Low Volatility – Will it Continue?

Getting towards the half way point of the year and thus far 2017 has been one of the least volatile in terms of intra-year drawdowns.  The chart below was created by Charlie Bilello as part of his summary on the topic. Charlie notes that the median drawdown since 1928 is 13%.  That’s not to say we will see something on that order this year but the chart does put the current market into perspective.

No One Wants Simple Advice

University endowments have flocked to an investment model pioneered by David Swensen of Yale that involves heavy concentration in “alternative” investments.  Swensen’s success, like most others, is of course hard to replicate.

This interesting post  by Ben Carlson highlight how a simpler approach to investing, using index funds – called the Bogle Model after Vanguard founder John Bogle – consistently outperformed the much more complex and costly alternative model.

“the fact that the Bogle Model portfolio was in the top quartile and even top decile of endowment returns is insane when you consider the depths these universities will go try to beat the market and how sophisticated they are in the eyes of other professional investors.

These funds are invested in venture capital, private equity, infrastructure, private real estate, timber, the best hedge funds money can buy; they have access to the best stock and bond fund managers; they use leverage; they invest in complicated derivatives; they use the biggest and most connected consultants, and the vast majority of these funds still fail to beat a low-cost Vanguard index fund portfolio.”

Why would Colleges and Universities continue to spend wildly in chase of excess performance when they can access the majority of the returns of most investments via ultra cheap index funds?  Answer – no one wants simple advice.  Imagine how many endowment management jobs would be eliminated – not something any of them want to contemplate.

Dividends as Part of Total Return

Receiving dividends is a tangible way of seeing returns from your investments.  Along with price increases (or decreases) dividends comprise what is known, not surprisingly, as total return.

And it’s intuitive – if you are being paid dividends you are getting a return on your investment. But good luck seeing that calculated into the returns shown on your brokerage statement or web site.

Schwab, for instance, will show you annualized dividends on the monthly statement.  But on their web interface if you check for Unrealized Gains/Losses you see only the change in price. If you automatically reinvest dividends back into a holding, they will track and report that as a new investment, not part of the return from the original investment.

Brokers do this as it ties to capital gains/losses that are realized, which they will feed into the 1099’s they issue for tax return purposes.

But as an investor seeking to understand the total return of a given investment you are often left to your own devices, with calculator in hand.

Eddy Elfenbein of Crossing Wall Street just published the following:

Investors sometimes overlook the importance of dividends. Consider these stats: From the market’s closing low on March 9, 2009 until yesterday’s close, the S&P 500 gained 233.74%. But the S&P 500 Total Return Index, which includes dividends, gained 294.06%. That’s a nice boost.

Like individual brokerage statements, most discussion of market returns focus on price change alone.

The point is that dividends are a major contributor to total returns, so keep them in mind when evaluating the performance of your investments.

Expect Volatility

As we end 2016, with the recent surge of stocks and market indices it’s helpful to remember that while we can never predict the short term movement of prices, we can be sure that the market will move in cycles over time.  It’s a given that at some point we will see declines of 10%, 20% or even more – it’s an inherent part of how markets work.

Since we know this will happen at some point it’s helpful to remember that this volatility produces future returns.  That is, when stocks decline the going forward returns for investors increases.  Just remember this January – the worst start for US stocks in recorded history. That produced a buying opportunity for those willing to act.

In this post Normal Accidents, analyst Michael Batnick points to repeated cases of major price declines over the past 100 years, all while stocks are up significantly in the long run.

Here are ways he points out that individual investors can prepare for a downturn (emphasis mine).

  • Never put yourself in a position to be a forced seller.
  • Always keep enough cash to survive a rainy day, or rainy years. Do not worry about it being a drag on your returns. The drag is nothing compared to the permanent damage of selling after a deep drawdown.
  • Everything looks good in a back test. Unfortunately there is no such thing as a front-test.
  • Be honest with yourself. Are you taking too much risk? Expect U.S. stocks will experience an intra-year drawdown of 15%.
  • Think in numbers, not percentages. If U.S. stocks fall by 30% or more, and I promise they will eventually, ask yourself if you can handle that? If you have $1,000,000 invested in U.S. stocks, a 30% decline means you will witness $300,000 disappear. I repeat, $300,000. If you don’t have the ability to sit through that, it’s better that you recognize it and do something now rather than fool yourself into thinking you can.

When this time inevitably comes it will still be painful, but mentally preparing yourself and seeing the future upside is important. Having a cash reserve can help you take advantage of the situation. If stepping in to buy is too hard (it’s not easy) having your stocks/funds set to automatically re-invest is one way to take advantage of lower prices.

Happy New Year!



The new F word – Fiduciary – goes mainstream

The single most important question to ask when selecting a financial adviser is if they adhere to the Fiduciary Standard.  In other words – will they always put your interests ahead of theirs?

That seems like a question you would not have to ask. But the financial services business has been built upon selling complex, high fee products to investors.  Is the primary goal growing your account? No, it’s generating fees for them.

Earlier this year the Department of Labor enacted regulations forcing the Fiduciary Standard onto the financial services industry, applying only to retirement accounts (industry lobbyists fought off the requirement for regular brokerage accounts etc).

The Trump administration is reportedly looking to peel back the DOL regulations but as this Wall Street Journal story reports – it may be too late as the concept of the Fiduciary has been highlighted broadly to investors who are now demanding that of their advisers.

The less you pay for financial advice/products, the more you keep. Don’t accept anything other than a Fiduciary relationship with your adviser or brokerage account manager.


Relevant Links

Here are some interesting items from around the Web

From the “sketch guy” Carl Richards:

  • When it comes to investing, focus on the next five years, not the next five days. NY Times
  • The importance of keeping “stuff” to a minimum – de-cluttering is only half the battle. NY Times

Interesting take on the advantages of a liberal arts education from The Atlantic

Here is a great list of advice from the Motley Fool new grads in only five words.  My favorites:

Ben Carlson, A Wealth of Common Sense: Budget. Save. But enjoy yourself.

Josh Brown, Reformed Broker: Buy every month, never stop.

Cullen Roche, Pragmatic Capitalism: Your best investment is yourself.

Finally: Ten Questions for your Financial Advisor.  All are important, but if you could only ask one of them:  Are you a Fiduciary?


10 Principles of Investing from Jack Bogle

From Jack Bogle’s “The Clash of Cultures, Investment vs. Speculation”  below are 10 principles to follow when investing.  Cullen Roche at Pragmatic Capitalism wrote about this a while back and given the Brexit news it seems like a good time for a review.

Jack Bogle is the founder of Vanguard and the father of what is now known as “passive investing”.  Rather than paying high fees to a fund manager who tries to pick the best sub-set of stocks, Index Funds allow you to buy all stocks in any different category (e.g. small cap stocks , value stocks  etc) or in fact the entire stock market (VTI).

When Vanguard was started it managed well less than $100 million and today is managing over $3 trillion largely in the passive/indexing category.  Bogle’s words of wisdom are derived from his belief that no one can consistently outperform the market as an active stock picker, a view largely borne out in research on investing.

  1. Remember reversion to the mean.What’s hot today isn’t likely to be hot tomorrow. The stock market reverts to fundamental returns over the long run. Don’t follow the herd.
  2. Time is your friend, impulse is your enemy.Take advantage of compound interest and don’t be captivated by the siren song of the market. That only seduces you into buying after stocks have soared and selling after they plunge.
  3. Buy right and hold tight. Once you set your asset allocation, stick to it no matter how greedy or scared you become.
  4. Have realistic expectations. You are unlikely to get rich quickly. Bogle thinks a 7.5 percent annual return for stocks and a 3.5 percent annual return for bonds is reasonable in the long-run.
  5. Forget the needle, buy the haystack.Buy the whole market and you can eliminate stock risk, style risk, and manager risk. Your odds of finding the next Apple (AAPL) are low.
  6. Minimize the “croupier’s” take.Beating the stock market and the casino are both zero-sum games, before costs. You get what you don’t pay for.
  7. There’s no escaping risk. I’ve long searched for high returns without risk; despite the many claims that such investments exist, however, I haven’t found it. And a money market may be the ultimate risk because it will likely lag inflation.
  8. Beware of fighting the last war. What worked in the recent past is not likely to work going forward. Investments that worked well in the first market plunge of the century failed miserably in the second plunge.
  9. Hedgehog beats the fox.Foxes represent the financial institutions that charge far too much for their artful, complicated advice. The hedgehog, which when threatened simply curls up into an impregnable spiny ball, represents the index fund with its “price-less” concept.
  10. Stay the course. The secret to investing is there is no secret. When you own the entire stock market through a broad stock index fund with an appropriate allocation to an all bond-market index fund, you have the optimal investment strategy. Discipline is best summed up by staying the course.


Brexit, the new Grexit

When the market hits a rough patch, the pessimists and doomsayers (who are always present) double down on their calls for some form of Armageddon. Last week people cited George Soros  selling stocks and going all in on Gold for fear of another global meltdown (nicely debunked here, and here). And there’s alway some exotic but horrible sounding crisis brewing. Today it’s Brexit, short for Britain leaving the EU. Before that it was Grexit – for Greece. Next month it will be something new (Italexit or Frexit?).

It’s always something and while these may be legitimate harbingers of trouble, the problem is there is no way to know with any reasonable level of surety. In January, markets were down sharply but have since rebounded (mostly). If you sold on that fear you missed that bounce. Markets will constantly try to shake out weak hands and throw head fakes to investors.

For the individual investor there is virtually no way to properly understand, interpret and act on macro global economic issues that have been driving markets in the past week or two. None of us can (or should) try to play that game. Goldman Sachs, JP Morgan et al employ legions of economists, strategists and analysts, few of whom accurately predict market action. And none can do it consistently, although they continue to put out market “notes” for their brokers to share with their clients in an effort to look smart and generate action – sales.

That’s not to say we should all stick our heads in the sand. There are sometimes good reasons to sell something in your portfolio: a stock has run up well past an estimation of fair market value, or its fundamental prospects have changed significantly for the worse.

A classic example of the former is Microsoft (see here) that hit a high in Dec 1999 at the tail of the dotcom bubble. It took over 15 years to trade at that level again. An example of the latter is Pitney Bowes (see here), the near monopolist in business mail systems, that also saw its all time high in 1999, right around the time that email was fully established as the corporate communications tool of choice. Today Pitney Bowes remains a near monopolist, only in a much smaller industry. But even those types of events are hard to see and act on.

So while there will always be uncertainty and concern in the future of the market, the reality is that it’s very hard to accurately interpret and act on macro events.  Being diversified with a long-term horizon is one way to ride through this noise.

Interesting things I read this week:

Jim Cramer Mad Money. Questionable Ethics. Or as one site put it “why does anyone listen to Jim Cramer? HuffPo

From Josh Brown – the perils of guessing what the next “hot sector” is going to be.  TRB

Quote:  there is any doubt in your mind about whether or not this is pure, pathetic performance chasing, let me ease your uncertainty. It is plain and simple, the most perfect form of performance chasing you’ll find. 

Never invest in anything you don’t totally understand – and other lessons shared by parents with their children. NY Times

How a $650,100 lunch with Warren Buffett changed one hedge fund manager’s life Yahoo Finance

Jason Zweig  on how today’s low-interest rates distort valuations WSJ

Quote:  “If you can only buy expensive things,” says Mr. Ilmanen, “at least buy a diverse set of them.”