Tag Archives: Investing

The Psychology Behind Your Worst Investment Decisions | Kiplinger Magazine

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“When it comes to investing, we have met the enemy, and it’s us.” Kiplinger Magazine

Excited by profit and terrified of loss, we let our emotions and minds trick us into making terrible investing decisions, writes Katherine Reynolds Lewis of Kiplinger Magazine.

Most individual investors allow their emotions to dictate their investment decisions. Effectively, there are two types of emotional reactions the average investor can experience:

Fear of Missing Out (FOMO). These investors will chase stocks that appear to be doing well, for fear of missing out on making money. This leads to speculation without regard for the underlying investment strategy. Investors can’t afford to get caught up in the “next big craze,” or they might be left holding valueless stocks when the craze subsides.

  • Fear of Missing Out (FOMO) can lead to speculative decision-making in emerging areas that are not yet established.
  • Fear of Losing Everything (FOLE) is a more powerful emotion that comes from the fear that they will lose all of their investment.

Acording to a 2021 Dalbar study of investor behavior, Dalbar found that individual fund investors consistently underperformed the market over the 20 years ending Dec. 31, 2020, generating a 5.96% average annualized return compared with 7.43% for the S&P 500 and 8.29% for the Global Equity Index 100.

“As humans, we’re wired to act opposite to our interests,” says Sunit Bhalla, a certified financial planner in Fort Collins, Colo. “We should be selling high and buying low, but our mind is telling us to buy when things are high and sell when they’re going down. It’s the classic fear-versus- greed fight we have in our brains.”

Avoiding these seven “emotional and behaviorial” investing traps will allow you to make rational investments.

  1. Fear of Missing Out – Like sheep, investors often take their cues from other investors and sometimes follow one another right over a market cliff. This herd mentality stems from a fear of missing out.  The remedy: By the time you invest in whatever is trending, it’s too late because professional investors trade the instant that news breaks. Individual investors should buy and sell based on the fundamentals of an investment, not the hype.
  2. Overconfidence – Some investors tend to overestimate their abilities. They believe they know better than everyone else about what the market is going to do next, says Aradhana Kejriwal, chartered financial analyst and founder of Practical Investment Consulting in Atlanta. “We want to believe we know the future. Our brains crave certainty.” The remedy: To combat overconfidence, build in a delay before you buy or sell an investment so that the decision is made rationally.
  3. Living in an Echo Chamber – Overconfidence sometimes goes hand in hand with confirmation bias, which is the tendency to seek out only information that confirms our beliefs. If we think an asset holds promise for riches, news about people making money sticks in our minds more than negative news, which we tend to dismiss. The remedy: To counteract this bias, actively seek out information that contradicts your thesis.
  4. Loss Aversion – Our brains feel pain more strongly than they experience pleasure. As a result, we tend to act more irrationally to avoid losses than we do to pursue gains. The remedy: Stock market losses, however, are inevitable.If seeing the losses pile up in a down market is too hard for you, simply don’t look. Have faith in your long-term investing strategy, and check your portfolio less often.
  5. No Patience for Sitting Idly By – As humans, we’re wired for action. That compulsion to act is known as action bias, and it’s one reason individual investors can’t outperform the market — we tend to trade too often. Doing so not only incurs trading fees and commissions, which eat into returns, but more often than not, we realize losses and miss out on potential gains. The remedy: Investors need to play the long game. Resist trading just for the sake of making a decision, and just buy and hold instead.
  6. Gambler’s Fallacy – “This is the tendency to overweight the probability of an event because it hasn’t recently occurred,” says Vicki Bogan, associate professor at Cornell University. Over time, the probability of equities having an up year or a down year is about the same, regardless of the previous year’s performance. That’s true for individual stocks as well. The remedy: When stocks go down, don’t just assume they’ll come back up. “You should be doing some analysis to see what’s going on,” Bogan says.
  7. Recency Bias – Past performance is no guarantee of future results. Yet, our minds tell us something different. “Most people think what has happened recently will continue to happen,” Bhalla says. It’s why investors will plow more money into a soaring stock market, when in fact they should be selling at least some of those appreciated shares. And if markets plummet, our brains tell us to run for the exits instead of buying when share prices are down.The remedy: You can combat this impulse by creating a solid, balanced portfolio and rebalancing it every six  months. That way, you sell the assets that have climbed and buy the ones that have fallen. “It forces us to act opposite to what our minds are telling us,” he says.

It is wise to always keep in mind that the market is volatile as a result of investors’ emotions and behaviors, and thus does not move logically.

References:

  1. https://www.kiplinger.com/investing/603153/the-psychology-behind-your-worst-investment-decisions

by: Katherine Reynolds Lewis – July 22, 2021

Price Line vs. Earnings Line

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“A quick way to tell if a stock is overpriced is to compare the price line to the earnings line. If you bought familiar growth companies – such as Shoney’s, The Limited, or Marriott – when the stock price fell well below the earnings line, and sold them when the stock price rose dramatically above it, the chances are you’d do pretty well.” Peter Lynch

As the former head of Fidelity’s flagship Magellan Fund, Peter Lynch produced an annualized rate of return of 29.2% over his 13-year stint at the helm. This track record has arguably placed him as the best mutual fund manager of all time.

In his best-selling book, “One Up On Wall Street,” Lynch revealed a powerful charting tool, called the “Peter Lynch chart,” that greatly simplified his investment decisions. This simple graph plots the stock price against its “earnings line,” a theoretical price equal to 15 times the earnings per share.

When a stock trades well below its earnings line, you should buy, according to Lynch’s theory. When it rises above its earnings line, you should sell. For example, the Wal-Mart Stores (ticker: WMT ) share-price line fell below the Lynch line at about $55 in March 2010. It didn’t climb back over the Lynch line until June 2012, when shares were $67.50. Had you bought the first crossover and sold the second, you would have gained $12.50 a share, or about 23%.

The idea behind this technique is simple. Lynch believe that mature, stable companies are worth roughly 15 times their annual earnings. And over the last 135 years, this has proven to be the mean valuation of the S&P 500 index.

This is known as a the P/E ratio. It is merely the price of the stock divided by its earnings per share. The resulting multiple represents how many times you are paying for last year’s earnings at today’s stock price.

All things being equal, the lower the number the better. Low P/E ratios mean that you are getting more earnings for your investment dollar. And since most large cap stocks eventually trade for at least 15 times earnings, you are more likely to see your shares appreciate as they return to the 15 P/E level.

This simple idea was the basis of Lynch’s investment approach and the reason he created the chart whichconsists of only two lines. The first is the stock price. The second is the hypothetical stock price if it were to trade at a P/E of 15 (the earnings line).

It is a well-known fact among experienced investors that a stock’s price follows its earnings. Over multi-year periods, stock prices move in sync with changing company earnings.

But over the short term, stock prices are unpredictable. This is what creates valuable opportunities for savvy and patience investors.

Furthermore, a good rule of thumb is that the P/E ratio of any fairly valued company will equal its earnings growth rate. A company with a P/E ratio that is half its growth rate is very positive. A company with a P/E ratio that is twice its growth rate is deemed negative.

Thirteen attributes you should investigate for in a stock with the potential for 10x growth, according to Peter Lynch:

  1. The company name is dull or ridiculous.
  2. The company does something dull and boring
  3. The company does something disagreeable or disgusting.
  4. The company is a spin-off like the Baby Bells.
  5. Institutions don’t own it and analysts don’t follow it.
  6. There are negative rumors about it, like Waste Management.
  7. There is something depressing about it such as SRB, which provides burial services.
  8. That it is a company in a no growth industry, since it’s in a non competitive business.
  9. It has a niche such as drug companies.
  10. People have to keep buying the products such as drugs, food and cigarettes.
  11. The company is the user of technology such as Domino’s.
  12. The company insiders are buyers of the stock.
  13. The company is buying back its shares.

Best stocks to avoid is the hottest stock in the hottest industry. Negative growth industries do not attract competitors. Additionally, avoid companies with excessive debt on its balance sheet and invest in companies that have little or no debt.

The debt must always be lower than the equity. If the company has a debt lower than 50% of the equity, it is considered to be in a good financial position. If it is lower than 25%, it’s excellent. When the debt is above 75% of the equity, it is recommended to avoid that company.

References:

  1. https://finance.yahoo.com/news/peter-lynch-earned-29-13-231636799.html
  2. https://tofinancialfreedom.co/en/one-up-on-wall-street-summary-book/
  3. https://www.forbes.com/sites/investor/2021/04/16/lynchs-one-up-on-wall-street-inspired-screening-strategy/

Investing Truths by Peter Lynch

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“Wisdom acquisition is a moral duty. It’s not something you do just to advance in life. Wisdom acquisition is a moral duty. As a corollary to that proposition which is very important, it means that you are hooked for lifetime learning. And without lifetime learning, you are not going to do very well.”  Charlie Munger

Peter Lynch stressed the importance of looking at the underlying business enterprise strength, which he believed eventually shows up in the company’s long-term stock price performance. Also, pay a reasonable price relative to the company’s market value.

Here are important investing truths from Peter Lynch:

  1. Know what you own and be able to explain why you own it.  Only buy what you understand. ” Never invest in any company before you’ve done the homework on the company’s earnings prospects, financial condition, competitive position, plans for expansion, and so forth.”
  2. Compounding of capital and principal takes time. Be patient, because most great wealth from the stock market is built over decades. “Often, there is no correlation between success of a company’s operations and the success of its stock over a few months or even years. In the long term, there is 100% correlation between the success of the company and the success of the stock. This disparity is the key to making money; it pays to be patient and to own successful companies.”
  3. Simple is usually better than complex and smart. “If you’re prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won’t get bored.”
  4. Volatility of the stock market is guaranteed. “You’ve got to look in the mirror every day and say: What am I going to do if the market goes down 10%? What do I do if it goes down 20%? Am I going to sell? Am I going to get out? If that’s your answer, you should consider reducing your stock holdings today.”
  5. Finding undervalued companies selling below their intrinsic value is a lot harder today. “A stock-market decline is as routine as a January blizzard in Colorado. If you’re prepared, it can’t hurt you. A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic.”
  6. Start early and at a very eary age. Invest for the long term…stocks are relatively predictable over 10-20 years. “Time is on your side when you own shares of superior companies. You can afford to be patient – even if you missed Walmart (WMT, Financial) in the first five years, it was a great stock to own in the next five years. Time is against you when you own options.”
  7. Focus on the company behind the stock. Do not become overly attached to a stock. “Although it’s easy to forget sometimes, a share is not a lottery ticket…it’s part-ownership of a business.”
  8. Don’t try to predict the market. “Nobody can predict the interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what‘s actually happening to the companies in which you’ve invested.”
  9. Study history. Market crashes are great opportunities. “During the Gold Rush, most would-be miners lost money, but people who sold them picks, shovels, tents, and blue-jeans (Levi Strauss) made a nice profit. Today, you can look for non-internet companies that indirectly benefit from internet traffic (package delivery is an obvious example); or you can invest in manufacturers of switches and related gizmos that keep the traffic moving.”
  10. It’s very tough for a company to go bankrupt if a company has more cash than debt or if they do not have debt. “The real key to making money in stocks is not to get scared out of them.”
  11. When you own stocks, it will alwalys be scary due to volatility and there is always something to worry about.  Everyone is a long term investor until stocks go down. “There is always something to worry about. Avoid weekend thinking and ignore the latest dire predictions of newscasters. Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.”
  12. When yields on long-term government bonds exceed the dividend yields of the S&P 500 by 6% or more, sell stocks and buy bonds. ““In the long run, a portfolio of well-chosen stocks and/or equity mutual funds will always outperform a portfolio of bonds or a money-market account. In the long run, a portfolio of poorly chosen stocks won’t outperform the money left under the mattress.”

Emotions can be a real performance killer according to Lynch, if market drops get you selling out in a panic, or market surges have you greedily snapping up overvalued shares. The best investors will do the opposite.

“The single greatest edge an investor can have is a long-term orientation.” Seth Klarman

References:

  1. https://www.investopedia.com/articles/stocks/06/peterlynch.asp
  2. https://www.fool.com/retirement/2020/04/07/9-investing-tips-from-peter-lynch-that-you-shouldn.aspx
  3. https://www.gurufocus.com/news/341584/peter-lynch-golden-rules-for-investing-
  4. https://www.valuewalk.com/2015/07/peter-lynchs-investing-principles-and-25-golden-rules/
  5. https://www.suredividend.com/peter-lynch-investing-lessons/

The Importance of Return on Equity

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ROE measures how much profit a company generates per dollar of shareholders’ equity.

Return on equity (ROE) is a must-know financial ratio. It is one of many numbers investors can use to measure return and support investing decision. It measures how many dollars of profit are generated by a company’s management for each dollar of shareholder’s equity.

The metric reveals just how well the company utilizes its equity to generate profits.  It reveals the company’s efficiency at turning shareholder investments into profits and explains, mathematically, the ratio of a company’s net income relative to its shareholder equity.

ROE is very useful for comparing the performance of similar companies in the same industry and can show you which are making most efficient use of their (and by extension investors’) money.

Billionaire investor Warren Buffett uses ROE as part of his investment decision making process. Buffet cares deeply about a company that uses its money wisely and efficiently. He believes that a successful stock investment is a result first and foremost of the underlying business; its value to the owner comes primarily from its ability to generate earnings at an increasing rate each year.

Buffett examines management’s use of owner’s equity, looking for management that has proven it is able to employ equity in new moneymaking ventures, or for stock buybacks when they offer a greater return.

What is ROE

Return on equity is a ratio of a public company’s net income to its shareholders’ equity, or the value of the company’s assets minus its liabilities. This is known as shareholders’ equity because it is the amount that would be divided up among those who held its stock if a company closed.

The basic formula for calculating ROE simply is to divide net income from a given period by shareholder equity. The net earnings can be found on the earnings statement from the company’s most recent annual report, and the shareholder equity will be listed on the company’s balance sheet. The specific ROE formula looks like this:

ROE = (Net Earnings / Shareholders’ Equity) x 100 or EPS / Book Value

“ROE tells you how good or bad management is doing with your investment,” says Mike Bailey, director of research at FBB Capital Partners in Bethesda, Maryland. “Higher ROEs generally stem from profitable businesses that enjoy competitive advantages within a given industry.”

A high ROE doesn’t always mean management is efficiently generating profits. ROE can be affected by the amount that a company borrows.

Increasing debt can cause ROE to grow even when management is not necessarily getting better at generating profit. Share buybacks and asset write-downs may also cause ROE to rise when the company’s profit is declining.

On the other hand, idle cash in excess of what the business needs to continue operations reduces the apparent profitability of the company when measured by return on equity. Distributing idle cash to shareholders is an effective way to boost its return on equity.

Key Takeaway

Return on Equity measures how efficiently a company generates net income based on each dollar invested by company’s shareholders.

A steady or increasing ROE is a company that knows how to successfully reinvest their earnings. This is important because most companies retain their earnings in the equity of the business.

A declining ROE is symbolic of executive management that is unable to successfully reinvest their capital in income producing assets. Companies like this should elect to pay most of their earnings to shareholders as dividends.

References:

  1. https://smartasset.com/investing/return-on-equity
  2. https://www.forbes.com/advisor/investing/roe-return-on-equity/
  3. https://www.nasdaq.com/articles/5-ways-improve-return-equity-2015-01-21
  4. https://money.usnews.com/investing/articles/what-is-return-on-equity-the-ultimate-guide-to-roe

The Laws of Wealth by Daniel Crosby

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“Get rid of the excuses and get invested.” Fidelity Investment

Daniel Crosby, author of The Laws of Wealth, presents 10 rules of behavioral self-management.

Rule #1 – You Control What Matters Most. “The behavior gap measures the loss that the average investor incurs as a result of emotional responses to market conditions.” As an example, the author notes that the best performing mutual fund during the period 2000-2010 was CGM Focus, with an 18.2% annualized return; however the average investor in the fund had a negative return! The reason is that they tended to buy when the fund was soaring and sell in a panic when the price dipped. More on volatility later…

Rule #2 — You Cannot Do This Alone. “Vanguard estimated that the value added by working with a competent financial advisor is roughly 3% per year… The benefits of working with an advisor will be ‘lumpy’ and most concentrated during times of profound fear and greed… The best use of a financial advisor is as a behavioral coach rather than an asset manager.” Make sure your advisor is a fiduciary. “A fiduciary has a legal requirement to place his clients’ interest ahead of his own.”

Rule #3 – Trouble Is Opportunity. “The market feels most scary when it is actually most safe… Corrections and bear markets are a common part of any investment lifetime, they represent long-term buying opportunity and a systematic process is required to take advantage of them.” The author quotes Ben Carlson: “Markets don’t usually perform the best when they go from good to great. They actually show the best performance when things go from terrible to not-quite-so-terrible as before.”

To do this is by keeping some assets in cash a buy list of stocks that are great qualitly, have a strong balance sheet and a strong brand, but are expensive.

Rule #4 – If You’re Excited, It’s a Bad Idea. “Emotions are the enemy of good investment decisions.”

Rule #5 – You Are Not Special. “A belief in personal exceptionality causes us to ignore potential danger, take excessively concentrated stock positions and stray from areas of personal competence… An admission of our own mediocrity is what is required for investment excellence… This tendency to own success and outsource failure [known as fundamental attribution error] leads us to view all investment successes as personal skill, thereby robbing us of opportunities for learning as well as any sense of history. When your stocks go up, you credit your personal genius. When your stocks go down, you fault externalities. Meanwhile, you learn nothing.”

Rule #6 – Your Life Is the Best Benchmark. “As a human race, we are generally more interested in being better than other people than we are in doing well ourselves.” However, “measuring performance against personal needs rather than an index has been shown to keep us invested during periods of market volatility, enhance savings behavior and help us maintain a long-term focus.”

Rule #7 – Forecasting Is For Weathermen. “The research is unequivocal—forecasts don’t work. As a corollary, neither does investing based on these forecasts…. Scrupulously avoid conjecture about the future, rely on systems rather than biased human judgment and be diversified enough to show appropriate humility.”

Rule #8 – Excess Is Never Permanent. “We expect that if a business is well-run and profitable today this excellence will persist.” The author quotes James O’Shaughnessy: “‘The most ironclad rule I have been able to find studying masses of data on the stock market, both in the United States and developed foreign markets, is the idea of reversion to the mean.’ Contrary to the popular idea of bear markets being risky and bull markets being risk-free, the behavioral investor must concede that risk is actually created in periods of market euphoria and actualized in down markets.”

Rule #9 – Diversification Means Always Having to Say You’re Sorry. “You can take it to the bank that some of your assets will underperform every single year… The simple fact is that no one knows which asset classes will do well at any given time and diversification is the only logical response to such uncertainty… Broad diversification and rebalancing have been shown to add half a percentage point of performance per year, a number that can seem small until you realize how it is compounded over an investment lifetime.”

Rule #10 – Risk Is Not a Squiggly Line. “Wall Street is stuck in a faulty, short-sighted paradigm that views risk as a mathematical reduction [of volatility]… a flaw that can be profitably exploited by the long-term, behavioral investor who understands the real definition of risk… Volatility is the norm, not the exception, and it should be planned for and diversified against, but never run from… Let me say emphatically, there is no greater risk than overpaying for a stock, regardless of its larger desirability as a brand.”

One of the most interesting concepts in the book is that investing in an index is not as passive as we might assume. Crosby quotes Rob Arnott: “‘The process is subjective—not entirely rules based and certainly not formulaic. There are many who argue that the S&P 500 isn’t an index at all: It’s an actively managed portfolio selected by a committee—whose very membership is a closely guarded secret!—and has shown a stark growth bias throughout its recent history of additions and deletions… The capitalization-weighted portfolio overweights the overvalued stocks and underweights the undervalued stocks…’ In a very real sense, index investing locks in the exact opposite of what we ought to be doing and causes us to buy high and sell low… Buying a capitalization weighted index like the S&P 500 means that you would have held nearly 50% tech stocks in 2000 and nearly 40% financials in 2008.”

“Once we realize that passive indexes are not mined from the Earth, but rather assembled arbitrarily by committee, the most pertinent question is not if you are actively investing (you are) but how best to actively invest.”

“Behavioral risk is the potential for your actions to increase the probability of permanent loss of capital… Behavioral risk is a failure of self… Our own behavior poses at least as great a threat as business or market risks… We must design a process that is resistant to emotion, ego, bad information, misplaced attention and our natural tendency to be loss averse.”

Crosby presents rule-based behavioral investment, or RBI for short. “The myriad behavior traps to which we can fall prey can largely be mitigated through the simple but elegant process that is RBI. The process is easily remembered by the following four Cs:

  1. Consistency – frees us from the pull of ego, emotion and loss aversion, while focusing our efforts on uniform execution.
  2. Clarity – we prioritize evidence-based factors and are not pulled down the seductive path of worrying about the frightening but unlikely or the exciting but useless.
  3. Courageousness – we automate the process of contrarianism: doing what the brain knows best but the heart and stomach have trouble accomplishing.
  4. Conviction – helps us walk the line between hubris and fear by creating portfolios that are diverse enough to be humble and focused enough to offer a shot at long-term outperformance.”

“Rule-based investing is about making simple, systematic tweaks to your investment portfolio to try and get an extra percentage point or two that has a dramatic positive impact on managing risk and compounding your wealth over time… We know that what works are strategies that are diversified, low fee, low turnover and account for behavioral biases.”

“Just like a casino, you will stick to your discipline in all weather, realizing that if you tilt probability in your favor ever so slightly, you will be greatly rewarded in the end… Becoming a successful behavioral investor looks a great deal like being The House instead of The Drunken Vacationer.”

The author quotes Jason Zweig: “You will do a great disservice to yourselves… if you view behavioral finance mainly as a window onto the world. In truth, it is also a mirror that you must hold up to yourselves.”

Crosby, Daniel. The Laws of Wealth: Psychology and the Secret to Investing Success. Hampshire, Great Britain: Harriman House, 2016.

7 Investing Principles

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The fundamentals you need for investing success.  Charles Schwab & Co., Inc

1. Establish a financial plan based on your goals

  • Be realistic about your goals
  • Review your plan at least annually
  • Make changes as your life circumstances change

Successful planning can help propel your net worth. Committing to a plan can put you on the path to building wealth. Investors who make the effort to plan for the future are more likely to take the steps necessary to achieve their financial goals.

A financial plan can help you navigate major life events, like buying a new house.

2. Start saving and investing today

  • Maximize what you can afford to invest
  • Time in the market is key
  • Don’t try to time the markets—it’s nearly impossible.

It pays to invest early.  Maria and Ana each invested $3,000 every year on January 1 for 10 years—regardless of whether the market was up or down. But Maria started 20 years ago, whereas Ana started only 10 years ago. So although they each invested a total of $30,000, by 2020 Maria had about $66,000 more because she was in the market longer.

Don’t try to predict market highs and lows. 2020 was a very volatile year for investing, so many investors were tempted to get out of the market—but investors withdrew at their peril. For example, if you had invested $100,000 on January 1, 2020 but missed the top 10 trading days, you would have had $51,256 less by the end of the year than if you’d stayed invested the whole time.

3. Build a diversified portfolio based on your tolerance for risk

  • Know your comfort level with temporary losses
  • Understand that asset classes behave differently
  • Don’t chase past performance

Colorful quilt chart showing why diversification makes long-term sense. The chart shows that it’s nearly impossible to predict which asset classes will perform best in any given year.

Asset classes perform differently. $100,000 invested at the beginning of 2000 would have had a volatile journey to nearly $425,000 by the end of 2020 if invested in U.S. stocks. If invested in cash investments or bonds, the ending amount would be lower, but the path would have been smoother. Investing in a moderate allocation portfolio would have captured some of the growth of stocks with lower volatility over the long term.

4. Minimize fees and taxes; eliminate debt

  • Markets are uncertain; fees are certain
  • Pay attention to net returns
  • Minimize taxes to maximize returns
  • Manage  and reduce debt

Fees can eat away at your returns. $3,000 is invested in a hypothetical portfolio that tracks the S&P 500 Index every year for 10 years, then nothing is invested for the next 10 years. Over 20 years, lowering fees by three-quarters of a percentage point would save roughly $13,000.

5. Build in protection against significant losses

  • Modest temporary losses are okay, but recovery from significant losses can take years
  • Use cash investments and bonds for diversification
  • Consider options as a hedge against market declines—certain options strategies can be designed to help you offset losses

Diversify to manage risk. Investing too much in any single sector or asset class can result in major losses when markets are volatile.

6. Rebalance your portfolio regularly

  • Be disciplined about your tolerance for risk
  • Stay engaged with your investments
  • Understand that asset classes behave differently

Regular rebalancing helps keep your portfolio aligned with your risk tolerance. A portfolio began with a 50/50 allocation to stocks and bonds and was never rebalanced. Over the next 10 years, the portfolio drifted to an allocation that was 71% stocks and only 29% bonds—leaving it positioned for larger losses when the COVID-19 crash hit in early 2020 than it would have experienced if it had been rebalanced regularly.

7. Ignore the noise

  • Press makes noise to sell advertising
  • Markets fluctuate
  • Stay focused on your plan

Progress toward your goal is more important than short-term performance. Over 20 years, markets went up and down—but a long-term investor who stuck to her plan would have been rewarded.

References:

  1. https://www.schwab.com/investing-principles

Closing the Black Wealth Gap

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Black families have one-eighth the wealth of white families as a result of economic discrimination and institutionalized racism.

This year marks the 100th anniversary of the Tulsa Race Massacres. Over two days, a white mob in the city’s Black district of Greenwood killed an estimated 300 Black Americans and left nearly 10,000 destitute and homeless. The Greenwood area was known as Black Wall Street, an epicenter of Black business and culture.

The Tulsa Race Massacres is just one many thousands of violent and economic incidents throughout American history that created the wealth gap. As such, the Black wealth gap was created through centuries of institutional racism and economic discrimination that limited opportunities for African-Americans.

Wealth was taken from these communities before it had the opportunity to grow. This history matters for contemporary inequality in part because its legacy is passed down generation-to-generation through unequal monetary inheritances which make up a great deal of current wealth.

The racial wealth gap is a chasm with Black families owning one-eighth the wealth of white families. According to the Survey of Consumer Finances, in 2019, the median net worth of Black households was $24,000 as opposed to $189,000 for white households. This shortfall in financial wealth creates a cascade of inequalities in education, homeownership, and simply saving for emergencies.

Historically, Blacks were limited to certain neighborhoods and had more trouble borrowing to buy a home than white home buyers. Additionally, Black workers don’t advance to the top positions in companies at a proportional rate as other groups.

Moreover, African American families have had fewer opportunities to build generational wealth through home ownership, investments and inheritance. In this century, many Black families were stripped of their wealth and financial security by by both public and private institutionalized racism whether called Jim Crow or redline policies.

There are other factors: Many African-Americans, particularly older ones, are too conservative as investors. Only 34% of Black families own stocks, while more than half of white families do, according to a Federal Reserve. It is important to help African American investors get more comfortable with owning risk assets such as equity stocks, ETF and mutual funds that build wealth over the long term.

Do not seek shortcuts to build wealth

You must build wealth over time. If you’re saving 15% or 20% of your income over 30 years, there’s a good chance you will be wealthy. These methods truly work whether you’re making $50,000 or making $500,000 a year.

‘We just had an 11-year bull market. If you didn’t take the appropriate amount of risk, you’re significantly behind,” says Malik Lee, an Atlanta financial advisor whose clientele is more than 90% African-American.

American Dream for Black families

The heart of the American Dream for Black families is financial wellness, independence and freedom. There are many ways to express the American Dream, including owning their home, not living paycheck to paycheck, and being able to travel. Today, 69% of African American families are confident the American Dream is still attainable, according to MassMutual’s ‘State of the American Family’ survey.

Financial wellness for most families is the heart of the American Dream. American families tend to view financial wellness in terms of five common financial priorities:

  • Having an emergency fund
  • Feeling confident in both short-term and long-term financial decision making
  • Not carrying a lot of debt
  • Being financially prepared for the unexpected
  • Not living paycheck to paycheck

Black families are taking steps to secure their financial future and dreams, but more needs to be done to keep the American Dream alive. The top financial regret across all consumer groups surveyed is “not starting early enough.”

References:

  1. https://www.barrons.com/articles/this-advisor-wants-to-close-the-black-wealth-gap-accepting-risk-is-key-51625077456
  2. https://www.federalreserve.gov/econres/scf/dataviz/scf/chart/#series:Net_Worth;demographic:racecl4;population:1,2,3,4;units:median;range:1989,2019
  3. https://www.brookings.edu/blog/up-front/2020/02/27/examining-the-black-white-wealth-gap/
  4. https://www.massmutual.com/static/path/media/files/mc1133aa_09248mr-final.pdf
  5. https://www.forbes.com/sites/brianthompson1/2021/06/17/the-key-to-closing-the-racial-wealth-gap-black-entrepreneurship/

Saving for the Future

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“Saving is about putting aside money for future use. Investing is about putting your money to work for you with the goal of growing it over time.”

Saving money isn’t the easiest thing to do, especially if you’re one of the many of Americans living paycheck to paycheck. But saving for the future remains vitally important — not just to enable you to make large discretionary purchases such as a big screen television or a luxury vacation, but for emergencies, retirement, or buying a home.

  • Saving involves putting aside money for future use.
  • Investing involves putting your money to work for you with the goal of growing it over the long term.
  • To build your financial future, you need to do both, save for the future and invest for the long term.

Unfortunately, many of Americans aren’t where they should be financially. A 2019 Charles Schwab Modern Wealth survey found that about 59 percent of American adults are living paycheck to paycheck.

If you’re having a hard enough time paying the bills and putting food on the table without racking up debt, saving for the future is probably the last thing on your mind. Only 38% of people have an emergency fund, according to Charles Schwab, and one in five Americans don’t have a dime saved for retirement, according to a survey from Northwestern Mutual.

But, being a good saver certainly puts you ahead of the game. And having solid savings’ habits are an important step toward financial security. But saving by itself is not enough. While saving is about accumulating money for the future, investing is about growing your money over the long term. And that can make a huge difference in your financial future.

Begin your savings journey today for a better tomorrow

The hardest part about saving is getting started.

Basically, saving is putting aside money for future use. Think of saving as paying yourself first or an essential expense. From your earnings, you should take out what you intend to save for taxes first, if you’re a freelancer, and then take out 10% to 15% for savings. In other words, before you spend your first dollar on monthly expenses, first you should set aside 10% to 15% of income for your savings.

You can think of it as money you have left over once you’ve covered your essential expenses. Essentially, you should make saving a line item on your monthly budget, so that saving becomes one of your essentials. And, having money tucked away will help you pay for the things you want above and beyond your daily expenses, and also cover you in case of emergency.

Having more month left then money

A savings account is an interest-bearing account that helps you save money and earn monthly interest. Separate from your checking account and long-term investments, savings accounts can grow with regular deposits and compounding interest that you can use for your future, large purchases or emergency funds.

Having a sizeable savings account can help you stay out of debt and give you the cushion you need should you face an unexpected illness, job loss or expense. Plus, when you want something special like a week’s vacation, you’ve got the money.

Building a “cash cushion” is an important step towards financial freedom. In a cash cushion, or emergency fund, you want enough cash on hand to cover three to six months’ essential expenses.

Additionally, a well-rounded savings strategy should focus on both short-term and long-term goals, says personal financial expert, Carrie Schwab-Pomerantz CFP® major moves in order to save money — Those extra dollars are being used in two ways: to pay off debt (credit cards and student loans) and to save for a new home.

Most people keep their savings in a bank account. The upside is that it’s easily accessible and safe; the downside is that it won’t earn very much. Money in savings accounts is not likely to keep pace with inflation. Which means the money you have saved today can actually lose buying power over time. That’s why just saving isn’t enough.

Investing creates the action

Investing, on the other hand, is about putting your money to work for you with the goal of growing it over time. Here’s an example. If you put $3,000 each year in a savings account and earn 1 percent, at the end of 20 years you’d have about $67,000. If you invested that same amount of money and got an average 6 percent return over the same time period, you’d have nearly $117,000. The sooner you start saving the less you may need to save because your money gets to work that much sooner. The more you save, the more you have to invest—and the more those returns can add up.

Nobody knows, especially the talking heads in the financial entertainment media, if the stock market is going up or down tomorrow, much less six months or 12 months from now. Moreover, it should not matter if the market meltdowns one day and melt-up the next. When it goes down, you should invest. And, when it goes up, you should invest. In other words, you must consistently invest in the market. Do not let volatility and market moving news faze you, or cause a bout of investing paralysis.

Investing involves risk

Of course, investing involves risk. And the stock market particularly will have its ups and downs. But there are ‘tried and true’ ways to mitigate that risk. The key to mitigating risk is to diversify by choosing a broad range of investments in stocks, bonds, and cash based assets that aligns with your financial plan asset allocation, risk tolerance and time horizon and never put all your money in one particular stock or asset.

One other important factor is time. To protect yourself against market downturns, a long-term approach is essential. At your age, you have time to keep your money in the market and ride out the inevitable market lows. The trick is to stick with it through those lows, keeping your focus on the potential for long-term gains.

Beginning with your next paycheck, commit to paying yourself first. Develop a budget, evaluate your spending needs, and understand your long-term goals.

References:

  1. www.schwab.com/resource-center/insights/content/youre-saving-should-you-be-investing-too
  1. https://www.bustle.com/life/3-women-share-how-theyre-saving-for-their-big-life-goals
  2. https://content.schwab.com/web/retail/public/about-schwab/Charles-Schwab-2019-Modern-Wealth-Survey-findings-0519-9JBP.pdf
  3. https://news.northwesternmutual.com/2018-05-08-1-In-3-Americans-Have-Less-Than-5-000-In-Retirement-Savings

Staying the Course…Investing | Vanguard

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“The volatility of the financial markets during the first half of 2020, punctuated by the most sudden, steep decline in U.S. market history, tested the mettle of most investors. Despite the gut-wrenching drop of nearly 34% in the S&P 500 Index in just over a month, Vanguard investors held firm, sticking with their plans and, in some cases, rebalancing into equities during the downturn. This discipline ultimately results in better outcomes over the long term.”

Tim Buckley, Vanguard Chairman and CEO

“Stay the course” doesn’t mean do nothing during market volatility or drop. It means stick to your investment plan. If you’re a long term investor or retired, focus on what you can control, such as your spending and asset mix.

A willingness to weather sudden market drops is an important part of long-term investing. Although it is a natural instinct to seek to preserve capital when the market drops precipitously, too often investors remain on the sidelines and miss the inevitable recovery.

Back in March 2020 during the height of stock market volatility and as many retail investors sold stocks in a panic, most financial experts reminded investors to stay the course. They reminded investors that a balanced, diversified portfolio is built to weather tough markets. The majority of investors (83%) held fast from late February to May and didn’t transact. Even better, 9% of their clients rebalanced into the storm, buying equities and regaining their targeted asset allocations. Rebalancing helps mitigate risk, and it is a staple of their advice.

They strongly recommended keeping a long-term perspective and don’t get thrown off by short-term volatility.

Why is staying the course so important? As an extreme example, consider the investor who lost faith in the markets and cashed out on March 23, the low point in the U.S. stock market. Stocks subsequently rebounded more than 39% over the next three months; the unfortunate individual who moved to a money market fund earned a meager 0.14%. Our analysis found that about 85% of investors who fled to cash would have been better off if they had just held their own portfolio.

Additionally, just as investors should stay even-keeled during stock market downturns, they should ignore the euphoria of a sudden surge in the market and the fear of missing out on easy gains from investing in stocks such as Tesla, Apple or SalesForce.

Staying the course isn’t easy. Instead, focus on what you can do during market volatility, and you (and your portfolio) can get through difficult times of market volatility and declines. Nobody wants to spend less because the market is down. But you can control what you spend.

References:

  1. https://investornews.vanguard/what-stay-the-course-means-if-youre-retired/
  2. https://investornews.vanguard/staying-the-course-really-matters/

Sage Advice: Stay Invested

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“If you’ve got $25,000, $50,000, $100,000, you’re better off paying off any debt you have because that’s a guaranteed return.” Mark Cuban

The late Jack Bogle was fond of saying, “Nobody knows nothing.”  Which demonstrates that predicting the future is always hard, but 2020 illustrated to us just how difficult it can be. If you would’ve predicted that U.S. domestic stocks would rise over 10% in the same year as a global pandemic, no one would have believed you.  But that’s what makes markets so complex and volatile, especially in 2020, a year unlike any other.

The real problem is that there are too many economic and financial market unknowns to consider in the coming years and decade. And, he says, we, as a nation, are not focusing on what he believes to be the single most important concern in the economy: the “soaring cost of health care”. There is also the soon to be problem of pandemic caused ballooning federal deficits and national debt as a percentage of GDP.

Elected officials seem content to continue to kick the health care cost can down the road. But, with all of the potential economic uncertainty and financial market volatility, it’s hard to know what to do when it comes to investing.

The U.S. stock market is the greatest wealth-creation tool in history.

Investing in the stock market allows you to become a partial owner of thousands of profitable and growing companies. And, when paired with the power of compounding, the market is what allows you to save for retirement.

Below are five pieces of advice for investors who are worried about the turbulent economy and volatile financial markets:

  1. Keep investing. Keep putting money away. Despite fluctuations in the market, Investors should continue to save. And if the market dips? That’s okay since a lower market can be beneficial for funding longer-term goals such as retirement and education. Saving is always a good idea, and if you can add to savings when the market is low, you may be in a better position when the market goes back up.
  2. Pay attention to asset allocation. A good starting point for asset allocation, according to most financial advisors is a portfolio consisting of 65% stocks and 35% bonds. That’s it. “Stay out of the exotic stuff,” he says, however, noting that the allocations of assets may change depending on age and circumstances. If you’re younger, for example, you might skew towards investing more in stocks: you have time to take more risks. However, if you’re older, you might consider putting more in bonds, typically more conservative and consistent. But don’t tilt too far in either direction, he warns, noting that you should pay attention to the norms.
  3. Diversification is the key to any successful portfolio, and for good reason–a well-diversified portfolio can help an investor weather through the most turbulent markets. Diversification is the practice of spreading money among different investments to reduce risk. Historically, stocks, bonds, and cash have not moved up and down at the same time. The rationale is that a portfolio constructed of different kinds of assets will, on average, yield higher long-term returns and lower the risk of any individual holding or security. Diversification is a strategy that can be neatly summed up as “Don’t put all your eggs in one basket.”
  4. Expect lower returns. For years, the market was flush and paying out significant returns. That’s not going to continue. You should expect to see lower stock returns for the next 10-20 years, noting that 12% returns moving forward isn’t realistic. The same is true when it comes to bonds, he says, claiming that 6% returns are not in the cards. Managing those expectations is key.
  5. Don’t pay attention to fluctuating markets and keep putting money away so long as you are able. Remember that the markets – and your own investment strategy – may change over time. That shouldn’t make you so nervous that you bail. “Stay the course.”

If 2020 taught investors anything, it was, “Nobody knows nothing.”

It’s important to focus on saving and investing. You need to live below your means and invest the difference to accumulate wealth. There’s no backdoor trick around that fact.

References:

  1. https://investornews.vanguard/getting-started-with-investing/
  2. https://www.forbes.com/sites/kellyphillipserb/2016/06/15/vanguard-founder-jack-bogle-talks-about-taxes-investing-and-the-election/