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February-16-16

Genius, Hypocrisy and Chicanery

Genius

Some of the best and brightest people -- often graduates of our finest business schools -- work on Wall Street. They are highly skilled at what they do. Here's a summary of their "genius" from my perspective:

  • They are great at convincing you to entrust your money to their care.
  • They do so by claiming to have an expertise they don't possess.
  • They are brilliant at hiding the fact they are terrible managers of your money.
  • They are extraordinarily creative at coming up with new, complex products and persuading you to invest in them.
  • They are extremely adept at ensuring the political process is rigged in their favor by making massive contributions to actual and prospective members of Congress.
  • They are superb at keeping their real agenda from you, specifically that their system for "managing" your money is set up to transfer as much of your savings as they can from you to them.

Hypocrisy

I believe the combination of hypocrisy and chicanery is stunning and unabated. The latest example of hypocrisy is the Feb. 3 approval by the House Ways and Means Committee of a bill that would raise barriers to the passage of the proposed rule by the Department of Labor requiring that advisors to retirement plans be fiduciaries.

What about the retirement plan for members of Congress? It's called the Thrift Savings Plan (TSP). If all advisors to retirement plans were required to be fiduciaries, you would likely see many more plans modeled after the TSP.

The TSP is a retirement savings and investment plan for Federal employees and members of the uniformed services. It has more than $400 billion in assets and is the largest 401(k) plan in the country.

The TSP offers a limited number of investment options. They consist only of index funds covering domestic and international markets, a short-term U.S. Treasury securities fund and target date funds, at different risk levels, that invest only in the individual index funds offered by the plan.

The key to the success of the TSP is the extremely low expense ratios of the funds it offers. For 2015, the average net expense ratio of these funds was only .029 percent, which is just under 3 basis points. Obviously the huge size of the TSP permits it to negotiate this low rate. Nevertheless, there are many multi-billion dollar plans using Fidelity's Freedom Funds, some of which have expense ratios as high as 0.75 percent.

Higher investment fees and expense ratios can dramatically affect your returns. Vanguard, a low-cost provider of index funds, has a calculator you can use to calculate their impact.

It's ironic that some members of Congress fight against a fiduciary rule that would likely allow their constituents to have a retirement plan modeled after their own superb plan.

Chicanery

Meanwhile, Wall Street continues to dream up new products likely to enrich itself at your expense. A recent article reported efforts by Morgan Stanley and Bank of America to persuade high-net-worth clients to invest in a fund called the New Rider LP. The fund essentially permits investors to invest in companies (like Uber) before they go public, but it has a unique twist. Investors are provided with no financial information, which means they are trusting totally in the judgment of their broker.

There's an alternative

If you want to maximize the possibility of a secure retirement, here's my suggestion. Heed this admonition to become an index-based investor from famed financial author Charles Ellis: "Think of how many people have gotten really good educations that come in to be practitioners and have been provided with fabulous equipment, tools, and information so that they can compete. Unfortunately each of them is competing against others who also went to great schools also studied also became CFA [charterholders] and also have wonderful facilities, and also have tremendous energy and brain power, and as a result the case for indexing gets stronger and stronger and stronger."

Wall Street wants to lure you into a game only it is likely to win.

Don't succumb.

 

Genius, Hypocrisy and Chicanery blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
February-16-16

Ignore Advice to "Do Something"

Almost every day I get an email from a concerned investor. Their litany of worries includes the terrible start to the year, market uncertainty, geopolitical risk and concern over who will be elected as the next president of the United States.

These investors are easy prey for the steady drumbeat of "advice" featured in the financial news. The import of much of this advice is to motivate you to "do something" to adjust your portfolio in response to changing market conditions. Examples abound.

Goldman Sachs wants you to short gold on market "overreaction."

Jim Cramer recommends using charts to try and time the highs and lows of the market. There may be worse ideas, but none come to mind. Historically, efforts by "experts" and "gurus" to successfully time the markets have failed miserably.

JPMorgan Private Bank's global head of equity strategy sees opportunity for equities where there is "decoupling" between the price of the stock and increased earnings.

Frankly, when I see the list of fines levied against JPMorgan Chase, I wonder why investors still entrust their hard-earned money to the firm's care. It's seems like relying on the latest predictions of its "strategists" would be the least of an investor's concerns. However, to the extent you may be tempted to rely on any predictions from "strategists" or others, remember this wise observation by Jason Zweig, a financial columnist for The Wall Street Journal: "Whenever some analyst seems to know what he's talking about, remember that pigs will fly before he'll ever release a full list of his past forecasts, including the bloopers."

Instead of relying on market seers, consider this:

At the beginning of the 15-year period ending Dec. 31, 2014, there were 2,711 U.S. stock mutual funds. Only 42 percent of them survived to the end of that period. Surely, those fund managers had extensive resources. Presumably, they had their own analysts and "strategists." Their demise was likely due to bad performance.

Of the funds that survived, only 19 percent outperformed their benchmarks.

If this is the performance of well-educated fund managers, entrusted with billions of dollars in assets and highly motivated to "beat the markets," how do you like your chances?

What if, instead of listening to emperors with no clothes, on Nov. 9, 1992 (its inception date) you just bought and held the investor shares version of the Vanguard Balanced Index Fund (VBINX)? The fund invests roughly 60 percent in stocks and 40 percent in bonds by tracking two indexes that represent broad barometers for the U.S. equity and U.S. taxable bond markets. It has an expense ratio of only 0.23 percent.

This fund has had an average annual return of 8.2 percent since its inception. No market timing, stock picking or paying any attention to the next "hot" fund manager.

I'm not suggesting you limit your stock holdings to the United States. You should be globally diversified. However, the performance of this fund illustrates the returns available to investors who invest in low-cost index funds, don't chase returns and pay no attention to short-term market fluctuations.

You should be one of those investors.

 

Ignore Advice to "Do Something" blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
February-14-16

January Returns Mean Nothing

The first two weeks of January returns for the S&P 500 index were the worst in history. That statement is true. The index returned -7.93 percent for the period from Jan. 4-15, which was its worst ever start to the year. How many times have you read or heard some variation of this in a headline?

Pundits are misleading you

The pundits were out in force conveying the significance of this bad start to the rest of us. This comment from Daniel Deming, managing director at KKM Financial, was typical: "I guess it makes a little more difficult hole (at the) start of the year for the market to dig itself out of."

The import of this hand-wringing was clear. Hunker down for a bad year for the markets. Consider "fleeing to safety."

January returns are not predictive

The reality is that returns in January have little predictive power. An analysis of January returns, comparing them to returns for the subsequent February through December from 1926 through 2015, demonstrates this point. A negative January was followed by positive returns in the following 11 months 59 percent of the time. The average return was a positive seven percent.

What about years when January returns were really bad? In the five years when January had the worst returns, the average return for the ensuing year was 13.8 percent.

Significant declines in the S&P 500 are not predictive

What about the fact that the S&P 500 was down by more than 10 percent from its high on Nov. 3, 2015, through Jan. 15, 2016? Isn't that the beginning of a downward trend?

Since 1926, there have been 152 times when the S&P 500 declined by 10 percent. The annualized compound return for the next year was 11.95 percent. For the next five years, it was 10.07 percent.

There have been 39 times when the S&P 500 declined by 20 percent. The annualized compound return for the next year was 10.43 percent, and over the next five years it was 9.63 percent.

Market volatility is not "abnormal"

The drop in the S&P 500 has been combined with what many commentators have dramatically (and incorrectly) hyped as "a volatile year for financial markets."

The message is clear. January was a terrible start to the year. The markets are abnormally volatile. It's time to bail.

Don't believe it.

From 2010 through 2015, the return of S&P 500 index was 12.98 percent, with an annualized standard deviation (a measure of volatility) of 13.09. In the previous eight decades (starting in 1930), returns varied widely, but volatility was higher in six of those decades.

Your plan of action

How should investors use this information?

  • Ignore most of the financial media. It appeals to fear, anxiety and greed.
  • Stick to a disciplined financial plan.
  • Pay no attention to short-term market returns.
  • Focus on your asset allocation, global diversification and low costs.
 

January Returns Mean Nothing blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
February-02-16

The Biggest Market Myth

Particularly in times of extreme volatility, pundits come out of the woodwork to "explain" to the rest of us the reasons underlying the rise or fall of the stock market. For example, how many times have you seen articles attributing recent market declines to a drop in oil prices?

I suspect if you polled investors, many would believe there is a direct relationship between the price of oil and the stock market. This belief is fueled by market commentators like Jim Cramer. In an article published in December 2014, Cramer "explains" how lower oil prices affect U.S. markets. According to him, the S&P 500 goes down every time oil prices go down.

Cramer is not alone in relating stock market behavior to the price of crude oil. Here's a recent headline from USA Today: "Dow Up 200-Plus as Oil Rallies Above $32". The import is clear. If only the price of crude oil would continue to increase, the market would gain momentum.

There are several problems with this assumption. We used to fret over high oil prices. Low prices were considered a positive event for the market. As this 2008 analysis from the Federal Reserve Bank of Cleveland noted, higher prices negatively impact transportation, heating and production costs, and can crimp discretionary spending by consumers as well. No wonder you may be confused by all the hand-wringing over low oil prices.

In fact, the authors, Andrea Pescatori and Beth Mowry, found a very weak relationship between the price of oil and the S&P 500 index. Refuting Cramer's uninformed observation to the contrary, no correlation was found between oil prices and the price of stocks with a 95 percent level of confidence.

Of course, some sectors of the economy -- most notably transportation -- are directly affected by the price of oil. Nevertheless, trying to predict the reaction of the market to changes in the price of oil appears to have very little to support it as a worthwhile endeavor.

So what's the biggest myth? It's that the "explanation" for what's happening in the market at any given time is often just hot air. All news -- good or bad -- is already factored into market prices. It's not a mystery to investors that there are problems with China's economy and unrest in the Middle East. Contrary to this Jan. 8 headline in The Wall Street Journal, the Dow didn't tumble nearly 400 points "on China worries." Those "worries" were already well known.

What causes prices to rise or fall is not information already in the public domain. It's whether news about events is better or worse than the markets anticipate. Since no one knows what that news will be, trying to predict the direction of markets, or extrapolate it from good or bad news already published, is little more than speculation.

Even if you knew whether future news would be good or bad, you could not predict the impact of that news on stock prices with confidence. There are many examples of good news negatively impacting the price of a stock and bad news causing it to rise.

Now that you know the biggest market myth, how can you profit from this information? Start by ignoring most of the financial media. They can't "explain" the market with any greater accuracy than a psychic can predict the future. Relying on their purported "expertise" can be harmful to your financial health.

 

The Biggest Market Myth blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments
February-01-16

The Deceptive Returns of Active Managers

A colleague related this sad story about the death of his elderly mother. Nearing the end of her life, she was in a coma in the hospital and it was clear to him she would not survive. He had always promised her she would not have to endure extraordinary measures to prolong her life if there was no realistic chance of recovery.

The doctors asked if he wanted her to go on a respirator. He responded with an inquiry about her chances of survival. "There's always hope," they told him. He consented to the use of the respirator. She died two days later.

"I felt I lost twice," he told me. "Once when she died and another time because I didn't honor her wishes."

What does this have to do with the returns of active managers?

Part of the financial media's agenda, it appears, is to give you "hope" that there's a guru out there who can reliably and consistently "beat the markets." Otherwise, you will succumb to the data supporting evidence-based investing, costing the mutual fund industry billions in profits.

It's not just shills like Jim Cramer who engage in this deception. Reliable sources of financial information join in with enthusiasm, adding misplaced credibility to the process. A recent example was a fawning article in Financial Advisor. It told the compelling story of Albert Nicholas, fund manager of The Nicholas Fund (NICSX), who the magazine anointed as its "No. 1 ranked fund manager." According to the article, Mr. Nicholas "has topped the Standard & Poor's 500 Index by an average of 2 percentage points a year for the past 40 years and has beaten it every year since 2008."

The article used Mr. Nicholas as an example of stock pickers who can "beat their benchmarks" over the long haul, thereby debunking the views of "some prominent academics" who question the value of active management.

Sounds very impressive. Maybe you should consider using Mr. Nicholas or another adept stock picker to manage your portfolio. That seems to be the point of the article.

Most investors don't have the quantitative skills or experience necessary to take a deeper look at the returns of The Nicholas Fund. Fortunately, Tom Allen and Mark Hebner at Index Fund Advisors don't suffer from that disadvantage. When they analyzed the returns of The Nicholas Fund, they came to a much different conclusion. Here's what they found.

Improper benchmarking

The Morningstar-assigned benchmark for The Nicholas Fund is the Russell 1000 Growth Index and not the S&P 500. It's misleading to compare the returns of this fund to any benchmark other than the Russell 1000 Growth Index.

Since 1979 (the beginning of the index) The Nicholas Fund beat the returns of the Russell 1000 Growth Index in some years and unperformed it in 15 other years. In 1999, the fund was down more than 30 percent relative to its benchmark. Over the entire period, from 1979 through 2015, it did have an average "alpha" (outperformance) of 0.79 percent.

Luck or skill?

Allen and Hebner calculated the "t-statistic" (a measure of statistical significance) of the fund's alpha to ensure that they weren't "being fooled by randomness." They concluded: "We can be less than 20% confident that this performance is in fact a display of skill and not just random luck."

At this point in the analysis, we know there are two things missing from the article in Financial Advisor:

  1. When you use the correct benchmark, Mr. Nicholas did not outperform for 40 consecutive years.
  2. The average outperformance (alpha) of The Nicholas Fund is most likely due to luck and not skill.

It gets worse.

Style drift

Over time, The Nicholas Fund shifted its portfolio from small-cap value stocks to large-cap growth stocks, then to large-cap value stocks, back to large-cap growth stocks and now mainly to large-cap value and large-cap growth stocks. The analysis found that, when compared to the entire market, The Nicholas Fund, on average, has been "slightly smaller and more value oriented."

When these factors are taken into account, the fund's alpha is reduced to a minuscule, and statistically insignificant, 0.04 percent.*

I am not suggesting Mr. Nicholas isn't a fine fund manager, but the hype about beating his benchmark for 40 consecutive years clearly doesn't withstand scrutiny.

It's not impossible to find an active fund manager who will "beat the markets." It's just that the large odds against doing so make it unwise to try.

* This alpha was calculated using a Fama-French three-factor regression.

 

The Deceptive Returns of Active Managers blog was originally posted on The Huffington Post website.

 

2014-04-01-Hiresfrontbookcover.jpgDan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You'll Ever Read, The Smartest Retirement Book You'll Ever Read and his latest, The Smartest Sales Book You'll Ever Read.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

 

 

By: Dan Solin | 0 comments