The Full Motley -- 4Q, 2016

Whataweek!!

Historic can describe the past week, but it would be a modest start because I am not sure if there is any hyperbole to articulate the surprise win of Donald Trump in the presidential elections. Thinking back to the original notion last year that he was running being met with dismissal and smirks, and a large portion of the population were probably still dismissing and smirking the idea up through Tuesday evening. Un-/Fortunately, his supporters and Clinton's dissenters knew that the election would not be decided by words or by actions, but strictly by voting. They showed up across the nation more consistently, and that is how elections are won.

Up early on Wednesday, November 9th, I happened to tweet "The American stock markets open in a few (minutes, so) let's see whether the financial media predictions that the market will crash if Trump wins are true!" As we know now, those predictions matched the political media predictions forecasting a Clinton win in terms of accuracy (or lack thereof). The DJIA went as high as 18,650 on Wednesday, before closing at 18,589, up 1.4%. Then, it closed at 18,808, up another 1.17% on Thursday, before setting a new all-time high closing earlier today at 18,847.

As for Thursday, November 10, which was the day that I processed my regular quarterly reallocation as usual, most of the money came out of Total International Stock Index (not surprisingly, as the international markets were rising over the past three months, although tempering lately) and almost all of it went into Total Bond Market Index (also not surprisingly since the index has been volatile since peaking in July).

Meanwhile, my individual brokerage account got an unexpected surprise of its own this week in the name of Nvidia, which had been sitting with a 300% return from where I bought it two years ago. After surpassing expectations by no small amount, the stock spiked 30% today! That increase pushed my return over 400% and the promise of the stock has an even higher upside. We will have to see where it goes from here. As the cliché goes, time will tell!

The Full Motley -- 3Q, 2016

It has been an active quarter since my last reallocation with the domestic stock markets setting all-time highs amid global jitters, which in the past couple weeks have subsided and seemingly reversed. In my last quarterly update, I compared a portfolio to a collective unit of investments working toward the same goal as opposed to the way people often view them, which is as a group of investments trying to outperform the rest of the group.

To my surprise, this reallocation shifted about 1.5% of my balance (most of the time, it is under 1% and typically way less), pulling from Vanguard Total Bond Market Index, Vanguard Explorer Fund and Vanguard PRIMECAP Fund, as listed from the most highest amount remove to the least (although, all three were almost the same amount). Those assets mostly were directed into Vanguard International Stock Index Fund, and the remainder split between Vanguard High-Yield Corporate Fund and Vanguard Total Stock Market Index Fund.

The fact that bonds performed so well in the past quarter caught me by surprise. I had known that small-caps were on a rise because I own a triple-leveraged small cap ETF in an unrelated brokerage account, which has had phenomenal performance in the past couple months. I was further surprised to see my actively managed large-cap fund outperform my total market index fund. While the index fund had gained assets, it lost pace to the higher performers.

The best part of this reallocation was that I moved a large portion into my international index fund on August 10, 2016, which is the date I have set for my reallocations, and in the following days, that sector has performed relatively strong against domestic stocks. It was not market timing in the sense that the shift was anticipated, but I unwittingly found the best moment to reallocate based on the disciple of rebalancing quarterly.

Are The Poor Greedy?

Last week, I proposed an unexpectedly intriguing question. "Are the poor greedy?" It reminded me of an episode of The Simpsons where Kent Brockman introduced his segment with Marge Simpson by posing a similarly contrarian question and adding, "Most people would say 'No, of course not! What kind of stupid question is that?' But one woman says 'yes'."

As I researched the thought online, I found what was most intriguing was not the conclusion itself, but rather the schools of thought attributing greed to the poor to reach that conclusion. Equally interesting were schools of thought engaging but ultimately rejecting the notion without outright dismissing it.

Defining greed as "wanting more than enough," then the poor may often qualify. For the poor who are in debt, they bought items before earning money to spend likely in a distorted sense of entitlement or simply for instant gratification. While volunteering at a shelter that provided food to the homeless, I saw a few occasions where people tried to take more than they were allotted either by rigging the system or by sneaking more items (for the record, the overwhelming majority of recipients detested those few; in large part because they threatened the entire distribution system).

In his podcast characterizing the poor as greedy, Robert Kiyosaki started the conversation by clarifying that what we often call "greedy" should actually be called "corrupt" (an abuse of power to benefit excessive) and what greed truly is boils down to expecting to benefit before acting or earning.

Other examples can include keeping up with the Joneses, living in excess, taking shortcuts, avoiding generosity, and gambling.

All in all, the answer is a matter of some conjecture and attained through a confirmation bias. If you want to believe that the poor are greedy, then there are plenty of reasons behind it. Conversely, if you believe that the poor cannot be greedy by definition or on principle, there are reasons to support it.

There was a slow paradigm shift that occurred in the American workforce, as well as the American Dream itself. It used to be that an American man could get hired by a company, work a full shift each day, support a family, and own a home and two vehicles. Through a variety of reasons (for those who want to look beyond the simplistic portrayal of it being solely corporate corruption), the American Dream was no longer enough for a large portion of the younger population. It was as if Americans started rejecting the simple American Dream as complacent and average, and the result of wanting more predictably ended in getting less.

In a March 2008 blog, John Mayer wrote, "What I want to do is to shed a little light on why we're all in the same boat, no matter the shape of the life we lead: because every one of us were told since birth that we were special ... We were promised we could be anything that we wanted to be, if only we believed it and then, faster than we saw coming, we were set loose into the world to shake hands with the millions of other people who were told the exact same thing."

Granted, that shift was not perpetrated through that mindset, and the other side of its disappearance involved corporations demanding the same work for less money (or more work for the same pay) through a variety of methods. I would be remiss to overlook it. However, many others are overlooking their own participation in where they are now and inflating the impact of influence corporate decisions by the corrupted greedy have on their lives. While those negative forces could be a setback, the individual decisions of inaction through a chosen belief in futility is what empowers them.

The Shocking Investing Fact They Don’t Want You To Know (Reprint)

https://wallethacks.com/shocking-investing-fact/
Written by Jim Wang

Investing is simple. (no that’s not the shocking fact)

Make regular contributions into an index fund, ensure that you are diversified, wait, and shift into more conservative investments as you near the age you want to withdraw the funds. (no, that’s not it either)

Everyone knows this! They've known this for eons!

Here’s the problem... it’s also BORING. Boring with a capital B. O. R. I. N. G.

You can’t sell magazines, blog posts, or television shows with that idea. You can’t make money as a broker with that idea. You can’t make money as a financial expert with that idea. It’s too simple, it lacks excitement, and anyone can do it themselves. Good luck getting investment into your hedge fund!

In 2006 at Berkshire Hathaway’s annual meeting, Warren Buffet offered up a bet.

The bet? He could pick an investment that will beat any hedge fund manager over a period of 10 years. Head to head. Your best versus my best.

Protege Partners, a hedge fund founded in 2002 and now with approximately $2 billion in assets under management, took him up on the bet.

The stakes? Just a million bucks. No big deal to billionaires.

Here’s the best part...

Warren Buffet’s pick? An S&P 500 index fund at Vanguard! Ha!

One of the best investors in the world — Warren Buffett! The Oracle of Omaha! — chose an index fund!

When the money is truly on the line... you go with an index fund. (yep, that’s the fact!)

The Worst Kept Secret on Wall Street
Hedge fund and investment portfolio managers rarely beat index investing, especially after they take their management fee and taxes. Actively managed mutual funds cannot beat index investing, especially after fees and taxes. It’s hard to beat the market when you have to pay over 1% each year in fees!

Unlike many hedge funds, Buffett’s pick is a fund you can buy if you have $3,000 (the minimum). It costs you nothing to buy or sell (no sales load) and has an expense ratio of 0.17% (0.05% if you get the Admiral shares). If you invested $100,000, it’s just $170 a year. Your cell phone probably costs more. Way more.

Planet Money did a story about this bet and how it’s doing, with a little under two years left. They give the story a little more color with a look at both sides of the bet (it’s 21 minutes and entertaining, definitely listen to it when you can), but I bet you can guess how it’s going…

How’s the bet doing? At the end of 2015, the index fund is up 66% and the hedge fund is up only 22% (remember the market fell sharply, ~45%, in 2008). There is almost no way the hedge fund can make up the gap in two years.

Who Doesn’t Want You To Know?
The investment establishment. Other brokers. Actively managed mutual funds. Hedge fund managers and salespeople. People who make money off those higher fees or when you trade stocks, options, and other assets.

Those trillions of dollars in index funds aren’t in other funds. Actively managed funds charge north of 1% in fees. Vanguard charges a fraction of that. That’s billions of dollars a year the establishment isn’t earning (like $40+ billion) and you know they aren’t happy about that!

Do you know when those folks make money? When you buy and trade stuff. Even buy and hold is too boring for them. Pay $5 to buy a stock and hold it for ten years — they won’t make another FIVE DOLLARS until you sell. $10 in 10 years? Ha — good luck paying for those executive shirts where the collars don’t match the shirt.

This is not new news… it’s just not IN the news
The gauntlet was thrown in 2006 by Warren Buffet, but the knowledge that actively managed funds can’t beat index funds has been around for a very long time.

I remember reading about it as a teenager, in the mid-1990s, on The Motley Fool (I found this article from 1999 — “The average actively managed stock mutual fund returns approximately 2% less per year to its shareholders than the stock market returns in general.”).

It’s not new news, it’s not in the news because it’s hard to write that story more than once.

And it’s hard to get advertising from the financial establishment if you’re telling folks they don’t need the financial establishment. 🙂

Why Doesn’t Everyone Invest in Index Funds?
A lot of people do... trillions of dollars are in index funds. But a lot of people don’t...

... because index investing is boring. Buy and hold is boring.

It’s boring to write about too. How many times can this article be written? Once. If another column is due next week... what then? 🙂 I’m fortunate in that I don’t have that pressure!

That’s why you get articles about how a billionaire warns about index funds or whether “passive investment is hurting the economy.”

Do you know what else is boring but made “more exciting” by marketing and the news? Losing weight. Weight loss is at its core a math problem — consume fewer calories than your body burns. No one said it was easy because ice cream is awesome, but that’s not a weight loss problem. That’s not a math problem. That’s a human behavior problem.

Investing is the same way.

What do the most successful investors recommend?
Warren Buffet recommends index funds. In the 2013 letter to Berkshire shareholders, he shared his instructions in his will (page 20, emphasis mine):

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.

David Swensen, Yale’s chief investment officer responsible for managing their endowment, also recommends index funds. Swensen beat the market for 20 straight years (1988 to 2008). If you wanted to make a bet with a manager, he’s the guy to make it with… and he recommends index funds!

How I have my investing ice cream…
I'm not an expert when it comes to investing but I understand a lot about human behavior. I know I like a little excitement in my life.

Most of my investments are in index funds. A small piece is invested in dividend growth stocks to scratch that itch. It lets me stretch my financial analysis muscles (a tiny bit), pick a few stocks, and enjoy the little shots of dopamine whenever I see a dividend come through. That’s good enough for me.

If you have this itch, put 90% of your investments in index funds and carve off a little bit to do the “fun stuff.” Bet it on some tech companies or biotech companies. Who cares... it’s fun money. It’s like cheat days or that piece of chocolate, a little bit won’t hurt you and you can make sure you don’t do anything truly bad or dangerous.

Once you realize you’re bad at it, you can always put it back into the index fund — there are no transaction costs! 🙂

In Case of Emergency

I have written a lot about long-term planning, re-allocations and the like, but that was all before the Brexit approval on Thursday night. Now, none of that matters! An EU with only 27 countries means everything is different, so short-term planning and all-in moves are the way to go now! [/sarcasm]

Fear-mongering was at its finest in the early morning hours of Friday, June 24, 2016, as the British pound plummeted to a 30-year low and many media analysts implying that its FTSE 100 would follow suit. When it only closed down 3.15% (and our domestic markets closed down 3-4%), I quipped on Twitter, "some #Brexit collapse, I haven't been this disappointed in a sale since Prime Day!"

Why cap at 7%, I doubt I hear back

But hold on, the shockwaves of this vote could continue its tremors and the markets can still fall even further next week (which MarketWatch has inexplicably capped at 7% for reasons not even worth pursuing).

In short, the markets fluctuate. The markets crash. The markets rebound. The markets will do what markets do, and no one can predict their movements 100% of the time with an degree of accuracy. In reality, a market increasing drastically in short bursts should be every bit as alarming as those that their decreases (albeit, less painful, so any warnings are often dismissed as buzzkillers).

Both the Motley Fool (no relation) and Vanguard warned their investors about the dangers of over-reacting in times of panic, and their points are perfectly valid. All professional long-term planning has already accounted for drastic declines and for sharp increases because, for the most part, they even out in the long run. Market timing is a difficult process and a foolish endeavor. One often touted benefit of reallocation is that it shifts money according to the markets, but its moves are small so there is no drastic change after drastic shifts in either direction.

Money.CNN.com after Brexit vote

While I maintain a strict quarterly reallocation in my biggest account, I have another method that I employ in my Roth IRA where I am dollar cost averaging in monthly. For those who do not know the phrase, "dollar cost averaging" is a reference to hedging "bets" while buying into the market. When an active 401(k) plan has a set allocation to apply all new (incoming) monies, that is dollar cost averaging. Putting in the same amount with each purchase will buy less shares when the markets are higher and buy more shares when the markets are lower.

For the most part, I adhere to that philosophy. However, the little bit of market timing I will employ is when the markets have set new all-time high and retreated off that mark. Then, I start directing a higher portion of my contributions to a cash position. Keep in mind, the operative word there is "portion" because I continue contributing to both stocks and bonds during these times (because either could continue to increase overall), but the logic behind gaining a higher cash position after setting a new high in the stock market is to have liquid assets on hand to benefit when (if) stocks or just market sectors present a rare buying opportunity.

For example, people who have been putting all their money into the stock market since 2009 have been doing awfully well for themselves. By March 4, 2013, the Dow Jones Industrial Average set a new all-time high closing mark. But the gains continued for another couple years until May 19, 2015, at which point it had closed on its current all-time high of 18,300. Since that time, for a plethora of reasons that have created a single reality, the markets have not closed above that mark. However, it has not closed 17% below that mark either. Some say we are still in a bull market. Others say we are in a bear market. The correct label will depend on whether the Dow closes above that 18,300 mark before retreating 20% or not.

Either way, I am buying into the market as it increases while upping my cash position to hedge either direction the market will take. The logic being that if the markets will eventually have to pull back, but they may continue increasing significantly until then. Yet, to benefit from a market retreat, cash on hand is necessary to buy into the depleted assets. If my portfolio were 100% in stocks and the stock markets declined drastically, then obviously, I would want to buy more at the lower price. Unfortunately, my portfolio value would be decreasing at the same rate as the falling prices, so it becomes a moot point. My idealistic hope would be that I could pull money out at the peak and then reinvest it at a lower amount (ideally at the lowest point of the valley). That's an ideal "buy low, sell high" scenario. Unfortunately, any given weekday, the market could move higher than it was the day before (in which case, I may have sold my shares for a lower price, and now I would have to buy them back at a higher amount).

This is the face of uncertainty. Once there is 100% certainty in the markets, then invest 100% into the asset classes that favor that direction.

The Full Motley -- 2Q, 2016

Like it or not, it is time for another quarterly update!

I have said a lot about periodic rebalancing over the years (February 2016 marked the seventh year of this blog, albeit I missed that update due to work volumes from two jobs), but the most consistent things that I have said about its merits is that it is the most practical method to employ "buy low/sell high" methodology and that it is the most effective method to remove emotions from investing (hence my minimalist pun in the first paragraph).

The amounts being shifted each quarter are insignificantly low, typically between 1-2% of the overall portfolio. But the more telling aspect is often which fund(s) had the most movement in any given quarter. I have not missed (m)any quarterly reallocations (even if I do not write out an actual update) so each quarter, the funds begin at their intended percentage; therefore, any deviation is the result of its relative performance. This quarter, the two biggest movers were Vanguard Explorer Fund (up) and Vanguard Total International Stock Index Fund (down). Not many other sectors moved over the past three months (which are inconveniently in the middle of each quarter), which is only noteworthy insomuch that I was surprised to see the bond market index hold its own.

To the uninitiated, it would appear as though rebalancing (even the "buy low/sell high" mantra itself) would "punish winners" and "reward losers," and it would if the stock market had absolute winners and absolute losers. American culture is very competitive, so the instinct to identify winners and losers is ingrained in our minds so heavily that it feels innate. However, the opposite of competition is cooperation, and that is in fact what the allocation is in the first place. These funds are working together within the same portfolio on the basis that each year is going to be different than the past. Some years, certain assets will perform better than the high performers of yesteryear.

Understand that there are two key elements involved herein though. The first is that the investments within the portfolio are broadly diversified within an asset class and, secondly, that the asset classes are viable sectors for future years. Using the past for example, it would not make sense to invest in telephone companies after the explosion in cellphones (that is, unless the company were positioned correctly to hold its own as the paradigm shifted). Cable companies would be a dangerous asset class today if they're a pure-play cable without exposure to delivering the Internet or other streaming services to its consumers. Conversely, bonds are poised for a sharp decline -- and they have been for a number of years, which we have yet to see -- but even if the market collapsed, bonds are still viable investments thereafter so a sharp recovery could be expected. As the market declined, investors who rebalance periodically would be directing money in the asset class, so when a recovery occurred, they would have purchased a considerable amount when the assets were deflated, which reaps immediate benefits from having a lower cost average per share.

There Is No King

With all due respect to Maria, how do you solve a problem like TINA? Because "she" is becoming a problem.

From a 5% return to nothing seemingly overnight.

If pictures are worth a thousand words, then the chart of the 10-year return on a hypothetical $10,000 in Vanguard Prime Money Market Fund should say it all. In 2006 and 2007, the fund was returning a generous 5% APR. In the eight following years, the fund earned less than 0.3% APR. In other words, stashing money under the mattress or burying in the front lawn legitimately may have had a better risk-adjusted return!

The Federal Reserve Bank (the "Fed") has kept its federal funds rate significantly less than 1% since December 2008. At that time, investors were so frightened by the markets that financial stability was its own incentive, so the funds did not need to offer a corresponding interest rate (because 0% APR is higher than any loss).

Consequently, the Fed left investors with no choice but to invest in stocks. As the markets plummeted, the good money acknowledged that it was far more probable that they would rise than continue falling and, without an interest rate yield, the opportunity costs were effectively eliminated. In other words, "there is no alternative" in which to invest than stocks (which was how TINA got her name).

Initially, the returns from stocks were fantastic with the market recovering in record time with the Dow returning to its pre-October 2008 levels in about a year and setting a new all-time high in March 2013. However, maintaining an artificially low interest rates has had its negative affects otherwise.

When I first started in finance, the known expectations for retirement planning was that stocks would get 9-11%, bonds would get 6-7%, and a cash position would get 2-3% (at times, falling below the pace of inflation).  Nowadays, the revised expectations place stocks getting 6-8%, bonds getting 4-5% and cash returning nothing.

Prime Money would return $250 on $11,000 over 8 years.

Therefore, anyone approaching retirement would need to review and likely revise their retirement plans because it would be too risky (in fact, foolhardy) to expect the old school returns in investments to be restored.  The difference in current returns in all investment classes is, across the board, effectively equal to the zeroed federal funds rate.

Whether the federal funds rate (or the recent regulation changes in Money Market Funds, which are required by October 2016) boosts the return of the Money Market Funds is almost irrelevant if the retirement plan is set to the worst case scenario, which is basically where the economy is right now. Because if you have planned for the worst, then anything else is an improvement -- and having more money in retirement than needed is hard to qualify as a problem.