I have been remiss in updating this blog since my 10th anniversary in February, but I have consistently been rebalancing quarterly. This week’s rebalance came amid a volatile week in the market. Losses of 800 points one day or gains of 500 points the next day evened out to end the week with a tolerable 300-point drop. Reactions to the daily volatility would be enough to convince market-watchers that big changes were occurring daily, but from a weekly view, those changes were rather minimal. This is the difference between investing for the short-term or investing for the long run. Our retirement investments are long-term investments. It is important to understand why (and how) the investments work, and that responsibility is falling to the individual – as many other things are as well.
This week, I was listening to a panel of Asian Americans speak about their cultural difference between their home countries (or origin countries, for those who were born here) and the United States, and a lot of the differences and obstacles that they identified sounded to be as much generational situations as cultural differences. The old way of succeeding was to keep quiet, keep your head down, and you would be rewarded for loyalty. The new way of succeeding is to carve out a path for yourself and you will be rewarded with opportunity.
Times are changing, in many ways – for better or worse. Among these changes, financial stability might have been one of the advantages lost in the shift away from "keep quiet and keep your head down" being sound advice. Just as workers are not rewarded for loyalty to companies; companies are not rewarded for loyalty to the workers. The idea of retirement pensions upon completion of a 40-year career with a single company is passe (both the pension, and the 40-year career with a single company). Now we speak up for ourselves. We assert our freedoms and individuality nowadays, but our financial stability was included in that shift. We can celebrate greater financial freedom now, but that requires taking the same approach of speaking up, asking questions and not keeping our heads down. Our financial success is up to us.
Investing in mutual funds spreads loyalty (the risks and rewards) to a single company by diversifying. Diversifying will mitigate the rewards when that company succeeds greatly, but it will limit the losses if the company fails. My investments are in the Vanguard Total Stock Market Index Fund, Vanguard PRIMECAP Fund, Vanguard Total International Stock Index Fund, Vanguard Bond Market Index Fund, and Vanguard Total International Bond Index Fund. These five investments provide me access to the global market, from domestic equities (both passive and active) to international equities, as well as domestic and international bonds. While I could diversify further with higher risk investments in alternative investments (such as real estate or commodities, including gold), I keep my 401k spread across the global marketplace and leave those investments for my individual accounts, such as my Roth IRA.
Interestingly, my rebalance for this quarter pulled from all assets to place into the Total International Stock Index Fund. That fund had been underperforming relative to the other funds in my account, but there are many strategic advantages to putting more money into that fund at this time, including the slowing American economy and/or the weakening American dollar will hit my largest funds the hardest. Whether the international index appreciates or just holds ground better, it is a good investment away from those investments that are most at-risk of those looming threats. If I read the headlines in the financial media (and I do), then I could become convinced that those threats are large and nearing. In a reactionary state of mind, I would pull more from those at-risk investments and shuffle the money into this international index. But much as the weekly market movement was relatively minor compared to the daily volatility seen, watching investments too closely can be hazardous to your wealth (and mental health). I will just endure what may come with my quarterly rebalancing. I am not convinced that any changes would be best in the long run, which is where I am truly invested.
Saturday, August 17, 2019
Sunday, February 10, 2019
The Full Motley -- 10 Year Anniversary (1Q, 2019)
No matter what age you are or which period you are tracking, ten years is a long time! As it is, ten years ago today was when I started tracking my 401(k) because the markets were about as low as I could imagine them, and I was so curious what was next. As it turned out, the markets would bottom out within a month and then begin on a record long bull run that did not end until December 2018. Basically, it was a 10-year period in which it was much harder to lose money than make money!
Regardless, a lot happened in that time: I quit my job, I went to school, I attempted to re-career from the finance industry into the legal field, I ended up in the legal department of a finance company, and I had to modify my 401(k) investments when my provider changed the investment options. As of today, I am also halfway through a M.B.A. program! Having worked in finance for 10 years though, this program feels more like it is papering down my knowledge base than brand new studies, which is not a bad thing.
My current ECON class textbook had an interesting take on active management versus indexing:
"Mutual fund investors have a choice between putting their money into actively managed mutual funds or into passively managed index funds. Actively managed funds constantly buy and sell assets in an attempt to build portfolios that will generate average expected rates of return that are higher than those of other portfolios possessing a similar level of risk. In terms of Figure 35.3, they try to construct portfolios similar to point A, which has the same level of risk as portfolio B but a much higher average expected rate of return. By contrast, the portfolios of index funds simply mimic the assets that are included in their underlying indexes and make no attempt whatsoever to generate higher returns than other portfolios having similar levels of risk.
"As a result, expecting actively managed funds to generate higher rates of return than index funds would seem only natural. Surprisingly, however, the exact opposite actually holds true. Once costs are taken into account, the average returns generated by index funds trounce those generated by actively managed funds by well over 1 percent per year. Now, 1 percent per year may not sound like a lot, but the compound interest formula of equation 1 shows that $10,000 growing for 30 years at 10 percent per year becomes $170,449.40, whereas that same amount of money growing at 11 percent for 30 years becomes $220,892.30. For anyone saving for retirement, an extra 1 percent per year is a very big deal.
"Why do actively managed funds do so much worse than index funds? The answer is twofold. First, arbitrage makes it virtually impossible for actively managed funds to select portfolios that will do any better than index funds that have similar levels of risk. As a result, before taking costs into account, actively managed funds and index funds produce very similar returns. Second, actively managed funds charge their investors much higher fees than do passively managed funds, so that, after taking costs into account, actively managed funds do worse by about 1 percent per year.
"Let us discuss each of these factors in more detail. The reason that actively managed funds cannot do better than index funds before taking costs into account has to do with the power of arbitrage to ensure that investments having equal levels of risk also have equal average expected rates of return. As we explained above with respect to Figure 35.3, assets and portfolios that deviate from the Security Market Line (SML) are very quickly forced back onto the SML by arbitrage, so that assets and portfolios with equal levels of risk have equal average expected rates of return. This implies that index funds and actively managed funds with equal levels of risk will end up with identical average expected rates of return despite the best efforts of actively managed funds to produce superior returns.
"The reason actively managed funds charge much higher fees than index funds is because they run up much higher costs while trying to produce superior returns. Not only do they have to pay large salaries to professional fund managers, but they also have to pay for the massive amounts of trading that those managers engage in as they buy and sell assets in their quest to produce superior returns. The costs of running an index fund are, by contrast, very small since changes are made to an index fund’s portfolio only on the rare occasions when the fund’s underlying index changes. As a result, trading costs are low and there is no need to pay for a professional manager. The overall result is that while the largest and most popular index fund currently charges its investors only 0.18 percent per year for its services, the typical actively managed fund charges more than 1.5 percent per year.
"So why are actively managed funds still in business? The answer may well be that index funds are boring. Because they are set up to mimic indexes that are in turn designed to show what average performance levels are, index funds are by definition stuck with average rates of return and absolutely no chance to exceed average rates of return. For investors who want to try to beat the average, actively managed funds are the only way to go."
Fairly rousing endorsement for what I have been following in the past 10+ years. Of course, the recurring question has been whether rebalancing quarterly has been too often, but this past quarter is a good example of its merits. On November 10, 2018, we had no idea what the next three months would be like! The markets were shaky, but a Christmas Eve Massacre saw the Dow plummet 650 points.
There were two ways to go: one, panic and make immediate changes or two, stay the course. In this case, staying my course involved weathering the fall for the next two months and then buying into the depleted markets by moving other assets that might have appreciated in that time. As it turned out, the market has recovered most of its losses since its recent lows, so staying the course was the best choice.
Therefore, my move for this rebalance was minor (as the past several have been). Instead of taking money from the stock funds though, this time I put money into those stock funds. Specifically, I took 1.5% from my International Stock Index Fund, 4.7% from my Bond Market Index Fund, and 4% from my International Bond Fund, and I placed that amount into my PRIMECAP Fund (53%) and my Total Stock Market Index Fund (47%). Nothing close to approaching 10%, but just like in baseball, winning in wealth creation is more about the consistent singles and doubles than the occasional home runs.
Regardless, a lot happened in that time: I quit my job, I went to school, I attempted to re-career from the finance industry into the legal field, I ended up in the legal department of a finance company, and I had to modify my 401(k) investments when my provider changed the investment options. As of today, I am also halfway through a M.B.A. program! Having worked in finance for 10 years though, this program feels more like it is papering down my knowledge base than brand new studies, which is not a bad thing.
My current ECON class textbook had an interesting take on active management versus indexing:
"Mutual fund investors have a choice between putting their money into actively managed mutual funds or into passively managed index funds. Actively managed funds constantly buy and sell assets in an attempt to build portfolios that will generate average expected rates of return that are higher than those of other portfolios possessing a similar level of risk. In terms of Figure 35.3, they try to construct portfolios similar to point A, which has the same level of risk as portfolio B but a much higher average expected rate of return. By contrast, the portfolios of index funds simply mimic the assets that are included in their underlying indexes and make no attempt whatsoever to generate higher returns than other portfolios having similar levels of risk.
"As a result, expecting actively managed funds to generate higher rates of return than index funds would seem only natural. Surprisingly, however, the exact opposite actually holds true. Once costs are taken into account, the average returns generated by index funds trounce those generated by actively managed funds by well over 1 percent per year. Now, 1 percent per year may not sound like a lot, but the compound interest formula of equation 1 shows that $10,000 growing for 30 years at 10 percent per year becomes $170,449.40, whereas that same amount of money growing at 11 percent for 30 years becomes $220,892.30. For anyone saving for retirement, an extra 1 percent per year is a very big deal.
"Why do actively managed funds do so much worse than index funds? The answer is twofold. First, arbitrage makes it virtually impossible for actively managed funds to select portfolios that will do any better than index funds that have similar levels of risk. As a result, before taking costs into account, actively managed funds and index funds produce very similar returns. Second, actively managed funds charge their investors much higher fees than do passively managed funds, so that, after taking costs into account, actively managed funds do worse by about 1 percent per year.
"Let us discuss each of these factors in more detail. The reason that actively managed funds cannot do better than index funds before taking costs into account has to do with the power of arbitrage to ensure that investments having equal levels of risk also have equal average expected rates of return. As we explained above with respect to Figure 35.3, assets and portfolios that deviate from the Security Market Line (SML) are very quickly forced back onto the SML by arbitrage, so that assets and portfolios with equal levels of risk have equal average expected rates of return. This implies that index funds and actively managed funds with equal levels of risk will end up with identical average expected rates of return despite the best efforts of actively managed funds to produce superior returns.
"The reason actively managed funds charge much higher fees than index funds is because they run up much higher costs while trying to produce superior returns. Not only do they have to pay large salaries to professional fund managers, but they also have to pay for the massive amounts of trading that those managers engage in as they buy and sell assets in their quest to produce superior returns. The costs of running an index fund are, by contrast, very small since changes are made to an index fund’s portfolio only on the rare occasions when the fund’s underlying index changes. As a result, trading costs are low and there is no need to pay for a professional manager. The overall result is that while the largest and most popular index fund currently charges its investors only 0.18 percent per year for its services, the typical actively managed fund charges more than 1.5 percent per year.
"So why are actively managed funds still in business? The answer may well be that index funds are boring. Because they are set up to mimic indexes that are in turn designed to show what average performance levels are, index funds are by definition stuck with average rates of return and absolutely no chance to exceed average rates of return. For investors who want to try to beat the average, actively managed funds are the only way to go."
Fairly rousing endorsement for what I have been following in the past 10+ years. Of course, the recurring question has been whether rebalancing quarterly has been too often, but this past quarter is a good example of its merits. On November 10, 2018, we had no idea what the next three months would be like! The markets were shaky, but a Christmas Eve Massacre saw the Dow plummet 650 points.
There were two ways to go: one, panic and make immediate changes or two, stay the course. In this case, staying my course involved weathering the fall for the next two months and then buying into the depleted markets by moving other assets that might have appreciated in that time. As it turned out, the market has recovered most of its losses since its recent lows, so staying the course was the best choice.
Therefore, my move for this rebalance was minor (as the past several have been). Instead of taking money from the stock funds though, this time I put money into those stock funds. Specifically, I took 1.5% from my International Stock Index Fund, 4.7% from my Bond Market Index Fund, and 4% from my International Bond Fund, and I placed that amount into my PRIMECAP Fund (53%) and my Total Stock Market Index Fund (47%). Nothing close to approaching 10%, but just like in baseball, winning in wealth creation is more about the consistent singles and doubles than the occasional home runs.
Wednesday, January 16, 2019
Remembering John Bogle (1929-2019)
On Jack Bogle
https://about.vanguard.com/who-we-are/a-remarkable-history/founder-Jack-Bogle-tribute/by Tim Buckley
As you may already know, this is a sad day for Vanguard.
We lost a good friend. And mutual fund investors everywhere have lost one of their most passionate advocates.
Jack Bogle was the founder of our company, and its leader for more than two decades.
By creating a client-owned company—or as he himself liked to say, “the only mutual mutual fund company,” Jack Bogle put billions of dollars back into the pockets of investors.
And he influenced the entire mutual fund industry in a positive manner. Without Vanguard, I'm certain that costs would be higher for investors across the mutual fund industry.
In many ways, Jack was a man of contrasts:
- He was a student of history … but he was also a forward-thinking innovator.
- He could readily quote lines from Shakespeare or Sophocles … but he could just as capably tell you what just about any Vanguard fund returned yesterday. And the day before. And the day before that.
- He valued conventional principles like hard work and thrift … but he took tremendous personal and professional risks to follow his vision.
- He revolutionized the complex mutual fund industry … but he did so with fundamentally simple concepts like low costs and client-focus.
You know, Jack was fond of saying that he left his old job at Wellington Management Company—where he had worked for almost 2½ decades—in the same way that he began his new job at Vanguard: “Fired with enthusiasm!”
He carried that enthusiasm throughout his Vanguard career, and he inspired millions as a crusader for the everyday investor.
He liked to remind us that our clients are “honest-to-God, down-to-earth, human beings, each with their own hopes, fears, and financial goals.”
In a daily business that is so often characterized by numbers and forms and paperwork, that perspective is refreshing—and so important. It’s why we’re here.
We send our condolences to Jack’s wife, Eve, to their children and grandchildren, and to all those who were close to Jack over the course of his remarkable life.
Saturday, November 10, 2018
The Full Motley -- 4Q, 2018
It has been a highly active three months, even though the amount of my rebalance would perceive it as rather uneventful. Political uncertainty dragged the markets down significantly for several weeks last month leading into the mid-term elections, and then the market recovered sharply in the wake of the elections when the House and Senate were split. Overall, the spread of the fluctuations this past month were about 10% but it ended just about where it was three months ago.
Despite the activity, rebalancing now was insignificant. However, these shaky markets serve as a microcosm for the value that periodic rebalancing provides against longer market activity. Any temptation to move during the height of market uncertainty was neutralized because my next scheduled rebalance was known. If the market retreat continued, then my rebalance at that time would have been more impactful (potentially buying more shares of the equity funds when they were lower). As it turned out, the markets recovered so the dip in values meant nothing as they virtually recovered in the same amount of time. In short, it took the emotion out of the equation during the most emotional time to invest.
As I discussed in my last update, I recently modified my target 85/15 allocation (due to changes at Vanguard) with 30% to Total Stock Index Fund and PRIMECAP Fund, 15% to Total International Stock Index Fund, 11% to Total Bond Index Fund, and the remaining 4% to Total International Bond Index Fund. After all the market activity, only Total International Stock Index Fund was off by 1%, so my reallocation involved fractional percentages coming from the other four funds to make up that percentage point.
To reintroduce the graph for these numbers, which I have not used in five years (back when I started at my current position), here was the impact of this quarter's reallocation:
Vanguard Total Stock Market Fund 30.3% / -0.3% / 30%
Vanguard PRIMECAP Fund 30.4% / -0.4% / 30%
Vanguard Total Int'l Stock Fund 14.0% / 1.0% / 15%
Vanguard Total Bond Market Fund 11.1% / -0.1% / 11%
Vanguard Total Int'l Bond Fund 4.2% / -0.2% / 4%
Despite the activity, rebalancing now was insignificant. However, these shaky markets serve as a microcosm for the value that periodic rebalancing provides against longer market activity. Any temptation to move during the height of market uncertainty was neutralized because my next scheduled rebalance was known. If the market retreat continued, then my rebalance at that time would have been more impactful (potentially buying more shares of the equity funds when they were lower). As it turned out, the markets recovered so the dip in values meant nothing as they virtually recovered in the same amount of time. In short, it took the emotion out of the equation during the most emotional time to invest.
As I discussed in my last update, I recently modified my target 85/15 allocation (due to changes at Vanguard) with 30% to Total Stock Index Fund and PRIMECAP Fund, 15% to Total International Stock Index Fund, 11% to Total Bond Index Fund, and the remaining 4% to Total International Bond Index Fund. After all the market activity, only Total International Stock Index Fund was off by 1%, so my reallocation involved fractional percentages coming from the other four funds to make up that percentage point.
To reintroduce the graph for these numbers, which I have not used in five years (back when I started at my current position), here was the impact of this quarter's reallocation:
Vanguard Total Stock Market Fund 30.3% / -0.3% / 30%
Vanguard PRIMECAP Fund 30.4% / -0.4% / 30%
Vanguard Total Int'l Stock Fund 14.0% / 1.0% / 15%
Vanguard Total Bond Market Fund 11.1% / -0.1% / 11%
Vanguard Total Int'l Bond Fund 4.2% / -0.2% / 4%
Sunday, October 28, 2018
Smoke Screen or True FIRE
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| Even firefighters can get burned |
Recently, the FIRE (financial independence, retire early) movement traded barbs with financial wisdom expert Suze Orman when she made disparaging remarks about early retirement. The ridicule coming back was fierce, and “escalated quickly” to align with Millennial nomenclature.
Unfortunately, what Orman’s critics do not understand – and what many FIRE proponents have not learned yet -- is that there are a lot of unforeseeable changes ahead. Orman is coming from the perspective of having lived through all the changes that she has, and she knows how unpredictable life gets. She knows that even the best laid plans often go awry. And she knows, but she graciously did not say it, that, in the case of a majority, FIRE is a fad.
As troublesome as instant gratification in everything is, delaying gratification in everything is fraught with its own pitfalls. As tragic as it is to say, witnessing the early deaths of fellow FIRE proponents or other friends will make many re-evaluate those priorities. And in terms of gratification, it is very rewarding to put $10,000 aside today and have it equal $15,000 within two years.
If their target is to retire between the ages of 35 through 40, then they are more likely than not earning a salary that reflects a full college education and equal work experience. That means that they started about 10 years ago, at most 15 years. Therefore, whatever little amount that they had invested in the markets were not devastated in 2008-09. They remind me of my peers who attempted early retirement based on the rising markets of the late-90s, most of whom refigured (or abandoned) their plans once the market retreated. While setting aside $10,000 and having it rise to $15,000 within two years reinforces that behavior, having that amount then equal $8,000 after five years will be a different story altogether. If the early deaths of peers do not make them reconsider their commitment, this financial loss could start a paradigm shift away from the lifestyle.
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| More to say than Twitter allows |
It is not that today’s FIRE kids cannot retire early. Suze Orman and I (and others) know that upwards of 90% simply will choose not to retire early.
To be clear, I am not rooting against the FIRE proponents. I am crediting that at least 10% of them will see the commitment through (and I hope it is more). Besides, plenty of FI/RE proponents will experience the markets tumbling below where they started investing, and immediately think “it’s a FIRE sale!” (Which, for the record, was my reaction in 2008 when it happened in relation to my own purchases in 2003 and thereafter.) But having a bit more experience and wisdom in life and in the markets, I am just a lot more skeptical and more reasonable to believe that most of the FIRE kids will see it through.
Sunday, September 30, 2018
If Finances Get Too Heavy
I believe the concept of financial gravity first appeared on my radar in a post by Jim Wang, who is an amazing financial blogger and most of his posts are easily digestible and I have reprinted his material on my blog before. He discusses the concept using an airplane, but the concept might be more visually appealing when considering a hot air balloon.
Either way, the concept is that our expenses are our financial gravity. The goal is to be airborne or levitate, so financial gravity is an opposing force. If we had no financial gravity, then 100% of our income would be placed toward our financial goals. However, we all have financial gravity because it is expensive to be alive. Plus, our consumerism culture puts a premium on spending.
The theory of financial gravity is that our expenses equate to the weight that we are putting into our airplane or hot air balloon. Whether you visualize it as our baggage or our own body weight, the less weight, the less effort it will require to become airborne. The more weight we have, the more effort it will exhaust to get airborne -- as well as sustain that status.
While everyone has expenses, the makeup of our expenses is almost as unique as we are individually. Even if two people earn the same, they are not going to spend it in the same ways. Therein lies the first part of the solution of financial gravity, jettison the excess baggage. Cutting expenses is taught all the time, but financial gravity provides a different visual and approach to the tired subject. If you want that brand name latte every morning because the coffee in the office is not the same, then it will weigh down your financial goals. Simply stated, the daily lattes are part of your financial gravity. Cutting out daily lattes for coffee in the office would equate to upwards of $1300 annually, which could be placed into a Roth IRA instead, and it would be earning for you. It would become the fuel for your airplane or hot air for the balloon.
Doubling the benefit, cutting out daily lattes means you have one less expense to satisfy, so not only is an extra $1300 being spent toward gas to fund your financial goals, but you will need less money to stay airborne because you have lost that extra weight.
Perhaps going without specialty lattes is too much of a sacrifice. Changing a daily latte habit into a weekly treat would change those numbers slightly. You would only set aside $1050 per year, but you would get to have a latte every week. This might be an additional benefit in that the latte would become more of a treat and less of a chore.
If swapping out specialty lattes for coffee from the office is laughable, then other areas of delaying gratification could be found in comparable exchanges. Maybe it is the weekly movie nights, or the drinks before, after and/or during live games, or declining invitations to happy hour and other social gatherings (perhaps even weddings when the invitations get excessive). Wherever those minor expenses add up in excess of the personal rewards; that is, wherever the drama exceeds the fun. I have heard "coming of age" stories where the subject realized that going out clubbing both nights of every single weekend had lost its appeal.
Do not underestimate how much your social circles weigh into your financial gravity. Being responsible enough to prioritize your social calendar is a good trait. Playing a victim of requests for your presence is not a good trait. Presumably, few friends are so close that that their personal finances are taken into consideration when making social plans. The assumption becomes that the invitation will be declined if the event is not a priority. If your long-term financial goals are more important than weekly clubbing events, then that is a sign of maturing. If your friends do not follow suit, then you may just be maturing ahead of them.
Daily lattes, weekly movie nights, happy hours, tailgating, clubbing, etc. are all weighing down your financial goals by giving you less money to set aside and bloating your personal maintenance.
Thursday, August 30, 2018
Value Foundations
This week, I successfully passed the CFA Institute Investment Foundations program exam. There were 20 chapters, ranging from Microeconomics and Macroeconomics to Performance Evaluation, among other topics. Despite a 15-year career and several degrees and certifications in business, I found myself learning more detail about the specific functions of finance from overlooked-or-underappreciated simple concepts up into the complex worlds of international trade and of business production. While I will not delve into the complex topics here, I also found certain recurring themes throughout the investment world that seemed to represent the core definition of "value."
When bond investors are willing to pay above par value for an existing bond, they are said to be buying the bond at a premium. A premium is effectively a surcharge on the additional benefits on investments (or other items) that make them more desirable, e.g. "premium seating." All other things equal, investments will be more expensive if they offer one of these three drivers: higher returns, lower risk, or flexibility.
Usually they balance each other out, such as investments that offer either high (potential) returns or low risk. Differences in motivation lead investors to decide between investing in stocks or putting money into a savings account. Consistently, one of those three identified factors could determine which investment was more expensive, and therefore, more desirable. If the risk-to-return ratio were equal between two options, then flexibility often determined which option would be more valuable to investors.
While the concept of time is not readily apparent among these factors, it is embedded within risk factors. The shorter of a time frame in which to invest (known as a "time horizon"), then the lower the risk tolerance. As defined by the CFA Institute, risk tolerance is comprised of an investor's ability and willingness to take risk. Of course, there are subtle differences between the two elements. An ability to take risk can be limited by time horizon or quantity of assets. If the assets will need to be used sooner than later, then investors should not take risks with those assets. Likewise, if an investor only has a few assets, then they should not take significant risks with those assets, even if it limits an investors ability to pursue a higher return.
Conversely, investors who have a long time horizon have the ability to pursue higher risks. However, an individual investor may not be so willing to take such risks. If this risk-adverse investor has limited investing experience or knowledge, then the ability to take risk may be stunted by the willingness to take risks. I can identify with this scenario. I was very risk adverse, regardless of the juxtaposition between returns and risks. I did not fully understand stocks. Admittedly, I related better to the horror stories than the enrichment tales, even if the latter were more likely than the former.
Index investing is the act of attempting to match the returns of a specific market index. Conversely, active investing is the act of attempting to outperform that market. Of the two, there is higher risk in active investing, which psychologically explains why people assess a premium to active investing (even when numbers favor index investing by large, and also despite the fact that investors generally dislike losses more than gains of the same value).
Furthermore, I remember working as a financial adviser for Simmers Capital Management in mid-2000, and being told that a successful argument for clients is that there is more pride in selecting your own stocks or investments than benefiting from the equal gains through a third party, such as a portfolio manager (or an investment adviser, but obviously, we would not feed them that information). This phenomenon supports the third and final factor of flexibility. Investors place premium on flexibility in part for this reason. Additionally, flexibility reflects an investors ability to select terms of an agreement or customize an investment to match their needs. By paying a premium for flexibility, investors immediately reduced their ultimate return; however, they (typically) have also lowered their risk involved.
I started studying for this exam in February and I took it this week, so there was a breadth of knowledge imparted to me. Unfortunately, I did not capture the full scope of the information (in fact, I would wager that I have studied some of the new information in the past for prior exams, such as the Series 6 registration exam or others) but I have the textbook downloaded to my computer to reference again in the future. The concepts of micro-/macroeconomics will be areas where I pursue additional understanding, as well as international trade, especially as our current affairs as a nation center around those concepts.
When bond investors are willing to pay above par value for an existing bond, they are said to be buying the bond at a premium. A premium is effectively a surcharge on the additional benefits on investments (or other items) that make them more desirable, e.g. "premium seating." All other things equal, investments will be more expensive if they offer one of these three drivers: higher returns, lower risk, or flexibility.
Usually they balance each other out, such as investments that offer either high (potential) returns or low risk. Differences in motivation lead investors to decide between investing in stocks or putting money into a savings account. Consistently, one of those three identified factors could determine which investment was more expensive, and therefore, more desirable. If the risk-to-return ratio were equal between two options, then flexibility often determined which option would be more valuable to investors.
While the concept of time is not readily apparent among these factors, it is embedded within risk factors. The shorter of a time frame in which to invest (known as a "time horizon"), then the lower the risk tolerance. As defined by the CFA Institute, risk tolerance is comprised of an investor's ability and willingness to take risk. Of course, there are subtle differences between the two elements. An ability to take risk can be limited by time horizon or quantity of assets. If the assets will need to be used sooner than later, then investors should not take risks with those assets. Likewise, if an investor only has a few assets, then they should not take significant risks with those assets, even if it limits an investors ability to pursue a higher return.
Conversely, investors who have a long time horizon have the ability to pursue higher risks. However, an individual investor may not be so willing to take such risks. If this risk-adverse investor has limited investing experience or knowledge, then the ability to take risk may be stunted by the willingness to take risks. I can identify with this scenario. I was very risk adverse, regardless of the juxtaposition between returns and risks. I did not fully understand stocks. Admittedly, I related better to the horror stories than the enrichment tales, even if the latter were more likely than the former.
Index investing is the act of attempting to match the returns of a specific market index. Conversely, active investing is the act of attempting to outperform that market. Of the two, there is higher risk in active investing, which psychologically explains why people assess a premium to active investing (even when numbers favor index investing by large, and also despite the fact that investors generally dislike losses more than gains of the same value).
Furthermore, I remember working as a financial adviser for Simmers Capital Management in mid-2000, and being told that a successful argument for clients is that there is more pride in selecting your own stocks or investments than benefiting from the equal gains through a third party, such as a portfolio manager (or an investment adviser, but obviously, we would not feed them that information). This phenomenon supports the third and final factor of flexibility. Investors place premium on flexibility in part for this reason. Additionally, flexibility reflects an investors ability to select terms of an agreement or customize an investment to match their needs. By paying a premium for flexibility, investors immediately reduced their ultimate return; however, they (typically) have also lowered their risk involved.
I started studying for this exam in February and I took it this week, so there was a breadth of knowledge imparted to me. Unfortunately, I did not capture the full scope of the information (in fact, I would wager that I have studied some of the new information in the past for prior exams, such as the Series 6 registration exam or others) but I have the textbook downloaded to my computer to reference again in the future. The concepts of micro-/macroeconomics will be areas where I pursue additional understanding, as well as international trade, especially as our current affairs as a nation center around those concepts.
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