk. Which is no doubt what the investors who held Tiger, Pershing, and Sequoia thought they were doing.

The Moral of the Story

Due diligence. While you and your financial advisor are most likely diversifying your holdings, make sure that your holdings are also diversifying their holdings. Review your mutual funds frequently to make sure that their strategies, risk tolerance, and diversification standards align with yours and that they are not over-weighted chasing impressive returns from a couple of current wall street darlings.

The jury is still out on Valeant and on the funds that held it. It may in fact recover, although it would have to recover quickly to make up for the loss of momentum for the funds and investors that held it.

Nonetheless, it’s an important lesson for individual investors. A truly diversified portfolio is made up of truly diversified assets.

 

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This analysis is provided for informational purposes only and is not to be considered investment advice. The securities mentioned herein are for illustration of the concepts discussed and are not a recommendation to buy or sell any security. Please see additional disclosures.

Donald Trump and the Benefit of Financial Foresight

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Donald Trump’s current net worth – as he would be the first to tell you – is estimated to be between $2 and $4 billion, most of which he made through inheritance and real estate investments, along with other business dealings. An article in National Journal recently took a look at what might have happened if he had invested in an S&P 500 index fund back in 1982 when his inherited real estate fortune was estimated to be worth “only” $200 million.  According to National Journal’s calculations, if he’d invested carefully in index funds, Trump’s net worth would be a whopping $8 billion today.

Does this mean Donald Trump is a bad investor? Not necessarily: the oldest lesson on Wall Street is that everything is easy in hindsight.

While highly speculative, those numbers do highlight the ongoing debate over which is a better investment – real estate instruments or stocks. Both stocks have and the real estate market have had great runs in recent history and, depending on when you invested, you could make cases for both investments being the better choice.

But the stock market and the real estate market both experience volatility, dips, and extended recovery times so, for the average investor, a portfolio composed of mainly real estate or other fixed assets (like art or collectibles, for instance) poses some risks that should be hedged with proper cash flow planning, a diversified portfolio, and proper tax planning.

Cash Flow Planning

A good financial plan takes into account how much cash you need access to, or may need access to in the future. Cash flow planning should be a key factor in deciding whether real estate investments are part your individualized financial strategy.

As National Journal points out, Trump claims he is willing to spend upwards of $1 billion of his own money to fund his presidential campaign, yet his financial disclosure statements show that he may have less than $200 million in cash, stocks, and bonds. The rest of his fortune is tied up in real estate investments, which could be much harder to liquidate and use for his campaign.

Most of us aren’t running for president but, if something like the 2007 housing collapse were to happen again, any investor who is predominantly invested in real estate could have problems liquidating those – diminished – assets for retirement, college funding, or other non-presidential goals.

A solution: diversification.

Diversification

Whether you are investing in real estate or the stock market, diversification is always a prudent way to address your own risk tolerance and use proper foresight in creating a winning strategy.

While with real estate funds, diversification can be achieved via many factors, including residential vs commercial investments, differing location focuses, and differing interest rates and financing mechanisms, it is still fundamentally one sector, subject to sentiment and swings.

With the stock market, on the other hand, diversification allows you the opportunity to invest not only in different asset classes, such as stocks, bonds, and money market funds, but in a variety of sectors and industries as well. Over the past 60 years, historically, the stock market has averaged an 8% annual return, so investors with strategically balanced and diversified portfolios, there is the opportunity for steady, while not spectacular gains, with the potential for less risk than investing only in the real estate market.

An investor who is properly diversified through multiple asset classes – including real estate if it makes sense for their own customized strategy – is potentially better protected against the short term results of one asset class experiencing a crash or a prolonged dip.

Taxes

Another thing to consider is that options for investing in real estate in IRAs and other tax-deferred accounts are complicated and not every custodian will allow you to include real estate investments in a tax-deferred account.

Hindsight vs Foresight

While Donald Trump is an outlier because his high net worth shelters him from some of the issues with primarily being invested in real estate, it’s intriguing to consider “what if.”

In the case of a more typical investor, a little foresight can go a long way in making sure you are on your way to achieving your own financial goals. A sound financial plan should be tailored to individual goals and cash flow needs, with a customized cash flow plan, and diversified across multiple asset classes for the potential for steady and compounded growth over time.

Whether you are a Donald Trump with a large inheritance or a young professional just getting started, a solid plan and strategy puts the benefit of hindsight where it belongs: in a conversation over coffee or cocktails, and not as the basis for a winning investment strategy.

My Response To a Millennial’s Open Letter To CNBC

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After the markets took an incredibly volatile ride on August 24th, zerohedge.com published this letter to CNBC from a millennial named Ryan, who wrote:

“I’ve dipped my toes in the stock market this past year but after today’s action, I have to say I’m done. Forever. Gone. Don’t count on another dime of mine in the market.”

Ryan isn’t alone. A surprising 74% of Millennials surveyed said they do not own stocks. And that’s unfortunate for Ryan and his fellow GenY-ers.

Ryan’s letter is worth a read – and he’s makes a couple of good points – but he’s also misses a very important point: none of this should really matter to a Millennial.

Here’s why.

“I’m sure countless little guys had their stocks absolutely steamrolled this morning only to see the big guys scoop up the shares on a discount.”  

There is obviously a wide range of ways to experience the market: as a small investor, as a large investor, and as a robot.  Are other people going to do better than you sometimes? Sure. They’re also going to do better than you at sudoko, finding parking spaces, and – unfortunately in my case – Fantasy Football as well. But that shouldn’t matter to you, and shouldn’t keep you from investing in your own financial independence.

The stock market is volatile and, sure, some investors may make impressive bets while others experience much too impressive losses (all investing involves risk, including the risk of the loss of principal.) But, historically, the S&P 500 averaged a 7-8% return (after inflation)* each year and that’s value you’re missing out on if you’re not invested.

 “The only “people” who can react to those pricing distortions in real time are computers. This isn’t a place for small time people like me.”

Nothing beats human guidance and judgment to prevent panic selling or override a previous decision when a drop in a price is anomalous and not due to a fundamental loss in value. Having a plan and sticking to it is usually the best approach and there are great Financial Advisors ready to help you or sharing their insight on the web.

“The only reasonable thing that any little guy can do is sit back and say, “Wow there is a lot of distortion going on and I can’t even guess at these prices.”

Investing shouldn’t be guesswork and doesn’t have to be. A good financial advisor – or your own research – can help you select a diversified group of financial instruments tailored to your own financial goals and risk tolerance. With that in place, along with a well-thought-out plan for steady saving and investing, market price fluctuations should not disrupt your plan. If you’ve got a solid financial plan, investing in the stock market does not affect your ability to pay your rent, take care of yourself or your family, or add to that rainy day emergency fund.

I hope you reconsider, Ryan.

As Millennials, we’re in it for the long haul, we have years of disciplined savings ahead of us with interest that will continue to compound if we avoid reacting emotionally to the markets.

Once the uneasiness of August 24th has worn off (and much of that day’s paper losses have already been recovered,) I hope you and the millions of Millennials who are not yet investing, take advantage of the opportunity to invest while you are young, to maximize your options for reaching your own financial goals, whatever they may be.

 

LFS-1307532-092215 

*http://www.investopedia.com/ask/answers/042415/what-average-annual-return-sp-500.asp

3 Winning Strategies Investing and Fantasy Football Share

Fantasy Football Goal

As the NFL season begins, millions of fantasy football fans are busy researching and drafting their teams. And this season, as in previous ones, fans will be wondering why some fantasy team managers just seem to have a knack for finding those sleepers and high upside players, while other managers routinely fail to understand and predict player value.

Investors often wonder the same thing: why do some investors consistently get it right and prosper, while others are lucky if they even break even?

Coincidence? Maybe, but there are several important things successful fantasy football managers have in common with successful real-life investors.

Here are three important mindsets that can help you go the whole 9 yards, whether it’s on the virtual gridiron or with your own financial plan.

Research the Players

A good fantasy football manager knows that you need to study all the different variables – including roster positions, draft picks, and expected performance – to build a winning team. Understanding the available options is critical to determining things like how many players you need at each position and which players you think will be the best.

This same principal applies to investing. A smart investor or financial advisor starts by understanding all the different variables, such as capital, types of investments, and asset classes. Understanding the pros and cons of various investment strategies is critical in determining how to choose a strategy that is the appropriate option for your own goals and needs.

Never count on a couple of stars to carry the team

When drafting your fantasy team, you always want to diversify your risk. You might not want to draft multiple offense players from the Green Bay Packers, for instance, even if that team is loaded with talent, because, if Aaron Rodgers and company have a bad week, your fantasy team will be struggling too. Smart fantasy managers build a stable foundation and don’t just count on rising stars.

When building your investment portfolio, risk diversification is critical as well. Wall Street is littered with stories of investors who put all their eggs in one “sure” basket, only to learn the lesson of diversification the hard way. Even if you’re extremely confident that a certain sector is a good bet, it’s usually better to diversify and limit your amount of exposure to individual sectors. That way, even if the sector doesn’t do as well as you had anticipated, your investments are distributed across other asset classes, and your risk should be better managed.

When the going gets tough, the tough stay disciplined

Anyone who has played fantasy football knows the danger of making a snap waiver wire decision you’ll regret later. On one hand, you don’t want to panic and drop your star player after a rough few weeks, only to see him rebound to a MVP-caliber season (and on someone else’s team!) On the other hand, just because an unproven player has a great week doesn’t mean he’s more valuable than the player you’d have to drop in order to acquire him.

When the market hits a volatile patch, it takes a disciplined investor to trust their plan and avoid making snap decisions about buying and selling. A look at the history of the stock market makes it abundantly clear that investors who take a long term view do better than those who shift their investment strategies with every changing wind. This doesn’t mean that any plan should be viewed as foolproof; a good investor or financial advisor knows the value of reassessing and recalibrating appropriately and strategically. What it does mean is that, when the going gets tough, a prudent investor takes the long view, stays disciplined, and sticks to a strategy.

It’s a long season

The only NFL team in history to have an undefeated season is the Miami Dolphins who finished 17-0 in the shorter 1972 season. No NFL team has gone 19-0 to date so it’s highly unlikely that any fantasy team will achieve perfection either. But that doesn’t mean you can’t have a great season and get smarter and smarter about putting together a winning team.

With investing too, there will always be ups and downs, touchdowns and penalties, fumbles and conversions, and a few Hail Mary’s. But with a solid game plan and clearly defined goal, you’ll be on your way to a putting together a strategy designed to stand the test of time and put you squarely where you want to be: heading toward your own end zone with your eye on the ball and your own goals in sight.

 

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Straight Talk about Volatility and Compound Interest – the Snowball Effect

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Compound interest is, simply put, the interest you earn on the sum of both your initial investment and the interest that investment has already earned.

Why is it important? Because your two potential advantages when it comes to maximizing potential earnings over time are:

  • The power of compound interest
  • Investing regularly through market highs and lows

Let’s break this dynamic duo down:

 

The Power of Compounding

 

Compound interest is often compared to a snowball. If a 2-inch snowball starts rolling, it picks up more snow, enough to cover its tiny circumference. As it keeps rolling, its surface grows, so it picks up more snow with each revolution.

If you invest $1000 in a fund that pays 8% annual interest compounded yearly, in 10 years you’ll have $2158.93, in 20 years that will be $4660.96, in 30 years it will be $10,062.66, and in 40 years it will be $21,724.52. All it takes is patience to turn $1000 – the price of one ski weekend – into $21,724.52.

That’s why it’s so important to start saving early.

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The above chart is hypothetical and assumes an 8% rate of return compounded annually. It is for illustrative purposes only and is not indicative of the performance of any specific investment.   Investment return and principal values will fluctuate so that your investment when redeemed may be worth more or less than its original cost. Rates of return do not include fees and charges, which are inherent to other investment products. Past performance is no guarantee of future results.

 

Volatility – Market Highs and Lows

 

But what happens if the market dips and your investment loses value?

Volatility – when market value fluctuates up and down – can be an opportunity for disciplined savers who contribute regularly to their investments, regardless of share price. When prices are low, you’re able to buy more shares. When prices are high you’re able to buy fewer shares for the same amount but those shares earn more interest, which is called Dollar Cost Averaging (Dollar cost averaging does not protect against a loss in declining markets. Since such a plan involves continuous investments in securities regardless of the fluctuating price levels, the investor should consider his or her financial ability to continue such purchases through period of low price levels.)

Imagine that snowball again, rolling down a hill, acquiring more and more snow as it goes. What happens when it hits a bare patch with no snow? Often it picks up rocks and pebbles, which add even more surface volume. So, when it hits the snow again, it picks up even more because it’s larger.

That’s how compound interest, coupled with regular investments, may work too: the “rough patches” produce more volume, which then allows you to acquire more compounded interest. So if you buy more shares during a dip, when the market recovers you could hypothetically not only earn compound interest on more shares, you earn more interest. So long as the price of your particular investment recovers, of course.

As Josh Brown points out in his recent blog post about Warren Buffett and David Tepper, both these legendary investors have gotten to where they are today because they’ve successfully ridden out volatility. In 1998 Warren Buffets own Berkshire Hathaway’s “A” shares had dropped in price from approximately $80,000 to $59,000 but Buffet didn’t sell. Those shares just hit a high of $229,000 this year.

If you see volatility – like what we experienced in August – as a tool and keep contributing regularly to your investments, you’ll potentially maximize the effect of compounded interest and watch your investments snowball over time!

 

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Additional Reading:

http://awealthofcommonsense.com/did-investors-just-experience-the-best-risk-adjusted-returns-ever/

http://www.bls.gov/data/inflation_calculator.htm

http://www.moneychimp.com/features/market_cagr.htm

http://investor.gov/tools/calculators/compound-interest-calculator

Millennials – Time to Wake Up and Smell the Stock Market

Smell the Stock Market

On Monday, as things were heating up a bit, Cullen Roche tweeted “The stock market is the only market where things go on sale and all the customers run out of the store…”

The problem is, many Millennials weren’t even in the store.

Only 26 percent of people under age 30 own stocks, according to a CNBC story that same day. That means that, while not panicking, most Millennials may have been missing one of the biggest potential opportunities of the past 10 years.

Why Aren’t Millennials Investing?

There are many theories –from Millennials being shell-shocked by experiencing their families’ anxiety in 2008, to YOLO, the feeling that it’s better to spend and enjoy the money now because who knows what the future may bring. The problem is that the future is likely to bring a whole lot fewer opportunities if you haven’t planned properly!

Are You Even Beating Inflation?

Let’s say hypothetically that the stock market may rebound by 5%… Simple, common sense math shows that keeping your money in the bank at .05% interest means it would take you 100 years to make the same amount of money that investing it now could. And the cash you are saving under the mattress or in one of your vintage vinyl sleeves? That money is just losing value every second you leave it there, as the cost of blankets and concert tickets continues to climb with inflation.

Risk, Volatility, and Paper Losses

It’s important to know the difference between risk and volatility and many people get it wrong.

Volatility – stock prices moving up and down – is a normal part of the stock market and an opportunity for a disciplined saver to buy when the market is both up and down. When you have a solid plan in place you can capitalize on market price dislocations, like what happened this week. Risk is how likely you are to lose it all and it’s important to remember – while everyone has their own risk tolerance – price corrections and market volatility does not necessarily mean you are going to lose it all. As the chart below borrowed from The Irrelevant Investor’s excellent post on staying the course shows, the stock market has historically climbed in spite of dips. And paper losses are just that: it’s not real loss if you don’t sell.

stock market drops

As this chart by Deutsche Bank’s Torsten Slok shows, in spite of other times of great volatility, markets have always recovered. It’s just a question of timing.

 

torsten

Millennials: This is Your Wake-up Call

When I speak to fellow Millennials, they say that the real reasons they don’t invest are that 1) it’s daunting to get started and 2) they don’t know where to get help. The big companies aren’t interested in smaller investors with less than 250-500K and the robo solutions don’t understand what makes each smaller investor’s situation unique. There’s a whole new breed of financial advisors, however, who combine personalized service with targeted tech solutions for smaller investors. So no excuses – there are financial pros ready help you create an investment strategy that makes sense for your personal goals and financial situation. And volatility doesn’t disrupt what we do!

The Bottom Line

If you’ve got a solid financial plan, investing in the stock market does not affect your ability to pay your rent, take care of yourself or your family, or add to that rainy day emergency fund. The money you’re saving and investing is money that you’ve determined you don’t need now, it’s money you have set aside for the long haul. Assuming your planner has planned correctly, you’re not going to miss your car payment because the Chinese stock market is crashing.

And that huge correction that scared you in 2008? It eventually rebounded and the market continued to climb. As a Millennial you’ve got years on your side if you start investing now. And you’re losing the potential for growth and compounded interest every moment you wait.

Baron Rothschild, of the Rothschild banking family, is credited with saying “The time to buy is when there’s blood in the streets.”

Look around. If you’re not investing yet, this might just be the time to start.

 

 

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