Why We Don’t Make Forecasts

Advice from Janet Yellen and a Spectacular Zero

At the end of this post, we will explain the picture above and the advice Janet Yellen gave to our Chief Investment Officer, Preston McSwain.  To start, though, we constantly get asked what we think is going to happen to the market going forward or for our picks of stocks, sectors or asset classes that we think are going to perform the best.

We know that people like to hear a hot tip, and earlier in our careers, when big Wall Street firms paid us to do this, we often tried to provide them.

Now, we are older and don’t care as much about impressing people.  In addition, we hope that our clients pay us to shoot straight, tell them what we really think, and stay focused on the consistent findings of independent peer reviewed research versus selling forecasts.

What do we say now based on our experience and the evidence about what’s most likely to come to pass?

As Preston encouraged more investment professionals to do when he recently spoke at the CFA’s annual wealth management conference, we say, “We don’t know.”

We’re sure a few people think that when we do this we are taking the easy way out or being passive in our approach to investing.

We understand why people might feel this way, especially when the word “passive” is used, which according to the dictionary means “inert” and has synonyms such as “acquiescent” and “compliant.”

Until very recently, and only due to more and more candid comments from people like Warren Buffett, the investment industry socialized both investors and industry professionals to believe that significant weight and value should be placed on estimates and actionable forecasts.

Why?

Because it sells.

Believe us when we say that the industry spends a lot of time and money training people about how to sell emotional presentations to different audiences. They know well that it’s much easier to acquiesce to the excitement of a presentation pitched by a haloed professional than to stay anchored on the evidence.  Even though they know the probability of getting it correct is low, they also know they only need to be correct once to become famous and see large flows into their profitable trades or products.

What does the evidence consistently show, however, about the accuracy of forecasts and analysts’ recommendations?

Like the old saying that is echoed frequently inside Wall Street, the presenters are never in doubt, but most often they are wrong.

We have written about this topic frequently for Trusts & Estates magazine and the CFA Institute, and even shared over-cocktails quotes from what we called the Honest Global Chief Investment Officer in our blog piece, Talking Heads.

We know we are fighting a constant battle against the financial public relations machine, though, so below are a few more pieces of evidence supporting our contrary-to-the-herd point of view.

First, to independent research produced by Salil Mehta, who has been collecting data on the accuracy of Wall Street forecasts for over 20 years.  In one of his most detailed pieces, Desolated Admirers of Investment Strategists, he highlights compelling long-term data.  It includes information that he’s sure Wall Street “emperors hope you forget.”

As he discusses, most people don’t care much about predictions in an up-market.  Even though bull market prognostications have been shown to be less accurate than a coin toss, if the market is up, investors tend to be quite forgiving.  Last year was a good example.  The U.S. equity market was up over 20% in 2017, but many on Wall Street predicted only single digit returns.

People focus more on pain avoidance, meaning that what investors really care about is downside protection – advice about when to sell before a bear market.

What does Mehta’s research show about how many times Wall Street consensus predicted a market drop?

“A spectacular zero.”

Unfortunately, this has been well known but generally ignored for quite some time.

As an example, CXO Advisory collected data from over 6,500 predictions made by 68 investment gurus covering the time period 1998 – 2012.

What did they find?

The accuracy of well-known investment strategy professionals, including industry luminaries Jeremy Grantham and Abby Joseph Cohen, was only 47%, or as Mehta found, also worse than a coin toss (see the following for the complete study – Guru Grades).

Finally, how about Federal Reserve leaders?

Take a look at the chart below. It is from a Wall Street Journal analysis of over 700 Fed policymaker predictions between 2009 and 2012. As you might expect, 1.00 is perfect, so it acts as a percentage accuracy score.

Fed a

These data suggest that Preston’s picture mate, Yellen, is indeed impressive relative to her peers, but the last we checked, an accuracy rating of 52% is still about the same as a coin toss.  And, before you think that we’re being too hard on them, keep in mind that the Fed acknowledges in its own research that its forecasting leaves much to be desired.

As an example, the following is from a report published in February of 2015 by the Federal Reserve Bank of San Francisco based on a study of the Federal Reserve Open Market Committee’s Summary of Economic Projections (SEP):

“Over the past seven years, many growth forecasts, including the SEP’s…, have been too optimistic. In particular, the SEP forecast (1) did not anticipate the Great Recession that started in December 2007, (2) underestimated the severity of the downturn once it began, and (3) consistently over-predicted the speed of the recovery that started in June 2009.”

That’s right, they completely missed the downturn and were overly optimistic about the recovery.  Yellen reinforced this herself in a 2010 comment when she acknowledged that she “didn’t see any of that coming until it happened.”

The evidence suggests that market forecasts aren’t worth much, but this doesn’t mean you shouldn’t look at data.  Data can absolutely help you develop a long-term plan you feel comfortable enough to stick with and not change based on short-term predictions.  Like the enduring design approach of Steve Jobs, the best financial strategies evaluate all kinds of data then strip away everything that isn’t in simple service of the underlying goal.

It might sound overly simplistic or passive, but as we detailed again this year in a piece for Trusts & Estates magazine titled, An Important Lesson, keeping it simple has consistently outperformed top university endowments over multiple long-term time periods.

So, what’s our advice?

The next time you hear an emotional investment forecast, stay anchored on what Janet Yellen privately cautioned Preston with a smile, after she shared with him her market view.

“Just remember, my projections are based on estimates (yes, estimates based on estimates) and my assessments contain a considerable amount of uncertainty.”

 

More of our posts on this subject and additional research related to this article can be found at the following links:

Equity Analysts: Still Too Bullish – McKinsey Quarterly 

Keep A Steady Hand On The Tiller

Don’t Be A Sheep

Our Support – Enough

Last year after the horrible events in Charlottesville, VA, we posted the following statement on our website:

“Thou shalt not make politically-oriented statements on a company website” is a commandment we often hear in business.

As before, however, sometimes the only right thing to do is to take a stand for what we believe.

Members of the Fiduciary Wealth Partners (FWP) team have been gun owners and respect the right of individuals to responsibly own firearms.

But enough is enough, and we aren’t standing by on the gun control debate.

FWP fully supports the March for Our Lives position and encourages individuals to sign its petition, which is centered on this statement:

“We support the right of law-abiding Americans to keep and bear arms, as set forth in the United States Constitution.

But with that right comes responsibility.

We call on all Congress to pass legislation that will protect and save children from gun violence.”

To show our conviction, we are making a $5,000 donation to the March for Our Lives organization.

In addition, we are encouraging our clients and network to join us by making a matching gift pledge challenge.

We will make a dollar for dollar matching donation to March for Our Lives up to $5,000, with the goal of making a total gift of $10,000.

To join us, please click the links below:

Sign the March for Our Live Petition

Donate to the March for Our Lives Organization

If you take action, let us know.  We will then work to amplify our collective message, and if you contribute, confirm back to you that we have matched your gift.

Just as we wrote before, we feel that this is not a time for politics or safe comments.

 
As many did in Boston and other cities around the world today, we choose to stand up.

The Normal

Stocks Are Risky – This is Not the New Normal, Just Normal

 

“The New Normal”, first coined in September 2009 to describe market changes “that may forever change the world”, has become a favorite on Wall Street and in the financial press.

It’s quite catchy.  Someone should have trademarked it.  Beyond its clickbait appeal, though, was it just another example of a haloed Wall Street prognosticator setting unrealistic market expectations?

New Normal circa 2009 suggested that the world was about to enter a prolonged period of lower stock market returns.  Instead, as has happened before, risk assets, such as stocks, have provided long-term investors with handsome returns.

Yes, the prognostications of 2009 were worth little to no weight.  Lest you think this characterization is a little too critical, the evidence behind this statement can be found in our recent posts titled “Why I Don’t Make Forecasts” and “Groundhog Day” (click the links to read).  The pieces aren’t long and contain data showing why I’ve never heard a seasoned professional deny – in private – that market predictions are never in doubt, but often wrong.

More to the point of the title of this piece, though, the New Normal didn’t bring any new – just the normal.

Normal

If you are going to invest in the stock market repeat the normal after me.

  • Stocks are risky
  • Markets experience shocks from time to time, and can produce short-term periods of low or even negative returns
  • Normal markets include ups and downs, and the swings can be large when too much emotion gets involved
  • No one can forecast the future, especially when emotion is involved
  • Over long-term periods the stock market consistently produces positive returns and long-term investors are rewarded
  • Long-term is 10-years or more

Many sensational headlines have been written the past few weeks about market declines, but two things have increased for sure: the viewership and the ad revenues of financial media organizations (see Michael Ramirez’s again on-point cartoon from 2009 – thanks also to Ben Carlson for helping to recirculate this).

Financial media

Most of the sensationalized media coverage from the past number of days has likely been detrimental to investor returns, but one balanced piece was written by Jeff Sommer of the New York Times.  His subtitle was, “Losses last week reminded investors that they play a risky… game.”

I don’t think investing is a game, but the fluctuation Sommer was speaking about is normal.

As he reminded investors, even though professional “traders… [somehow] become accustomed to… placid conditions,” and the market “movements we’ve been having the last couple of weeks may not be pleasant, they are entirely normal.”

About a week ago, my firm sent out a blast email that included links to “Keep A Steady Hand on the Tiller” and “What To Do Now About…”, the latter of which included the graph below.

The Cycle of Market Emotions
Emotional Cycle

We received many thank you notes for helping to remind investors that what we were all feeling was indeed normal.

Notably, the reminders we sent out were slightly re-worded versions of articles I had written in 2015 and 2016.  Yes, concerning market headlines and downturns happen much more often than we think.

Related to this, one of the best charts that I saw circulated this week was this one:

The 10 Worst Days Over the Past 30 Years

History
Source: Schroders Investment Insights. Thomson Reuters Datastream as of February 6, 2018. Data shown for the one-day fall is for S&P 500 over the last 30 years. Returns after a one and five-year period are for the total return index, which includes dividend. For information purposes only. Past performance is not a guide to future performance and may not be repeated.

First, notice that even though last week’s 4.6% one-day drop made everyone feel uneasy, it didn’t rank in the top ten one-day drops over the past 30 years.  In fact, it didn’t even rank in the top 100 worst days in history, and as the chart below shows, since the year 1900 it was about average.

Summary of the Largest 300 One Day Losses by Decade
Decade
Source:  Crandall, Pierce & Company with data from Dow Jones & Company (the full chart can be found here).

Back to the previous chart, as the Cycle of Emotions illustrated with its Greatest Potential Reward notation, the strongest rebound was a total 5-year return of 164%, which came after one of the worst drops of 6.7%.

Market conditions might continue to generate concerning stories.  When they do, just remember the following:

Normal is the market going up and down in a manner that can be unnerving over short-term periods.

And, normal is that true long-term investors are rewarded for not reacting to sensational New Normal headlines.

 

Preston McSwain is a Managing Partner and Founder of Fiduciary Wealth Partners, an SEC registered investment advisor committed to forming fiduciary wealth partnerships with clients, professional colleagues, and the community. To see more of his posts, and follow him on social media, please visit the following:

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Thou Shalt Not Stand Idly By

“Thou shalt not make politically-oriented statements on a company website” is a commandment we often hear in business.

Sometimes, however, the only right thing to do is to take a stand for what we believe.

The events in Charlottesville, VA are deeply saddening.

Fiduciary Wealth Partners strongly condemns the actions of anyone who attacks, or supports those who attack, a fellow human being based on their race, ethnicity, religion or faith, sexual orientation, or gender.

This is not a moment for politics or safe comments.  It is about what is right and what is wrong.

We stand with all who believe that no moral equivalency exists between racists and those who stand up to racism, hate and bigotry.

This is about values we hold dear and we choose to not stand idly by.

Say It Ain’t So, Joe – Again

“No large-cap, mid-cap, or small-cap funds managed to remain in the top quartile at the end of the five-year measurement period.”

This is one of the findings out this week from S&P / Dow Jones related to “the ability of top-performing funds to maintain their status” and persist as top performing funds.1

For many of us who have been in the industry for many years, this type of finding is hard to take. As I wrote in a 2015 piece titled Say It Ain’t So, Joe, sometimes I feel like the little guy in the movie “Field of Dreams”.

Until founding Fiduciary Wealth Partners in 2012, I spent my career promoting actively managed funds. I believed in them. I was quite good at selling them. I received an award one year for selling record amounts of active equity for the firm I worked for at the time.

Now, I sometimes wonder:

Was I wrong all those years?   How can this be?”

Like the little boy, who had learned of Shoeless Joe Jackson’s involvement in throwing the 1919 World Series, negative news about something we have believed in for many years is hard to take.

In the past, active management was the only game on Wall Street, and managers with hot hands were put on pedestals. Many of us grew up in an investment world that was dominated by reports of star active portfolio managers such as Warren Buffett or Peter Lynch.

Like most anyone, I believe that people who work harder should have an advantage. As with many things, however, it is not all about working harder. You need to work smarter, not let emotion get the better of you, and stay focused on the evidence about what works consistently over multiple long-term periods.

What does the evidence now consistently show?

“The best way to own common stocks is through index funds.”
– Warren Buffett, Berkshire Hathaway 1996 Shareholder Letter

And

“All the time and effort people devote to picking the right fund, the hot hand, the great manager, have, in most cases, led to no advantage.”
– Peter Lynch, Beat the Street, 1993

I have been drafting another piece, which I will publish soon, that might dispel some myths about index funds and counter the active managers who are sure to continue protesting loudly about how the promotion of index funds is worse than the “misuse of antibiotics.”

I’ll keep this short and simple this time, however, and just finish with a 2016 quote from another well-respected data analysis firm, Morningstar.

“In most cases, the odds of picking a future long-term [active management] winner from the best performing quintile in each category aren’t materially different than selecting from the bottom quintile.”2

Yes, it’s hard for many alpha-oriented investment personalities such as me to swallow, but the evidence in favor of index funds is real and consistent.

Stay it ain’t so, Joe. Say it ain’t so.

 

  1. S&P Dow Jones – Does Past Performance Matter? – The Persistence Scorecard
  1. Morningstar – Performance Persistence Among Mutual Funds

 

Preston McSwain is a Managing Partner and Founder of Fiduciary Wealth Partners, an SEC registered investment advisor committed to forming fiduciary wealth partnerships with clients, professional colleagues, and the community. To see more of his posts, and follow him on social media, please visit the following:

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How Should You Invest Now?

Trump wins unexpectedly.

What are we reminded of from an investment standpoint?

The chart above that we posted after the Brexit vote and will probably publish again someday.

We’re also reminded that uncertainty is relatively consistent and that, consistently, emotion leads us to make investment changes in the face of uncertainty at the wrong time.

Before the market opened on the day after the election, we had received at least 10 invitations to hear from leading Wall Street analysts and strategy professionals about what their crystal balls suggest investors should do now (more continue to come in and yes, the post-election-day stock market down 800 points before the open and rally to finish up approximately 260 points is creating graphs that look just like the emotion chart).

We are dialing into many of the calls because, we want to understand and respect what are sure to be differing opinions.

What else are we doing?

Striving to avoid making changes.

Why?

Not because we don’t believe we shouldn’t constantly be asking ourselves how we can be better.

But, because being better often means resisting overly tactical moves and sticking to a long-term plan.

Very consistently, and again last night, the following holds true:

  • Analysts and strategists are never in doubt, but often wrong.
  • Individual and professional investors make investment changes at the wrong time.

We have written about this before, so we are keeping this relatively short, but please click on the following to read more of our thoughts on the points mentioned above:

What Should Investors Do About XXXX?
(Changed the title because we are sure the message will be appropriate sometime again soon – includes the same cycle of emotions chart and links to data in other articles)

Chicken Fried & Cold Beer On A Friday Night
(Adding a smile here for the day and includes a list of “Don’t” bullets for Wall Street and investors to consider)

Importantly, know that we are here and available to lend an ear or answer any questions you may have.

Please call us at 617-602-1900 or email us personally at preston@fwp.partners or james@fwp.partners

All the Best,

Preston & Jamie

What Should Investors Do Now About…. ?

What should investors do now about….  (insert the latest stock market headline)?

We continue to suggest that they follow the advice we published the day after the Brexit vote was announced: Keep Calm and Carry On (click the link to read our recommendations related to this 500 + point market drop).

Reflecting on the daily stream of emotional market headlines, maybe we should have titled that piece, Focus on What You Can Control.

Why?

First, the vast majority of the haloed prognosticators you see on CNBC, etc. consistently get it wrong. As I have written about many times in pieces such as Groundhog Day, the accuracy, or maybe I should say inaccuracy, of Wall Street estimates consistently reminds me of the saying, “often wrong, but never in doubt.” To reinforce this point, John Authers of the Financial Times recently wrote the following: “Populations across the world have lost faith in the expert guidance of professional economists.” (click here to read his full piece).

Second, you are likely to damage both your mental state and your portfolio if you make investment decisions based on all too common yo-yo like financial headlines such as the following that regularly appear on my news feeds:

  • The ….. Danger
  • S&P500 is on Pace for Best Week in …..
  • Due to …… Markets are at a Treacherous Junction

Again, insert your latest favorite headline event.

This all reminds me of two headlines that I recently received only two days apart via emails:

  • “Wall Street rallies as Yellen’s comments suggest that the Fed is unlikely to raise rates.”
  • “Wall Street falls as the strength of payroll data suggest that the Fed is likely to raise rates”

The lesson of those conflicting messages should be:

Remember, “projections are based on estimates” (yes, estimates based on estimates) and “assessments have a considerable amount of uncertainty” (both are direct quotes I received from Janet Yellen, Chair of the Federal Reserve – for more click Why I Don’t Make Market Forecasts).

So, what should you be focused on that is within your control?

Your long-term plan, not the models or projections of others.

I know it’s hard to not get caught up in the emotion of the market, but try to remember the old saying, “investors create 50-year market floods every few years.”

When market floods happen, my firm gets calls asking for our opinion about where the market will go next.

We don’t have a crystal ball, but we are always willing to make this prediction.

Whenever you see large market swings you will see:

  • Sensational headlines that are designed to catch eyeballs and sell ads, but that are often not conducive to good investing
  • Wall Street, which loves volatility, not missing out on the opportunity to sell a trade or product when emotions are high
  • Investors being sold short-term ideas that harm long-term returns

If and when our prediction comes to pass, you might be wise to remember the tag line of the anti- drug public service announcement from the 1980s and “Just Say No“.

To help, below is a graph that illustrates what all investors feel from time to time (professionals included).

Cycle_of_Market_Emotions3

Notice that the greatest potential for returns is when you are feeling the most frightened.

We aren’t sure what the next few weeks or months will bring, but along the lines of the picture above, at some point more “alarmed” comments will be published again.

When this happens, try to remember that even though it can sometimes be frightening, if you resist emotion and stick to your long-term plan, the evidence consistently shows that the slow and steady tortoise comes out on top.

In-line with this week’s focus on…. (again, insert the latest concerning headline), as long as you have a well-diversified, long-term plan that is designed to meet your goals, keep in mind the following age-old investing quote from a well known British writer:

“My ventures are not in one bottom trusted,
Nor to one place; nor is my whole estate….
Therefore, my merchandise makes me not sad.”

- William Shakespeare, Merchant of Venice

For more on our thoughts, including a more contemporary quote from my then 11-year old son following yet another 500+ plus point market drop, click on the following.  It also includes evidence of just how unwise investors’ timing decisions have been.

Keep A Steady Hand On The Tiller

 

Preston McSwain is a Managing Partner and Founder of Fiduciary Wealth Partners, an SEC registered investment advisor committed to forming fiduciary wealth partnerships with clients, professional colleagues, and the community. To see more of his posts, and follow him on social media, please visit the following:

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Why Do Warren’s Words Carry Weight?

“When [Warren Buffet] talks, people listen.”

Those who are old enough might know that this is a play on the old E.F. Hutton ad.

Related to this, someone recently asked me, “How did Warren Buffett attain the admiration of top investment professionals and the investing public alike?”

I smiled and responded:

“The old-fashioned way, he earned it.”*

Warren Buffett has unique personal I.P that can be summed up in two words.

Experience & Respect

He has seen it all.  The good, the bad and the ugly.

Buffett is also a proven investment superstar who has not just talked the talk, but has walked the walk.  Versus a theory or hypothetical model, behind his words is a solid track record of success over many market cycles, which even other investing outliers look up to and value.

This is why it’s so powerful when the person whom many consider to be one of the best active investment managers of both public and private equity of all time says the following with respect to how his family trust should be invested:

“Put 10% of the cash in short‐term government bonds and 90% in a very low‐cost S&P 500 index fund” because “the trust’s long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions, individuals—who employ high fee managers.”

- Warren Buffett

   (see Can I Do Better? for references to instructions Buffett has given to the trustee of his family trust)

People do listen to Warren Buffett, but in spite of his consistent recommendations (click here for more of his advice to other superstars such as LeBron James) and the evidence (click here for the facts on historical performance of investment funds), much time, and investors’ money, continue to be spent on the search for shiny, new, complex and high fee holy grail-promising investment funds.

Maybe the title of my next piece should be:

Why don’t more people follow Warren Buffett’s advice?

 

*  See below for one of the best investment ads of all time.  Now if only the evidence showed that Wall Street investment analysts’ recommendations were consistently accurate (for more read Ground Hog Day).

 

Preston McSwain is a Managing Partner and Founder of Fiduciary Wealth Partners, an SEC registered investment advisor committed to forming fiduciary wealth partnerships with clients, professional colleagues, and the community. To see more of his posts, and follow him on social media, please visit the following:

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About.me

Personal Blog

Chicken Fried & Cold Beer On A Friday Night

Can Investors Learn A Few Things From A Country Song?

Those of you who know me well know that I am from Alabama and that I still have some Southern boy in me.

Those of you who know a little country music may also recognize that the title of this post is based on a Zac Brown Band song, Chicken Fried.

The part of the song that inspired me to write this piece is:

“Well, it’s funny how it’s the little things in life that mean the most
Not where you live, the car you drive, or the price tag on your clothes
There’s no dollar sign on a piece of mind; this I’ve come to know”

It goes with the following chorus about what really matters most in life:

“Cold beer on a Friday night
A pair of jeans that fit just right
And the radio up
Well, I’ve see the sun rise
See the love in my woman’s eyes
Feel the touch of a precious child
And know a mother’s love”

Beyond my fondness for good country music, why is a wealth management guy quoting Zac Brown?

Well, if you stay with me on this, I promise to tie it all together in the end.

I probably don’t have to remind many readers that, unfortunately, the market is off to a rocky start this year. Understandably, some investors are concerned.

Based on my past experience inside big investment firms, how are some investment product managers and sales professionals likely feeling?

Giddy.

As I have written about before, Wall Street likes nothing more than a little fear and is off to the races marketing the latest impressively presented strategies designed to protect investors. I am getting multiple emails a day from large investment houses and asset managers selling low volatility funds, down-side protection trades and absolute return funds. The pitches all have implied promises of significant down-side protection, and some are even being sold based on attractive hypothetical returns (yes, was smiling when I wrote “hypothetical”).

The vast majority have little transparency, however, and, you guessed it, high fees that drive high profit margins.

I am not suggesting that all of the presentations are improper.

What I am saying is that our industry tends to make things too complex and does not give investors enough information about how products are created (translation, the real ingredients) and about how they work, especially when you need them the most (example: many broke down during the last financial crisis).

To be fair to the industry, many of these strategies, which are literally created by rocket scientists, are based on complex investment and economic theories. What is the key word in this sentence?

Theories.

The products tend to be designed based on models that strive to price how multiple investments, which themselves are priced based on multiple factors such as earnings estimates, interest rate and currency projections, and emotion, will perform in various market cycles.

Whew, yes, that was a mouthful.

What could possibly go wrong with complex models that rely on key words such as “estimates”, “projections”, “emotion”, “likely” and “multiple factors”?

Among the things that make me pause is that, when pressed over “a cold beer on a Friday night”, my ex-rocket scientist investment friends from MIT admit that their theories can, and likely will, break down from time to time based on market dislocations that can’t be fully factored into their models.

Getting back to Zac, my hope is that this is all starting to spark a few questions about what’s really important and what really adds value.

When I founded my firm almost four years ago, I spent a lot time asking questions about what adds the most value to clients. During conversations with many wealthy individuals and investment professionals, I was routinely reminded of the following comment from a long-time client:

“Preston, I hired you to help our family develop and implement an investment plan. I am very happy with the management of our investments but do you know what I have come to realize that I really pay you for? Transparency, simplicity and peace of mind.”

Yes, some might think I’m a broken record on this but, as an adviser to President Kennedy is rumored to have told him when he thought he was saying the same things over and over again:

“When you are at the point that you think you are going to get sick if you say it one more time, you have finally reached the point when many people hear it for the first time.”

Some folks seem to be hearing what the evidence consistently says:

Keep-it-simple index strategies can perform just as well, if not better, than complex approaches.

Investors are following the advice of Warren Buffet and David Swenson, the Chief Investment Officer of Yale*, and putting record amounts into index funds (see links to articles on Buffet and Swenson at the bottom of this post).

It seems that our industry still has some listening to do, however, as it continues to spend an enormous share of its time and money promoting complex products, such as multi-factor models, that are designed to protect against market down-turns and defaults (if this doesn’t sound familiar, go see the movie or read the book The Big Short).

To hopefully help, the following are a few “Don’t” bullets points for Wall Street to consider.

Don’t Make Investing A Competitive Sport

  • Each individual is different and can have unique goals
  • Winning in investing is reaching client specific goals, not beating the other guy who might have different objectives or appetite for risk

Don’t Sell Crystal Balls or Be A Sheep

  • As we all know, but don’t want to admit, Wall Street predictions are often wrong (see our recent Groundhog Day or Talking Heads blogs)
  • Resist the urge to run with the herd and easily sell what has been hot in the past or whatever is being currently promoted as the next great New New Thing

Don’t Avoid Conversations About The Bad or Ugly

  • Fully disclose the Good, the Bad and the Ugly
  • If clients understand the pros and cons of a strategy before implementing it, they will be less likely to change course at the wrong time when the going gets rough, which it will from time to time

Don’t Forget Taxes, Especially With Hedge Funds

  • Remember that a very large portion of hedge fund returns tend to come back to clients in the form of short-term capital gains
  • If your client is in the highest tax bracket, please adjust your return projections down by approximately 50% before making your pitch

Don’t Underestimate the Advantage of Liquidity

  • Individual clients are not endowments and generally have periodic liquidity needs for large purchases, gifts, and regular income
  • Place a premium on fully liquid investments
  • Remember that during the financial crisis many endowments found out the importance of liquidity the hard way when they did not have access to funds that they needed

Don’t Sell Anything That You Don’t Fully Understand

  • Do we really understand how complex strategies will perform over various market cycles?
  • No additional comments really needed

As you can sense, I am little cynical about how Wall Street sells the fear of missing out by helping to create what data suggest are relatively unproductive competitions to find and sell alpha.

Rather than taking the easy way out and simply selling relative performance and relative risk metrics, let’s spend more time listening to what clients want to achieve, and implementing strategies that are designed based on their goals, not industry models.

Related to this, I am not a big fan of active management, but as I recently wrote in What’s In A Name, if investing in an active strategy or working with a large brand makes a client feel more comfortable, and will allow him or her to stick to a plan more easily then, regardless of the relative performance versus an index, these might be the correct choices.

At Fiduciary Wealth Partners, we believe that by focusing on transparency and simplicity, our clients will benefit by being more comfortable with their investments, which in turn will increase the likelihood that they’ll stick to long-term plans during good times and bad (what many studies show is the key to long-term investing success).

Hopefully this will also increase peace of mind and allow all to enjoy a little more

“Cold beer on a Friday night
A pair of jeans that fit just right
And the radio up
Well, I’ve see the run rise
See the love in my woman’s eyes
Feel the touch of a precious child
And know a mother’s love”

 

*  Both Warren Buffett and David Swenson have repeatedly discussed the evidence in favor of index funds and consistently recommended index investing to individual investors.  See the following links for more information:

Warren Buffett To His Heirs: Put My Estate In Index Funds

Warren Buffett’s Advice to LeBron James: Index Funds

Unconventional Success: A Fundamental Approach to Personal Investment – David F. Swensen

 

Preston McSwain is a Managing Partner and Founder of Fiduciary Wealth Partners, an SEC registered investment advisor committed to forming fiduciary wealth partnerships with clients, professional colleagues, and the community. To see more of his posts, and follow him on social media, please visit the following:

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Don’t Let Your Portfolio Get Sacked

Are you ready for the big game?

Super Bowl 50.

The seasoned star, Peyton Manning, in what could be his final game, versus the new star, Cam Newton.

The only improvement from my New England perspective would be watching our Patriots this Sunday, but I am sure I will enjoy the excitment on the field and off, with the TV commercials and halftime show.

Beyond the entertainment of the Super Bowl, the NFL runs a business that generates exceptional returns. If marketing is your game, you could do a lot worse than to follow the lead of the NFL.

In investing, we can also learn a lot from some NFL stars.

How not to invest.

Star players run up impressive records on the field, but many stories exist of even combined Heisman Trophy, College National Champion and Super Bowl stars like Tony Dorsett failing in finance (Cam, if you win Sunday, read here and don’t let this be you).

Some might think spending is the problem, and in some cases you would be correct. More often than not, however, professional athletes make the same mistakes as many other investors.

A good article on this was published in Forbes titled, How To Lose $20 million. In the piece, a top sports agent made the following quote:

“What really gets these guys are not the cars, jewelry, or even houses, it is the big three – divorce, poor tax planning, and bad investments.”

I won’t make any comments on family issues, and I am not an accountant, but I will make a few quick comments on investing.

In our last post, Groundhog Day, I talked about the halo effect, which is a documented psychological bias we have to place confidence in people who are better known and deemed to be more intelligent, better looking, or more respected.

What marketing machine knows this well?

Wall Street.

Evidence consistenly shows that low cost, boring, simple investments such as index funds often outperform more complex strategies, but our defenses are constantly rushed with CNBC spots presented by professionals with halos. In the morning someone might say “buy”, but in the afternoon someone might say “sell”.

It is no wonder studies show that the average investor significantly underperforms the market due to emotional selling or buying at the wrong time.

According to research from Morningstar, the 10-year return of the average balanced fund (mix of stocks and bonds) for the period ending 12/31/13 was almost 7%.

What was the average return of investors in balanced funds over this same time period?

Approximately 5%, which represents a gap of 2% on average per year for 10 years.

The gap for investors in sector funds, which tend to attract more active traders, was even higher at over 3% on average per year for 10 years (click here for the full report and see the below chart).

morningstarSo, why so much focus on new investing plays?

Just as exciting calls on the field drive sales of TV ads and profits for the NFL, transactions and new products quarterbacked by haloed investment managers drive Wall Street profits.

I am not a fan of market predictions, but I did recently go on the record with the following:

If you see the market continue to have a difficult time, you will see

  • More sensational headlines that are designed to sell ads, but not conducive to good investing
  • Wall Street, which loves volatility, not missing out on the opportunity to sell a trade or a product when anxiety is high
  • Sales pitches for expensive downside protection products and hedging strategies

As I wrote about in Your Brain On The Market, if an investment coach is constantly recommending new schemes, especially during volatile times, “Just Say No”.

Next, as your own best general manager, consider firing the coach.

To help you defend again aggressive offensive moves, consider the following quote:

“Preston, what you need to understand is that I get paid to publish ideas that we can sell for a profit. If I don’t, the transactional brokers and management complain. I then lose my job. I learned a long time ago that it pays to feed the Street.”

I heard this one night over dinner from the Global Chief Investment Officer of a large international wealth management firm. I got to know this person well over the years and even though it was his job to help pitch active investment strategies, ironically he often said his belief in investing skill was very low. What did he quietly admit was often the best choice for investors?

Index funds.

Crazy you might say. Top investors don’t invest passively. They are active stars who have access to the best talent and top MBA draft picks. With their years of training and resources, surely they believe they can consistently post record stats.

Well, it has been my experience that many in the industry, especially off the record after an adult beverage, consistently say the following:

No.

What have a few investing superstars said on the record?

First, consider David Swenson, Chief Investment Officer of Yale’s Endowment.

Yale and other Ivy League schools might not produce as many NFL stars as my favorite SEC schools, but they do have some of the top endowment returns in the nation, and Yale consistently leads the division.

What does Swenson say in his book on personal investing?

“A serious fiduciary with responsibility for taxable assets recognizes that only extraordinary circumstances justify deviation from a simple strategy…”

You can read more on this in a piece that I wrote titled What Would Yale Do If It Was Taxable (yes, as Swenson and the NFL agent mention, don’t forget to factor in taxes).

Second, how about Warren Buffett?

Recently, he gave the following advice on CNBC to the NBA star, LeBron James.

“Everybody’s got an idea… [but] usually simplest is the best”

Buffett went on to say that athletes are often approached with investment ideas but that LeBron should “just make monthly investments in a low-cost index fund” (click here to read the full story). As an FYI, he also wrote in a 2013 Berkshire annual letter to shareholders that the trustee of his estate should do the following for the benefit of his heirs:

“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…”

So, before rushing onto the investing field, consider taking a time-out.

Don’t get by getting caught up in Super Bowl type investing hype, and don’t make investing a competition.

Is winning really defined by outperforming the other guy or is it about reaching goals on behalf of your family?

To avoid getting sacked by Wall Street’s marketing blitzes, stick to your long-term game plan and consider following the advice of investing superstars such as Buffet and Swenson.

As they have said, the evidence is clear on how to consistenly produce goal winning investment scores.

Keep it simple and consider more index funds.

 

Preston McSwain is a Managing Partner and Founder of Fiduciary Wealth Partners, an SEC registered investment advisor committed to forming fiduciary wealth partnerships with clients, professional colleagues, and the community. To see more of his posts, and follow him on social media, please visit the following:

Twitter

Linked In

About.me

Personal Blog