Journey Archives

Staying Invested

February 11, 2019 by Justin M. Follmer, MBA, CFP®, AIF®

If we could choose a near-perfect example of why we harp on staying invested and remaining committed to an investment strategy that’s rooted in academic science, it would be the returns that equities experienced during January 2019. After a terrible 4th Quarter in 2018, most global equity benchmarks roared back from their holiday blues.

Here’s where we stand so far (from 1.1.19 through 2.1.19)¹:

S&P 500 Growth	+7.51%
S&P 500 Value	+8.80%
S&P Mid-Cap 400 Growth	+9.73%
S&P Mid-Cap 400 Value	+12.02%
S&P Small-Cap 600 Growth	+8.81%
S&P Small-Cap 600 Value	+12.46%

A keen eye will notice a couple of points with the data above that coincide with our Investment Philosophy and why staying invested was far better than selling out at the end of December. First, Small and Mid-Caps outperformed Large Caps. Second, Value in each market cap outperformed Growth. And while this is great news, it doesn’t mean that we’re now in the clear. In fact, I wouldn’t let any single month of data, either good or bad, persuade you to make any portfolio strategy changes nor would I let it convince you of any strategy other than staying invested.

I highlight the points above merely to show that in any given month, the premiums we target for our clients will either be positive or negative and it’s impossible to predict one way or the other. By staying invested, the goal is to constantly pursue the premiums regardless of our personal outlook. I touched on this topic back in November of 2018 in a newsletter titled “Chasing Premiums;” contact us to be included on future newsletter mailings.

As mentioned above, Value outperformed Growth across market capitalization. Using the Small-Cap results as an example, historically speaking, the amount of outperformance in any given month is expected² to be 0.27% (statistical mean) . In simpler terms, we should expect to have Small Cap Value outperform Small Cap Growth by 0.27%. Holding all else equal, if Small Cap Growth returns 1.00% for a hypothetical month, we should expect Small Cap Value to return 1.27% in that same month. Make sense?

In January 2019, Small Cap Value outperformed growth by 3.65%, well above the expected 0.27%. How can this be? Let’s travel all the way back to statistics class…you know, the class most people hated! Whenever there’s a mathematical mean or average, there’s also a measurement of results spread around that mean; what we call a standard deviation. Using historical data, the standard deviation of Small Cap Value is 2.82%. This signifies that performance of this premium in any given month has shown to be anywhere from -5.37% to 5.91% calculated as 2 standard deviations from the mean. This represents 95% of the results within a normal distribution.

To take this one step further and bring us back full circle as to why we care about this data and why staying invested is preferred to not, think about the following question for a minute. If we expect the premium of Small Cap Value in a given month to be positive (0.27% is a positive number) what percent of observations over the last, say, 10 years, were not? The answer: 4.53% of the observations were negative. Let’s ask the same question for other time periods:

Any given month:	42.68% negative.
1 Year:	29.59% negative.
3 Years:	18.00% negative.
5 Years:	11.68% negative.
10 Years:	4.53% negative.
20 Years:	0.82% negative.
30 Years:	0.17% negative.

Notice a trend? The longer you pursue the premiums by staying invested, the greater your chance of realizing positive premium results.

I’ll reiterate the following point: do not let a single month of data, or even six single months of data, change your outlook and, thus, investment strategy nor let it cause you to do anything other than staying invested. Your investment strategy should be based on your time horizon, financial goals, and tolerance for volatility (risk) and should change only when one of those change. We help guide, manage, and make minor adjustments along the way for our clients and we’d love to help you and your family too. Get in touch today to begin your journey.

Image Credit: MCLB Albany – navigating by use of compass and data – not by gut feelings and emotion.

https://www.ftportfolios.com/Commentary/MarketCommentary/2019/2/4/week-of-february-4th
I italicize the word “expect” on purpose – we expect these results because of past statistically significant observations, they are not guaranteed results. Very little is guaranteed in the investor world.
French, K. (2018) Volatility Lessons: What do past returns say about future performance. Tuck School of Business, Dartmouth College.

When Markets Drop

October 31, 2018 by Justin M. Follmer, MBA, CFP®, AIF®

In the next couple of weeks, investors will begin receiving October portfolio statements from their custodians and may ask themselves what to do when markets drop. If you’re like most investors, you usually don’t take the time to check your account balances daily, online or through your mobile app, but rather only decide to look when you hear bleak headlines on the nightly news. And with recent headlines such as these, we can understand why:

“Stock market experts say this is a stumble, not a plunge”

“U.S. stocks close lower as Dow drops nearly 1,400 points in 2 days”

“Market timers say it’s still too early to jump back into stocks”

“Dow drops more than 1000 points in two days”

Here’s what to do when markets drop:

Understand that articles are written to trigger an emotional response.
Be rational and proactive, not emotional and reactive.
Address “1,000+ point drops” long before they happen.
Either hire an Investment Advisor with a Fiduciary Duty or have a battle buddy.

Journalists have a unique job; they pen headlines that are designed to invoke an emotional response to get readers to click on the article. And when markets drop, the headlines get more wild. More clicks = more traffic = more ad revenue. Let’s illustrate this point with two headlines. Which is more exciting?

“Dow Drops 1,000 points.”

“Dow closes down 3.7%.”

We’re willing to bet the “1,000 point” headline is more exciting for the mere psychological idea that 1,000 is larger than 3.7. But if the Dow is sitting at 27,000, these hypothetical headlines depict the same results, just written differently. While our example above is purely hypothetical, a seasoned investor needs to know when to dig deeper than flashy headlines.

The third principle of Our Investment Philosophy reads:

Emotions are Destructive. Reacting to current market conditions may lead one to making poor investment decisions at the worst times.

Market corrections and other major news events affecting the world tend to alter investor’s outlook about the future when markets drop. When you hear advisors suggesting you take a long-term approach, the advice can feel too cliché and ambiguous. We believe this advice is more about historical evidence and emotional pause rather than an effort to brush off the pain you may be feeling. When an investor is proactive, it means she has positioned her portfolio in a manner paralleled with market uncertainty. Recognize that markets rise and fall as they digest information daily. These movements are a fundamental part of being an investor and should be embraced rather than avoided. It is our opinion that one of the best ways to accomplish this is by having a globally diversified portfolio that pursues your financial goals and is based on your tolerance and capacity for risk. This means that rarely will you be 100% stocks, 100% cash, or 100% bonds. You’ll more than likely be a combination of each through all market conditions. How much of each is outside the purview of this blog post, but we’d love to sit down with you and build a portfolio just for you.

A principle of portfolio design is understanding the long-term characteristics and historical performance of a similar portfolio. While history may not be indicative of future results, it provides some insight into how one’s portfolio may have performed in past markets as well as the variability of returns over time. With this information and an understanding of your financial goals, it’s relatively easy to address 1,000+ point drops long before they happen. Often, the question isn’t about whether these drops in markets will occur, but rather, how much of the drop your portfolio will feel and what your reaction may be in those moments. Will you decided to sell everything and go to cash, will you double-down and buy more, or will you do nothing? We believe utilizing an intuitive risk tolerance assessment is a great starting point towards designing a personalized portfolio that is customized to you and your feelings.

As you plan for your family’s financial future, it can feel daunting to go at it alone. An easy way to address this is by having a trusted friend or partner who you can freely talk to about these personal issues, one you can rely on for accountability when markets drop, and one who goes through the same process as you. In the military, this person is often called a “battle buddy.” If you’re a DIY investor, do you have someone like this that you can rely on?

If not, another way is to hire someone to fulfill this role. An investment advisor with a Fiduciary Duty can not only help you structure your investments for market uncertainty, but also keep you invested when markets drop. It’s easy to hire any financial advisor to implement an investment strategy, but we find that non-investment related issues have a meaningful impact on an investor’s behavior. For these reasons, we believe working with a Fiduciary is the most prudent way to approach your relationship with financial advisors. And that’s precisely why we choose to be Fiduciaries. We’d love nothing more than earning the chance to meet you and learn how we can help make sudden market movements have a more meaningful impact in your life. Here’s how you can get in touch with us.

What are Alternative Investments?

August 24, 2018 by Justin M. Follmer, MBA, CFP®, AIF®

Diversification has been called the only free lunch in investing, so what’s the alternative?

This idea is based on research showing that diversification, through a combination of assets like stocks and bonds, could reduce volatility without reducing expected return or increase expected return without increasing volatility compared to those individual assets alone. Many investors have taken notice, and today, highly diversified portfolios of global stocks and bonds are readily available to investors at a comparatively low cost. A global stock portfolio can hold thousands of stocks from over 40 countries around the world, and a global bond portfolio can be diversified across bonds issued by many different governments and companies and in many different currencies.

Some investors, in search of additional potential volatility reduction or return enhancement opportunities, may even try to extend the opportunity set beyond stocks and bonds to other assets, many of which are commonly referred to as “alternative investments.” The types of offerings labeled as alternative investments today are wide and varied. Depending on who you talk with, this category can include, but is not limited to, different types of hedge fund strategies, private equity, commodities, and so on. These alternative investments are often marketed as having greater return potential than traditional stocks or bonds or low correlations with other asset classes.

In recent years, “liquid alternative investments” have increased in popularity considerably. This sub-category of alternative investments consists of mutual funds that may start from the same building blocks as the global stock and bond market but then select, weight, and even short securities¹ in an attempt to deliver positive returns that differ from the stock and bond markets. Exhibit 1 shows how the growth in several popular classifications of liquid alternative investments mutual funds in the US has ballooned over the past several years.

The growth in this category of funds is somewhat remarkable given their poor historical performance over the preceding decade. Exhibit 2 illustrates that the annualized return for such strategies over the last decade has tended to be underwhelming when compared to less complicated approaches such as a simple stock or bond index. The return of this category has even failed to keep pace with the most conservative of investments. For example, the average annualized return for these products over the period measured was less than the return of T-bills but with significantly more volatility.

While expected returns from such strategies are unknown, the costs and turnover associated with them are easily observable. The average expense ratio of such products tends to be significantly higher than a long-only stock or bond approach. These high costs by themselves may pose a significant barrier to such strategies delivering their intended results to investors. Combine this with the high turnover many of these strategies may generate and it is not challenging to understand possible reasons for their poor performance compared to more traditional stock and bond indices.

This data by itself, though, does not warrant a wholesale condemnation of evaluating assets beyond stocks or bonds for inclusion in a portfolio. The conclusion here is simply that, given the ready availability of low cost and transparent stock and bond portfolios, the intended benefits of some alternative investments strategies may not be worth the added complexity and costs.

CONCLUSION

When confronted with choices about whether to add additional types of assets or strategies to a portfolio for diversification beyond stocks, bonds, and cash it may help to ask three simple questions.

What is this alternative getting me that is not already in my portfolio?
If it is not in my portfolio, can I reasonably expect that including it will increase expected returns or reduce expected volatility?
Is there an efficient and cost-effective way to get exposure to this alternative investments asset class or strategy?

If investors are left with doubts about any of these three questions it may be wise to use caution before proceeding. Our financial advisors can help investors answer these questions and ultimately decide if a given strategy is right for them. Have questions or want to find out if alternative investments are right for your portfolio and financial goals? Get in touch today.

ALTERNATIVE INVESTMENTS STRATEGY DEFINITIONS

Absolute Return: Funds that aim for positive return in all market conditions. The funds are not benchmarked against a traditional long-only market index but rather have the aim of outperforming a cash or risk-free benchmark.

Equity Market Neutral: Funds that employ portfolio strategies that generate consistent returns in both up and down markets by selecting positions with a total net market exposure of zero.

Long/Short Equity: Funds that employ portfolio strategies that combine long holdings of equities with short sales of equity, equity options, or equity index options. The fund may be either net long or net short depending on the portfolio manager’s view of the market.

Managed Futures: Funds that invest primarily in a basket of futures contracts with the aim of reduced volatility and positive returns in any market environment. Investment strategies are based on proprietary trading strategies that include the ability to go long and/or short.

Category descriptions are based on Lipper Class Codes provided in the CRSP Survivorship bias-free Mutual Fund Database.

A short position is the sale of a borrowed security. Short positions benefit if the borrowed security falls in value.
Written by Dimensional Fund Advisors, LP with edits by Coastal Wealth Advisors, LLC.
Top image credit: InvestmentZen

Sailing with the Tides and Winds

March 22, 2018 by Justin M. Follmer, MBA, CFP®, AIF®

Embarking on a financial plan is like sailing around the world. The voyage won’t always go to plan, and there’ll be rough seas. But the odds of reaching your destination increase greatly if you are prepared, flexible, patient, and well-advised.

A mistake many inexperienced sailors make is not having a plan at all. They embark without a clear sense of their destination. And once they do decide, they often find themselves lost at sea in the wrong boat with inadequate provisions.

Likewise, in planning an investment journey, you need to decide on your goal. A first step might be to consider whether the goal is realistic and achievable. For instance, while you may long to retire in the south of France, you may not be prepared to sacrifice your needs today to satisfy that distant desire.

Once you are set on a realistic destination, you need to ensure you have the right portfolio to get you there. Have you planned for multiple contingencies? What degree of “bad weather” can your plan withstand along the way?

Key to a successful voyage is a good navigator. A trusted financial advisor is like that, regularly taking coordinates and making adjustments, if necessary. If your circumstances change, the investment advisor may suggest you replot your course.

As with the weather at sea, markets can be unpredictable. A sudden squall can whip up waves of volatility, tides can shift, and strong currents can threaten to blow you off course. Like a seasoned sailor, an experienced investment manager will work with the conditions.

Once the storm passes, you can pick up speed again. Just as a sturdy vessel will help you withstand most conditions at sea, a well-diversified portfolio can act as a bulwark against the sometimes tempestuous conditions in markets.

Circumnavigating the globe is not exciting every day. Patience is required with local customs and paperwork as you pull into different ports. Likewise, a lack of attention to costs and taxes is the enemy of many a long-term financial plan.

Distractions can also send investors, like sailors, off course. In the face of “hot” investment trends, it takes discipline not to veer from your chosen plan. Like the sirens of Greek mythology, media pundits can also be diverting, tempting you to change tack and act on news that is already priced in to markets.

A lack of flexibility is another impediment to a successful investment journey. If it doesn’t look as though you’ll make your destination in time, you may have to extend your voyage, take a different route to get there, or even moderate your goal.

The important point is that you become comfortable with the idea that uncertainty is inherent to the investment journey, just as it is with any sea voyage. That is why preparation and planning are so critical. While you can’t control every outcome, you can be prepared for the range of possibilities and understand that you have clear choices if things don’t go according to plan.

If you can’t live with the volatility, you can change your plan. If the goal looks unachievable, you can lower your sights. If it doesn’t look as if you’ll arrive on time, you can extend your journey.

Of course, not everyone’s journey is the same. Neither is everyone’s destination. We take different routes to different places, and we meet a range of challenges and opportunities along the way.

But for all of us, it’s critical that we are prepared for our journeys in the right vessel, keep our destinations in mind, stick with the plans, and have a trusted navigator to chart our courses and keep us on target. Ready to plot your course? Contact us today to see how our financial advisor can help you and subscribe to our weekly newsletter to stay in touch.

Written by Jim Parker, Outside the Flags series, Dimensional Fund Advisors, LP with edits by Coastal Wealth Advisors.

Average Annual Return

October 31, 2017 by Justin M. Follmer, MBA, CFP®, AIF®

“I have found that the importance of having an investment philosophy—one that is robust and that you can stick with— cannot be overstated.” —David Booth

The US stock market has delivered an average annual return of around 10% since 1926.¹ But short-term results may vary, and in any given period stock returns can be positive, negative, or flat. When setting expectations, it’s helpful to see the range of outcomes experienced by investors historically. For example, how often have the stock market’s annual returns actually aligned with its long-term average?

Exhibit 1 shows calendar year returns for the S&P 500 Index since 1926. The shaded band marks the historical average annual return of 10%, plus or minus 2 percentage points. The S&P 500 had a return within this range in only six of the past 91 calendar years. In most years the index’s return was outside of the range, often above or below by a wide margin, with no obvious pattern. For investors, this data highlights the importance of looking beyond average annual returns and being aware of the range of potential outcomes.

TUNING IN TO DIFFERENT FREQUENCIES

Despite the year-to-year uncertainty, investors can potentially increase their chances of having a positive average annual return outcome by maintaining a long-term focus. Exhibit 2 documents the historical frequency of positive returns over rolling periods of one, five, 10, and 15 years in the US market. The data shows that, while positive performance is never assured, investors’ odds improve over longer time horizons.

Conclusion

While some investors might find it easy to stay the course in years with above average annual returns, periods of disappointing results may test an investor’s faith in equity markets. Being aware of the range of potential outcomes can help investors remain disciplined, which in the long term can increase the odds of a successful investment experience. What can help investors endure the ups and downs? While there is no silver bullet, having an understanding of how markets work and trusting market prices are good starting points. An asset allocation that aligns with personal risk tolerances and investment goals is also valuable. In addition, we believe that a Johns Island Financial Advisor can play a critical role in helping investors sort through these and other issues as well as keeping them focused on their long‑term goals. We’d love to get to know you; give us a call to see how we can become your trusted financial partner.

^1. As measured by the S&P 500 Index from 1926–2016.

^2. In US dollars. The S&P data are provided by Standard & Poor’s Index Services Group. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Index returns and average annual return do not reflect the cost associated with an actual investment.

^3. From January 1926–December 2016 there are 913 overlapping 15-year periods, 973 overlapping 10-year periods, 1,033 overlapping 5-year periods, and 1,081 overlapping 1-year periods. The first period starts in January 1926, the second period starts in February 1926, the third in March 1926, and so on. In US dollars. The S&P data are provided by Standard & Poor’s Index Services Group. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not an indication of future results.

^4. Source: Dimensional Fund Advisors with edits by Coastal Wealth Advisors, LLC