Investor Knowledge

June 4, 2013

Newsflash: investors are overconfident about their financial knowledge.  Business Insider reports:

A new  survey by the FINRA Investor Education Foundation found that 75% of U.S.  adults say they’re pros at managing their finances, but only 14% could ace a  five-question quiz on basic financial concepts.

This was no small study sample size either. A whopping 25,000 consumers took  the quiz.

The quiz is, in fact, laughably easy for a competent investment professional.  I am shocked that only 14% of consumers could ace the quiz.  I wouldn’t necessarily expect a plumber to go 5-for-5, but I would think that most adults would get most questions correct.

You can see the Business Insider story here, and take the quiz.  If you are a financial advisor and miss any of these questions that would freak me out.  It does go to show, though, that we need to do a thorough job of educating and communicating information to clients.


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Inflation Also Rises

October 8, 2012

Inflation has been a big fear in the investment community for a few years now, but so far nothing has happened.  An article at AdvisorOne suggests that the onset of inflation can sometimes be rapid and unexpected.

Someday, in the possibly near future, you will suddenly be paying $10 for a gallon of milk and wondering how the heck it happened so fast.

That is the strange and terrible way of inflation, said State Street Global senior portfolio manager Chris Goolgasian in a panel talk on Thursday at Morningstar ETF Invest 2012. Inflation has a way of appearing to be a distant threat before it sneaks up suddenly and starts driving prices through the roof.

Quoting from Ernest Hemingway’s novel “The Sun Also Rises,” Goolgasian took note of a passage where a man is asked how he went bankrupt. “Two ways,” the man answered. “Gradually, then suddenly.”

“The danger is in the future, and it’s important to manage portfolios for the future,” Goolgasian concluded. “Real assets can give you some assurance against that chance.”

That’s good to know—but which real assets, and when?  After all, Japanese investors have probably been waiting for the inflation bogeyman for the last two decades.  This is one situation in which tactical asset allocation driven by relative strength can be a big help.  If you monitor a large number of asset classes continuously, you can identify when any particular real asset starts to surge in relative performance.

For example, on the Dorsey Wright database, the last extended run that gold had as a high relative strength asset class (ETF score > 3) was from 3/9/2011 to 12/21/2011.  Below, I’ve got a picture of the ETF score chart, along with a performance snip during that same period.  Perhaps because of investor concern about inflation—misplaced, as it turned out—gold outperformed fixed income over that stretch of time.

ETF Score for GLD

2011 Performance Snip

Source: Dorsey Wright  (click on images to enlarge)

There’s no guarantee that gold will be an inflation hedge, of course.  We never know what asset class will become strong when investors fear future inflation.  Next time around it could be real estate, Swiss francs, TIPs, or energy stocks—or nothing.  There are so many variables impacting performance that it is impractical (and impossible) to account for them all.  However, relative strength has the simple virtue of pointing out—based on actual market performance—where the strength is appearing.

Investment history sometimes seems to be a never-ending cycle of discredited themes, but those themes can drive the market quite powerfully until they are discredited.  (Remember the “new era” of the internet?  Or how “peak oil” was so compelling with crude at $140/barrel?)  It’s helpful to know what those themes are, whether you are trying to take advantage of them or just trying to get out of the way.

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More on the Value of a Financial Advisor

September 5, 2012

I noticed an article the other day in Financial Advisor magazine that discussed a study that was completed by Schwab Retirement Plan Services.  The main thrust of the study was how more employers were encouraging 401k plan participation.  More employers are providing matching funds, for example, and many employers have instituted automatic enrollment and automatic savings increases.  These are all important, as we’ve discussed chronic under-saving here for a long time.  All of these things together can go a long way toward a client’s successful retirement.

What really jumped out at me, though, was the following nugget buried in the text:

Schwab data also indicates that employees who use independent professional advice services inside their 401(k) plan have tended to save twice as much, were better diversified and stuck to their long-term plan, even in the most volatile market environments.

Wow!  That really speaks to the value of a good professional advisor!  It hits all of the bases for retirement success.

  • boost your savings rate,
  • construct a portfolio that is appropriately diversified by asset class and strategy, and
  • stay the course.

If investors were easily able to do this on their own, there wouldn’t be any difference between self-directed accounts and accounts associated with a professional advisor.  But there is a big difference—and it points out what a positive impact a good advisor can have on clients’ financial outcomes.

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Dorsey, Wright Client Sentiment Survey Results – 6/22/12

July 2, 2012

Our latest sentiment survey was open from 6/22/12 to 6/29/12.  The Dorsey, Wright Polo Shirt Raffle continues to drive advisor participation, and we greatly appreciate your support!  We will announce the winner early next week.  This round, we had 49 advisors participate in the survey. If you believe, as we do, that markets are driven by supply and demand, client behavior is important.  We’re not asking what you think of the market—since most of our blog readers are financial advisors, we’re asking instead about the behavior of your clients.  Then we’re aggregating responses exclusively for our readership.  Your privacy will not be compromised in any way.

After the first 30 or so responses, the established pattern was simply magnified, so we are fairly comfortable about the statistical validity of our sample. Any statistical uncertainty this round comes from the fact that we only had three investors say that thier clients are more afraid of missing a stock upturn than being caught in a downdraft. Most of the responses were from the U.S., but we also had multiple advisors respond from at least three other countries.  Let’s get down to an analysis of the data! Note: You can click on any of the charts to enlarge them.

Question 1. Based on their behavior, are your clients currently more afraid of: a) getting caught in a stock market downdraft, or b) missing a stock market upturn?

Chart 1: Greatest Fear.  From survey to survey, the S&P 500 increased 0.71%. The greatest fear numbers did not perform as expected.  The fear of downturn group increased from 86% to 94%, while fear of a missed opportunity decreased from 14% to 6%.  Client sentiment remains poor.

Chart 2: Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups.  The spread increased from 73% to 88%.

Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?

Chart 3: Average Risk Appetite.  Average risk appetite did not perform as expected. It fell slightly from 2.41 to 2.39, even though S&P 500 rose.

Chart 4: Risk Appetite Bell Curve.  This chart uses a bell curve to break out the percentage of respondents at each risk appetite level.  We are still seeing a low amount of risk, with most clients having a risk appetite of 2 or 3.

Chart 5: Risk appetite Bell Curve by Group.  The next three charts use cross-sectional data.  The chat plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups. Those who fear a downdraft prefer a low amount of risk, with most clients having a risk appetite of 2 or 3. We only had three responses that indicated a fear of missing an upturn, but even our limited number of responses showed that these people do prefer more risk.

Chart 6: Average Risk Appetite by Group.  The average risk appetite of those who fear a downturn increased slightly with the market.  The average risk appetite of those who fear missing an upturn also increased.

Chart 7: Risk Appetite Spread.  This is a chart constructed from the data in Chart 6, where the average risk appetite of the downdraft group is subtracted from the average risk appetite of the missing upturn group.  The spread increased this round and is at its highest level so far this year.

The S&P 500 rose by 0.71% from survey to survey, and some of our indicators responded accordingly.  Average risk appetite by each group increased, but the total average risk appetite fell.  As the market does better, we would expect more people to fear missing an upturn, yet more investors feared a downturn. Overall, client sentiment remains poor.

No one can predict the future, as we all know, so instead of prognosticating, we will sit back and enjoy the ride.  A rigorously tested, systematic investment process provides a great deal of comfort for clients during these types of fearful, highly uncertain market environments.  Until next time, good trading and thank you for participating.

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From the Archives: A Wakeup Call for Investors

June 5, 2012

If you have money left over after paying your bills, you fall into the category of “investor.”  You could invest your surplus money in having a good time in Vegas, a mattress, a bank savings account, or any manner of financial instruments.  Some investments have a financial return; others only a psychic return if you are lucky.

Most people invest for a simple reason: to provide income when they are no longer able to work.  Some people might actually want to retire, so they invest to provide income for the time after they voluntarily choose to stop working.  To get from “investor” status to actual retirement status, a few difficult things have to happen correctly.

1. You actually need to save money.  And you have to save a lot.  In today’s America, this means becoming a cultural outlaw and foregoing some current consumption.  Welcome to the radical underground.

2. You need to save the money in assets that produce income or capital gains.  (Income-producing assets are nice, but capital gains can be spent just as effectively.)  These assets are often volatile, leveraged like real estate, or intangible like stocks and bonds.  Scary stuff, in other words.   Investing your surplus funds in Budweiser, while it may confer certain social benefits, will not provide a retirement income.

3. You need to manage not to muck up your returns.  The DALBAR numbers don’t lie.  To earn decent real returns, you need to select  quality money managers and/or funds and then leave them to do their work.

4. You need to be able to do realistic math.  For example, most people think their home is a great investment—but they never subtract from the returns all of the property taxes and maintenance that are required, or remove the effects of leverage.  Every study that does shows that homes are not a good financial investment.  In addition, in order to make a projection of how much money you will require to retire, you need to be able to make a reasonable estimate of your real net-net-net returns (after inflation, taxes, and expenses) over your compounding period.  Investors, imbued with overconfidence, almost always make assumptions that are far too bullish.

Jason Zweig has an excellent article in the Wall Street Journal discussing realistic assumptions for net-net-net rates of return.

Since 1926, according to Ibbotson Associates, U.S. stocks have earned an annual average of 9.8%. Their long-term, net-net-net return is under 4%.

All other major assets earned even less. If, like most people, you mix in some bonds and cash, your net-net-net is likely to be more like 2%.

Mr. Zweig points out that many investors, even some institutional investors, are assuming net-net-net returns of 7% or more.  When he asked truly sophisticated investors what return they thought was reasonable, he got very different answers.

I asked several investing experts what guaranteed net-net-net return they would accept to swap out their own assets. William Bernstein of Efficient Frontier Advisors would take 4%. Laurence Siegel, a consultant and former head of investment research at the Ford Foundation: 3%. John C. Bogle, founder of the Vanguard Group of mutual funds: 2.5%. Elroy Dimson of London Business School, an expert on the history of market returns: 0.5%.

The reality is pretty shocking, isn’t it?  This is why the investor has an uphill battle.  And the consequences of messing any of the four steps up along the way can be pretty steep.  In Mr. Zweig’s eloquent words,

The faith in fancifully high returns isn’t just a harmless fairy tale. It leads many people to save too little, in hopes that the markets will bail them out. It leaves others to chase hot performance that cannot last. The end result of fairy-tale expectations, whether you invest for yourself or with the help of a financial adviser, will be a huge shortfall in wealth late in life, and more years working rather than putting your feet up in retirement.

Saving too little can become a big problem.  I would add that ruining your returns by thrashing about impulsively will only add to the amount you will need to save.  Almost everyone has a number in mind for the amount of assets they will need in retirement.  Try redoing the math with realistic numbers and see if you are really saving enough.

—-this article originally appeared 1/19/2010.  Americans are still under-saving to an alarming extent.  Given that we are currently in a very low yield environment, a high savings level is more important than ever.

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Hedge Fund Alternatives

May 29, 2012

From Barron’s, an interesting insight into the alternative space:

Investor interest in hedge-fund strategies has never been higher—but it’s the mutual-fund industry that seems to be benefiting.

Financial advisors and institutions are increasingly turning to alternative strategies to manage portfolio risk, though the flood of money into that area tapered off a bit last year, according to an about-to-be-released survey of financial advisors and institutional managers conducted by Morningstar and Barron’s. Many of them are finding the best vehicle for those strategies to be mutual funds.

Very intriguing, no?  There are quite a few ways now, through ETFs or mutual funds, to get exposure to alternatives.  We’ve discussed the Arrow DWA Tactical Fund (DWTFX) as a hedge fund alternative in the past as well.  Tactical asset allocation is one way to go, but there are also multi-strategy hedge fund trackers, macro fund trackers, and absolute-return fund trackers, to say nothing of managed futures.

Each of these options has a different set of trade-offs in terms of potential return and volatility.  For example, the chart below shows the Arrow DWA Tactical Fund, the IQ Hedge Macro Tracker, the IQ Hedge Multi-Strategy Tracker, and the Goldman Sachs Absolute Return Fund for the maximum period of time that all of the funds have overlapped.

(click on image to enlarge)

You can see that each of these funds moves differently.  For example, the Arrow DWA Tactical Fund, which is definitely directional, has a very different profile than the Goldman Sachs Absolute Return Fund, which presumably is not (as) directional.

Very few of these options were even available to retail investors ten years ago.  Now they are numerous, giving individuals the opportunity to diversify like never before.  With proper due diligence, it’s quite possible you will find an alternative strategy that can improve your overall portfolio.

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There Were These Megatrends…

May 24, 2012

American Funds is one of the largest and most respected mutual fund companies around.  One of their portfolio managers, Jim Dunton, is retiring after 50 years.  I love these sorts of articles because of the tremendous perspective that long-time investors have.  (That’s part of the reason that Warren Buffett’s annual reports are such a hoot.)

Jim Dunton of American Funds reflecting on his 50 years in the investment business:

There were these megatrends — including the Cold War, inflation and energy — that both continued for a long period of time and then aborted and went in the other direction. The Cold War began around 1946 and continued all the way until 1990 when the Berlin Wall came down. Much happened during that period that affected the investment business. There were hot wars in Korea and Vietnam. But also important were the many scientific developments that came out of the Cold War — like satellites, GPS and aerospace advances — that we were able to invest in over the period.

With inflation, we had one long trend of almost no inflation from the 1930s, a build of inflation from the mid-60s to the early 1980s, and then a great dénouement from then until now. Inflation was matched, of course, by interest rates which were around 2% in the 1950s, went to 12% in 1980 and now are back down to 2% again.

Another key trend was energy. After the 1973 oil embargo, oil prices went from $3 per barrel to $36. The biggest input cost in the world went up 12 times almost overnight, and that fed further into high inflation. In 1979, we were consuming about 18.5 million barrels of oil per day in this country. The rise in oil prices was so significant that the resulting changes in automobile technology and alternative resources have meant that today oil consumption is back to about 18.5 million barrels.

Fantastic.  Investors worry all the time about trend following somehow ceasing to work.  But an experienced investor like Mr. Dunton can look back on 50 years and see a number of megatrends that made a big difference in the investment process.  That probably won’t change.  Relative strength remains one of the best ways to identify and participate in big trends.

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People First

May 18, 2012

Financial advisors often become enamored with new whiz-bang products and new and improved methodologies.  Sometimes they really are new and improved, so we always need to check them out.  But the bedrock of the business is really the relationship with the client.  You need to care about the client’s well-being and they need to know you care.  You need to go the extra mile.

I was thinking about this in relation to this article about customer service in the retail world from PandoDaily.

There is simply no such thing as a shortcut when it comes to customer service. You can provide an alternate service, if you don’t want to invest in a local call center of friendly competent people armed with helpful databases of customer information. But don’t call this customer service, because it isn’t. To call a person reading from a script a customer-service representative is like calling a middle school play Broadway. You might as well not have an 800 number.

Zappos, GoDaddy, Qualtrics and Braintree have proven that spending money on customer service isn’t throwing money away — it’s investing in the business. Done well, good customer service is the difference between a mediocre business and a great one. You can get shoes anywhere, and Zappos’ site design has never been that amazing; its entire success is wrapped up in treating people well. GoDaddy doesn’t view its call center as a “cost center,” arguing it has actually generated more than $100 million in annual revenues.

If anything, client service is even more important in wealth management because the product itself is intangible.  How can you put a price on financial security and peace of mind?  And, as GoDaddy shows, good client service can generate revenues, not just add to costs.  People come first.

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