Why Investors Can Be Their Own Worst Enemy

Sherman Wealth Management | Fee Only Fiduciary

Investors often think they are doing better than they actually are. But the reality is that most investors are actually underperforming their benchmark. Two recent articles regarding behavioral finance — Which Investor Personality Best Describes You? and 8 Common Investor Biases That Impact Investment Decisions — detail a concept which is the thought that our own instinctive behaviors are the biggest challenge to us as investors. Another topic that we have written on is the issue with trying to “time” the market. What people often don’t realize is that these two concepts have more in common than you might think.

For over two decades, financial research firm Dalbar has been analyzing investor returns. It recently published its 22nd annual Quantitative Analysis of Investor Behavior study that compared these investor equity fund returns versus the market benchmark. The results showed significant underperformance from investors. Dalbar points out that “for the 30 years ended Dec. 31, 2015, the S&P 500 index produced an annual return of 10.35%, while the average equity mutual fund investor earned only 3.66%. The gap of 6.69 percentage points represents the diminished returns.”

So why is this the case?

As advisors, we have long preached the importance of cost and the large effects it can have on returns. While cost is a factor in investor underperformance, there are other factors that play even a larger role. The study showed that the biggest contributing factor to equity investors’ underperformance over the past 20 years is voluntary investor behavior. What does that mean? Let’s look at a couple of examples of investor behavior that contributes to underperformance.

1. Panic selling: The No. 1 rule in a market collapse is not to panic. Markets can be erratic with times of larger-than-normal volatility. Responding emotionally is never a good idea. Start by understanding what your risk tolerance is. At that point, make sure you understand your investments and what their purpose is in your portfolio. Finally, look at your portfolio as a whole and make sure it is aligned properly with your risk tolerance and goals.

2. Trend chasing/herd mentality/FOMO (Fear of Missing Out): As the phrase goes: what you see is what you believe. When investors see a stock continue to go up, or everyone around them is talking about buying that stock, it is easy to follow the crowd and jump in without thinking. History has shown us that past performance is no guarantee of future returns.

3. Overconfidence: Many investors feel they perform better than what is actually happening or real. This can cause investors to believe they can accurately time the markets.

Source: BlackRock; Informa Investment Solutions

Telling investors about these issues is one thing. Actually seeing the fixes put into practice is another challenge. The key point to remember is that we are often our own worst enemies when it comes to managing our own investments. Having a great financial and investment plan is irrelevant if you don’t have the mindset to follow through and stick to it. Becoming self-aware of these issues is a great first step.

This article was originally published on investopedia.com

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Where Millennials Can Turn for Financial Advice

Sherman Wealth Management | Fee Only Fiduciary

We live in a fascinating time. The biggest wealth transfer in history is beginning, as Millennials will soon become the wealth bearing demographic in this county.  Not surprisingly, as we pointed out in a recent blog post, personal finance is a huge issue for many Millennials. But where can a Millennial turn for advice?

Goals, dreams, jobs, family plans, etc. are going to vary widely, but there a few common themes that seem relevant across the spectrum. We constantly write on many of these issues, so decided to summarize the topics for you and answer some of those nagging questions.

 

  • Getting started is often the hardest part. Beginning a savings plan early is key, which makes planning all the more important. We constantly preach the importance of determining your short, intermediate and long term goals and then focusing on creating a plan on how to achieve them. Having the “money conversation” is a great way to get started. Remember, it’s not how much you make, but how much you save. Read more here on getting started with the money conversation.

 

  • Student Loans/Debt – A common financial hurdle for many millennials is navigating student loans. So how do you determine if your focus should be on accelerating the payoff of that debt or maximizing saving instead? We wrote about that here.

 

 

  • Knowing Who to Trust – Even if you understand the advantages of investing in the stock market, it’s not always easy to find a professional you can trust. A recent facebook study shows that over 50% of millennials have no one to trust for financial guidance.

 

FB Study

Source: insights.fb.com

 

A few months back we wrote a piece titled “Why Go Where Your Money’s Not Wanted” that touches on the point of many financial institutions turning down Millennials as clients. Most of the corporate institutions prefer high-net worth clients because it creates “efficiencies of scale” and a higher profit margin on larger trades. As frustrating as the requirement for a high minimum balance is for first time investors, it’s actually one of the main reasons I created Sherman Wealth Management. It was important to me to make sure top notch financial advice was available to anyone and everyone,  particularly to those who are starting out on the path to wealth accumulation. We created this guide to make sure you are asking your potential financial advisors the right questions to determine if they are right for you. – 6 Questions to Ask Your Financial Advisor

 

  • Marriage – Getting married is more than just substituting the word “ours” for “yours” and “mine”. It’s combining your finances, histories, dreams, aspirations, possessions – even your music – and making all of that “ours” too. If you have started to think about marriage, or are married already, there are a few financial discussions you should be sure you have.  Since a significant part of those pre-marital dreams and aspirations involve money, having multiple financial conversations before marriage (or right after, if you’re newlyweds!) can help you start married life on a firmer footing, with regard to financial goals. Here are two blogs we wrote for those getting married or already married.

 

  • Buying a house – There are studies out there saying that Millennials are not buying houses. A prudent home purchase often can be one of the most stable and solid investments a young person can make. So why the hesitation? Some Millennials wonder if given the rate increase and current market turmoil – if this is really the right time to purchase a first home, or if renting makes more sense for you right now? We wrote about this exact topic here.

 

  • Kids – Babies change your life in many ways, including requiring large amounts of time and money. While you may already be thinking about childcare costs and options, or about paying the medical bills that accompanied your new child, there are several other – important – financial considerations you should be thinking about even before the new baby arrives – 5 Planning Tips for New Parents

 

If this all seems overwhelming, don’t be discouraged. Personal finance is a journey and everyone is going to take a slightly different path. Taking the initiative to educate yourself on these topics is a great 1st step.

We are passionate about improving financial literacy in our society which is why we try to write blogs like these that will be useful to those trying to navigate the rocky waters on personal finance. If there are additional topics you would like us to write about, we would love to hear your thoughts! Email us at info@shermanwealth.com.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Which Investor Personality Best Describes You?

psycology-investment

This article was originally published on investopedia.com

According to many studies, our different personality traits and preferences, along with a range of emotional and mental behavioral biases, have a strong impact on the way we invest. This is commonly referred to as behavioral finance. As part of a two-part series on Behavioral Finance, we will start by exploring the different personality types of most investors. When it comes to money and investing, there are many factors that contribute to the “how” and “why” of important financial decisions.

Investor Personality Types

There are four different types of investors, according to the CFA Institute, each with their own distinct behavioral biases. Understanding your own investor personality type can go a long way toward helping you determine and meet your long term investment goals, as well as producing better returns. (For more from Brad Sherman, see: 6 Questions to Ask a Financial Advisor.)

Which of these profiles best describes you?

Preservers

Preservers are investors who place a great deal of emphasis on financial security and on preserving wealth rather than taking risks to grow wealth. Preservers watch closely over their assets and are anxious about losses and short-term performance. Preservers also have trouble taking action for fear of making the wrong investments decisions.

Common Issues with Preservers: An investment strategy should take into account short-, mid- and long-term goals. By overemphasizing short-term returns, an investor risks making an emotional decision based on the short-term performance, which may end up being more detrimental to them in the long run.

Accumulators

Accumulators are investors who are interested in accumulating wealth and are confident they can do so. Accumulators tend to want to steer the ship when it comes to making investment decisions. They are risk takers and typically believe that whatever path they choose is the correct one. Accumulators have frequently been successful in prior business endeavors and are confident that they will make successful investors as well.

Common issue with Accumulators: Overconfidence. We recently wrote a blog on the issue with stock picking and active management. Overconfidence is a natural human tendency. As investors, accumulators consistently overestimate their ability to predict future returns. History has shown that it is impossible to predict markets at large scale, yet accumulators continue to try and do so and expose themselves to extreme risk.

Followers

Followers are investors who tend to follow the lead of their friends and colleagues, a general investing fad, or the status quo, rather than having their own ideas or making their own decisions about investing. Followers may lack interest and/or knowledge of the financial markets and their decision-making process may lack a long-term plan.

Common Issues with Followers: The herd mentality is a concept of investors piling into the same investments as others. This is often the basis of investment bubbles and subsequent crashes in the stock market. When you are a follower, you are typically following fund managers who have tools and recourses to act on new information in a fraction of a second. By the time the average investor “follows” them into a position, it is often too late. It is always important to understand your investment decisions and how they fit into your overall plan.

Independents

Independents are investors who have original ideas about investing and like to be involved in the investment process. Unlike followers, they are very interested in the process of investing, and are engaged in the financial markets. Many Independents are analytical and critical thinkers and trust themselves to make confident and informed decisions, but risk the pitfalls of only following their own research.

Common Issues with Independents: Similar to overconfidence bias associated with accumulators, independents face similar issues with relying too heavily on their own train of thought. We as humans have ability to convince ourselves that we are correct or that we don’t need guidance, even when that is not the case.

 

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

6 Questions to Ask A Financial Advisor

6 Questions for Financial Advisor

Finding a financial advisor who is right for you is an important process. A good financial advisor is there to prevent you from making decisions that would have a negative, unintended impact on you. Who wouldn’t love to have a financial coach to keep you on track to achieve your financial goals?

Just like with any working relationship, it’s a good idea to interview advisors until you find the one who is the best fit for you, your life, and your financial goals. Since you are entrusting your financial well-being to someone, you should get to know them and their financial planning and investing philosophy before committing to a long-term relationship.

As you may have heard the Department of Labor (DOL) has just released its new fiduciary rule in its final form. We previously wrote about the reasons why someone would oppose this rule considering it was created to improve financial transparency and eliminate conflicted advice from advisors. While this rule would still allow advisors to keep their “conflicted” commissions in some instances, it would require advisors to act as fiduciaries (a.k.a. “best interests contract”) when handling client’s retirement accounts.

We have long been proponents of more transparency and conflict-free advice and feel this is a step in the right direction.

So how does this affect your search for the right financial advisor? Here are 6 questions to ask to help with finding a financial advisor.

1. Are You a Fiduciary? (Are You ALWAYS a Fiduciary?)

As we mentioned earlier, this new rule will only require financial advisors to act as a fiduciary for client’s retirement accounts. A fiduciary is regulated by federal law and must adhere to strict standards. They must act in the client’s best interest, in good faith, and they must provide full disclosure regarding fees, compensation, and any current or potential conflicts of interest.

Until now, broker-dealers, insurance salesman, bank and financial company representatives, and others were only required to follow a Suitability Standard. That means they only had to provide recommendations that are “suitable” for a client – based on age or aversion to risk for example – but this may or may not be in that client’s best interest.

The brokerage industry, as you can probably imagine, and all those who earn their compensation from commissions are strongly against these new rules.

Even with this new law passed, we feel it is important to make sure your advisor is acting as a fiduciary when dealing with ANY of your finances, not just retirement accounts.

 

2. What is Your Fee Structure? (Difference Between Fee-Only, Fee-Based and Commission)

Advisors throw out terms like “fee-based” and consumers assume that is the same as
“fee-only.” That is not the case. At Sherman Wealth Management, we are fee-only which means that we are paid exclusively by our clients, so we are completely conflict-free. We do not get commissions from the investments or products we recommend. We do not get bonuses based on how many clients we get to invest in company products. We are paid an hourly or quarterly fee by our clients who retain us because we are making their money work for them with only their best interest in mind.

Think of it this way: would you want to work with an accountant who also gets commissions from the IRS? Of course not. You want your accountant to represent your best interests. Would you go to a doctor who makes money each time he prescribes penicillin? No, you want your doctor to prescribe what is right for you.

Do not assume that an advisor is following a fiduciary standard with their compensation now. The new rules will not be enforced until 2018. Ask your financial advisor to clearly specify their fees. With many layers of diversification that can be applied to your portfolio, you want to be aware of whether you are exposed to up-front charges, back-end fees, expense ratios, and/or whether a percentage of your returns will be deducted.

 

3. Why Are They Right for YOU?

A financial advisor should be able to tell you their strengths and what sets them apart. Some advisors will advise on investments while others specialize in comprehensive financial planning. While you may think all advisors are the same, and it certainly may seem like that on the surface, by now you should be seeing that is not the case.

Ask how involved they are with their client’s portfolios. Are they hands-on in their approach? How available are they for their clients’ needs?

For us, we enjoy serving a wide-range of clients, from young first-timers who are just getting started with investing and financial planning, to experienced savers, to high-net-worth investors who are well on their way to financial independence.

We strive to understand our clients wants and needs. We help our clients plan for the long term while simultaneously working to avoid short-term roadblocks. We do so by making it a point to SHOW you that you are not alone. We’re just like you, we’ve been there, and we know that financial planning can be an anxiety provoking activity for many. We use a fluid process to help set clear, realistic goals with an easy to understand roadmap of what you need to do to get there. We are right there with you every step of the way.

In today’s world you don’t just want a trusted advisor, you want instant access to your accounts and the progress you are making. That is why we offer some of the best in new financial services technology tools.

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The relationship with your financial advisor is an important one. You need to feel comfortable with whom you are working with.

 

4. What is Your Investment Philosophy?

Every financial advisor has a specific approach to planning and investing. Some advisors prefer trying to time the market and actively manage funds versus passive investments. Others may seek to gain high returns and make riskier investments. Your goals and risk tolerance need to align with the advisor’s philosophy.

When anyone invests money, they are doing so with the hopes of growing it faster than inflation. While some traditional investment managers not only want to generate a profitable return, they aim to beat the market by taking advantage of pricing discrepancies and attempting to time the market and predict the future. Some investment companies offer “one-size-fits-all” investment management solutions that only take into account your age and income.

We have a different approach. We believe an individuals best chance at building wealth through the capital markets is to avoid common behavioral biases in the beginning and utilize a well thought out, disciplined, and long-term approach to investing. We create a well diversified, customized portfolio that focuses on tax efficiency, cost effectiveness, and risk management. Read more about how we do this.

Make it a top priority to understand the strategy your advisor uses and that you are comfortable with it.

 

5. How Personalized Are Your Recommendations for Your Clients?

It is important that your financial advisor tailors your financial plan to your specific goals. Your retirement plan and investment strategy should be customized to take into account your risk tolerance, age, income, net-worth, and other factors specific to your situation. There should not be a one-size-fits-all approach to managing your money.

Some traditional brokers and insurance companies are so big that it becomes impossible for them to give you a truly individualized experience. They have a corporate agenda that they must follow and it can restrict the service they provide to you.

As frustrating as the requirement for a high minimum balance is for first-time investors, it has also inspired a new breed of smaller independent Registered Investment Advisors (RIAs), like Sherman Wealth Management. What our clients all have in common is that they appreciate the focus on their own individual goals and best interests that we guarantee as a boutique, independent, fee-only fiduciary.

We know that each client is unique.  We don’t look for “market efficiencies” or work for sales commissions on the products we recommend. Our focus is different. We strive to help investors build a strong foundation and grow with them, not by profiting off good or bad trades. This gives us the opportunity to create individual strategies and plans that are uniquely suited to each client, not just a cookie-cutter plan based on age, income, or broadly assessed risk tolerance.

 

6. Do You Have Any Asset or Revenue Minimums?

Some have argued that the proposed DOL rule will end up hurting the small investor because larger institutions will not be willing to serve small accounts. This logic is fundamentally backward and flawed, as those clients were never on their radar to begin with. In fact, the ability for these large institutions to generate commissions and thus charge more to these small investor clients have driven that business, without regard to the best interests of the individual investor.

For example, In a company statement quoted by Janet Levaux in Think Advisor, Wells Fargo, the most valuable financial institution in the world according to the Wall Street Journal, said that in 2016, “bonuses will be awarded to FAs with 75% of their client households at $250,000.”

Wells Fargo isn’t the only large institution effectively ignoring Millennials and other smaller and entry-level clients. Most of the corporate institutions prefer high-net-worth clients because it creates “efficiencies of scale” and a higher profit margin on larger trades.

The complaints against the new DOL rule have nothing to do with protecting the little guy. Rather, the complaints are driven by the desire of commission-based large institutions, insurance companies, and broker-dealers who are trying to protect their ability to generate commissions and charge clients unnecessary fees.

Make sure you understand your advisor’s motivations. If they don’t want you, why should you want them?

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Is Your Retirement Advisor a Fiduciary?

Is your Retirement Advisor a Fiduciary?

Do you want a financial professional who is opposed to financial transparency managing your money?

The upcoming and long anticipated proposed rules by the Department of Labor (“DOL”) exposes that very debate, as it seeks to eliminate the ability of financial advisors to profit by selling retirement account products to investors without being held to a “fiduciary standard.”

For those wondering what that means, with a fiduciary standard an advisor must always act in your (their client’s) best interests. A fiduciary standard ensures that the advisor’s duty is to the client only, not the corporation they represent. To the surprise of many, that currently is not always the case. Financial advisors have had the ability to profit (through commissions and high fees) to the potential detriment of their clients. That is exactly what many large financial institutions and insurance companies have done. In fact, the federal government estimates that there are roughly $17 billion dollars of fees generated each year from conflicted advice.

The DOL has made clear –and we agree– that a commission based investment model creates a conflict of interest. Companies with a commission based model operate with an inherent conflict: the pressure to sell products that are more profitable for them and/or their firm can be important factors in how they direct you to invest. For example, an advisor may receive a 5% commission by selling you a fund through their company when you could get a similar product elsewhere without commission. Think of it this way: would you want to work with an accountant who also gets commissions from the IRS? Of course not. You want your accountant to represent your best interests. Would you go to a doctor who makes money each time he prescribes penicillin? No, you want your doctor to prescribe what is right for you. That is the primary reason we stay completely independent and operate as conflict-free, fee-only advisors.

The proposed DOL rule will hopefully begin to fix this issue as it is expected to require a strict fiduciary standard for financial advisors in the context of sales for retirement account products.  This standard will require advisors to certify that they are acting independently and in their client’s best interest, and are not motivated by the prospect of a commission. This has created a firestorm among big insurance companies, broker dealers and other institutional investors who, as we pointed out, don’t typically operate as fiduciaries.

In a letter sent last week to the SEC, Senator Elizabeth Warren, a strong proponent of the proposed DOL rule, pointed out that presidents of Transamerica, Lincoln National, Jackson National and Prudential all have called this proposal “unworkable.”  She commented on the self interest in their position, and the danger in permitting unwitting investors to be guided by non-fiduciaries in the context of their retirement investments.

Why would a rule that requires a financial advisor to act in their client’s best interest create such an uproar? One reason is that unlike Sherman Wealth Management, they are in a commission driven model, and therefore fear that the way they currently serve clients would not meet the standards of this new rule. We hope that because of the conflict a commission driven model creates, that eventually enough pressure from policy-makers like Senator Warren and Labor Secretary Perez will propel this proposed new rule beyond just retirement accounts. In the meantime, think to yourself why anyone would oppose this rule if not for purely selfish reasons?

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

Don’t Expect to Win With Actively Managed Funds

actively managed

This article was originally published on NerdWallet.com

Trying to pick individual stocks is a losing game, and this doesn’t just apply to individual investors. It’s also true for professionally run, actively managed mutual funds.

Actively managed funds are tasked with picking a collection of stocks and bonds that will outperform market indices, or benchmarks, such as the S&P 500 or the Dow. They’re armed with Ph.D. analysts, hundreds of interns, and tools and research to which very few of us have access — but they can’t consistently beat their benchmarks by enough to justify their costs.

Long-term underperformance

Eighty-six percent of actively managed funds failed to beat their benchmarks in 2014, according to the S&P Dow Jones Indices scorecard. “So what?” you may say, “That’s only one year.” But 89% of funds failed to beat their benchmarks during the past five years; 82% failed to do so during the last decade.

The following data help illustrate how unlikely it is for active managers to beat the market over longer periods. During a one-year period, a high percentage of active managers in some categories may outperform their benchmarks. But over five- and 10-year periods, fewer active managers outperform.

Percentage of Actively Managed Funds That Outperform Benchmarks

1 YEAR 5 YEARS 10 YEARS
Source: 2015 Morningstar data
Large-cap value 36.5 19.6 33.7
Large-cap core 28.7 16.7 16.6
Large-cap growth 49.3 11.9 12.2
Mid-cap value 53.5 22.7 42.3
Mid-cap core 42.1 27.7 11.0
Mid-cap growth 41.6 26.0 32.4
Small-cap value 66.7 38.0 38.3
Small-cap core 44.7 32.8 23.1
Small-cap growth 22.2 20.5 23.1

Some managers do outperform the market, but picking a winning manager is as tricky as picking winning stocks. If you still think you can find “a good manager” who is the exception, consider this widely accepted Wall Street rule of thumb: Past performance doesn’t guarantee future performance. A manager who outperformed last year may not do it again this year.

Reasons for underperformance

There are a few main reasons actively managed funds underperform, aside from picking the wrong investments:

FEES

Many actively managed funds charge 1% to 2% per year in management fees, while a passively managed exchange-traded fund could charge as little as 0.1% to 0.2% per year. And many actively managed mutual funds are loaded funds, which means you’ll pay a sales charge, typically between 4% to 8% of your investment, when you buy or sell the fund — though the fee may decrease the longer you stay invested. Compounded over time, these higher fees can eat up a lot of gain, reducing overall returns.

TAXES

Because actively managed funds try to time the market and pick winners, they buy and sell positions frequently. These transaction costs reduce the fund’s returns, and all the buying and selling can also create taxable gain. Fund managers have no incentive to avoid this because they simply pass those taxable gains on to you, the shareholder.

MARKET EFFICIENCY

Some argue that markets are becoming more efficient, making it difficult to identify overvalued or undervalued stocks. The efficient market hypothesis states that stocks are constantly adjusting to news and information, and thus their share prices reflect their “fair value.” In simpler language, other than in the very short term, there are no undervalued stocks to buy or inflated stocks to sell. This makes it virtually impossible to outperform the market through individual stock selection and market timing.

An unsustainable approach

Whether active management can outperform is a controversial topic. Many experts dismiss the science and say that they can indeed beat the market. Some of them may even do so for a year or two, or even five, but what about over the long run? It’s simply not sustainable, and to think otherwise is dangerous.

If the data shows that the vast majority of the brightest and most well-equipped professional investors can’t beat their benchmarks, why should you believe anyone who says they can?

This story also appears on Nasdaq.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

March Madness and Investing: Surprising Similarities (And How to Avoid Common Mistakes)

March Madness (1)

What a great time of the year. Cherry blossoms are out, baseball opening day is right around the corner, and the best single elimination tournament in sports is on its way. That’s right, it’s March Madness time.

For those of you unfamiliar, March Madness, as it’s commonly called, is a 64-team college basketball single elimination tournament. There are four regions that each have 16 teams seeded 1 though 16. The winners of each region meet in the “final four” to determine who will emerge as the champion.

Offices around the country are buzzing with brackets, upset picks and friendly wagers. In other words, it’s chaos both on and off the court and it’s glorious!

In case you couldn’t tell, I love sports. As a financial advisor, I am constantly looking at seemingly unrelated topics, and comparing them to the world of finance. What may come as a surprise to you is that investing and March Madness have more in common than you think.

So what does the tournament have to do with investing? Let’s have some fun and take a look.

You Can’t Predict the Future

Every year people get excited about their bracket. We watch the “experts” on TV and eagerly listen to their reasons for picking one team over another. We all go into the season thinking that this is “our year.” We’ve done the research and we’ve studied history. What could possibly go wrong?

In the first round of this year’s tournament, a record 10 double-digit seeds advanced to the second round! Do you think a lot of people predicted that? Not a chance.

March Madness BracketsHave you ever heard the saying on Wall Street that past performance does not guarantee future performance? There’s a reason the saying exists. Just like last year’s successful mutual fund managers aren’t any more likely to pick this year’s best accounts, the winner of last year’s bracket pool is no more likely than you to pick this year’s winning March Madness team.

When it comes to investing, “experts” love to tell us what is going to happen in the future. People brag about their best stock picks and conveniently leave out their poor ones. The truth is, no one knows what is coming. Once you accept that, you can create a financial plan that takes into account your risk tolerance, and current life situation to make the best investment decisions for you.

Diversification and Risk vs. Reward

No one picks a perfect bracket. The odds of filling out a perfect bracket are 1 in 9.2 quintillion (source: USA Today). According to that number, if everyone in the US filled out one bracket each year, we would see a perfect bracket once every 400 years. You’d be better off gambling with the lottery based on those odds.

However, straying from the standard “favorites” isn’t always the answer either. People love to pick the underdog or “dark horse,” but if you do this consistently year after year, you aren’t likely to have much success. That doesn’t mean you can’t pick an underdog here or there, but the risky picks should be a subset of your overall picks, not the full strategy.

The truth is, no one wins a bracket pool by picking all favorites or all upsets. As the point above taught us, everyone is just guessing. By diversifying your picks with some favorites and some upsets, you give yourself the best chance at success.

The same principal applies with investing. If your portfolio is composed of stocks from one sector or all growth stocks, you are exposing yourself to huge amounts of risk. Sure, the reward may be great if you end up being right, but as we’ve seen time and time again, that is a strategy that can set you up for disaster.

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

When A Storm Hits Are Investors Still Gluten-Free?

Empty Shelves

More snow coming?

Get ready for Instagrams and TV reports about empty bread shelves!

Here’s one from my local store before the blizzard a couple of weeks ago:

BreadShelvesNo matter how many people have resolved to stick to a gluten-free diet, that gluten seems much more appealing when a storm is on the horizon and gluten-free bread may get harder to find.

The same thing happens to investors. When the market is stormy, anxious investors often disregard their financial plans and start switching to what they perceive as “staples,’ sometimes at surge prices.

The trick with smart investing, as well smart shopping, is to make sure you’ve got enough of what you need – and want – before the storm hits, not during a run on the shelves. If you’re gluten-free, that means having a pantry already stocked with gluten-free pasta and a gluten-free loaf of bread in the freezer – not to mention beans, rice and tomato sauce – to tide you through the blizzard. It also means sticking to what you know has made sense for you in the past and realizing that two days without bread is not the end of the world – the bread will return to the shelves once the storm has passed.

Likewise, if you know your risk tolerance and have already planned effectively, you’ll have a balanced portfolio that contains the right balance of stocks and other less volatile instruments before a storm hits. With a fully diversified asset allocation strategy, there will be parts of your portfolio that go up, as well as other parts that go down, during times of stress. That way you’ll be comfortable sticking to your investment strategy and plan when the market is stormy. Plus, you’ll have purchased those less volatile instruments before pundits start shouting and everyone starts panic-purchasing.

A good financial advisor will help you build a portfolio strategy that truly for reflects your risk tolerance and, importantly, helps you understand exactly where the risk is in your portfolio. Your advisor will help you understand if, when and why to own bonds, Munis, Treasuries, and CDs, and how much of a cash component makes sense for your particular situation and need for liquidity.

The volatility we’re experiencing, current geopolitical uncertainty (like Japanese negative interest rates), and Federal Reserve uncertainty are all great litmus tests to determine whether you have a properly diversified portfolio and whether or not it’s an accurate match for your true risk tolerance.  If current market conditions or any paper losses you may be experiencing make you feel uncomfortable – or keeps you up at night – it’s likely that your investment strategy does not match your actual risk tolerance and needs to be re-balanced.

If, however, you’ve worked with your financial advisor and are comfortable with where you, then you’re best bet is probably to ignore the noise, ignore the panicking pundits, and stick to your saving and investing plan. Remember, if your investments made sense to you a couple of weeks ago, they probably continue to make sense for you, even during market volatility.

Just like a diversified pantry will help you stick to your nutritional goals when there’s a run on the supermarket, a good fee-only financial advisor can help you create a portfolio that is truly diversified, risk appropriate, and with the exact amount of liquidity that makes sense for your long-term goals, so you can sit back and weather the storm with confidence.

Photo Source: Reuters/Shannon Stapleton

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.
If you have any questions regarding this Blog Post, please Contact Us.

7 Tips to Maximize the Value of a Bonus or Raise

Dock

Expecting a bonus or a raise? Read these tips before you start Googling timeshares in Cancun

If you’ve got an end-of-year bonus or a well-deserved raise coming, it’s easy to think of it as “extra money” you can use to splurge on a trip to Mexico, a new phone, or a serious visit to the outlet stores. It’s particularly easy if you’ve been sticking to your budget and feel you deserve a little fun after behaving so responsibly all year!

Before you blow that bonus on a phone upgrade or a cruise, though, consider these smart ways to really reward yourself with the extra infusion of resources.

1. Upgrade Your Budget Instead of Your Phone

Still rocking a flip phone from the 90s? If so, yes, maybe you should invest in something smarter. But for most of us, it’s smarter to spread the extra cash across several budget items. Go ahead and add a little to your entertainment or entertaining budget, but consider allocating the rest of it to these smart ideas!

2. Make a Bigger Dent in your Debt

Are you feeling the weight of college loans, a mortgage, or, even worse, high interest credit card debt? You can lighten that load by using your bonus to make a larger payment than usual. It lowers your balance so it reduces some of those high interest charges moving forward. Increasing this budget category when you get that raise can also add up to a significant reduction of interest in the long run.

3. Invest to Watch it Grow

Setting aside money when you have large expenses to deal with now can be daunting. But the earlier you start investing the more time your money has to grow. If you haven’t already, create an investment account and put that bonus money to work for you, instead of leaving it in a checking account.

4. Kickstart Retiring

If you’ve kicked your tires and they need to be replaced, by all means, safety first! Use some of the rest of the money, though, to max out your company’s 401(k) contribution limits. If you qualify for an employer match, your bonus just got bigger!

5. Recalibrate Your Portfolios

If you’re already an investor, consider adding some of those extra funds to your investment portfolios. While you’re at it, take a look and see what’s working and what’s not. Your financial advisor can help you evaluate whether your allocations should be adjusted based on your risk tolerance and your long and short-term financial goals.

6. Start a College Savings Plan 

It’s never too early to start saving for a child’s college education. By starting early, you can get a good head start and maximize compounded interest. Your financial advisor can help you choose a plan that works with your life, you goals your timeline, and, most importantly, your bonus!

7. Save for a Rainy Day

Those emergency funds may seem like low priority, until you suddenly need them. If you haven’t already, create an account with funds for unexepected expenses like job loss, emergency repairs, medical bills for you, your family, or your pets, and even weather emergencies (remember Hurricane Sandy?) A good rule of thumb is to have three to six months of expenses saved up just in case.

There’s nothing wrong with treating yourself a little. You worked hard and you deserve it! Remember though, that by keeping the splurging and celebrating to a minimum, and letting that bonus or raise work for you, chances are you’ll have much more to celebrate when next year’s bonus comes around!

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The views expressed in this blog post are as of the date of the posting, and are subject to change based on market and other conditions. This blog contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

Please note that nothing in this blog post should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax or legal advice. If you would like investment, accounting, tax or legal advice, you should consult with your own financial advisors, accountants, or attorneys regarding your individual circumstances and needs. No advice may be rendered by Sherman Wealth unless a client service agreement is in place.

If you have any questions regarding this Blog Post, please Contact Us.

How Diversified is your Diversification?

Eggs

In November yet another firm fell victim to the growing Valeant fallout as Tiger Ratan Capital Fund LP fell 33% over the past three months, wiping out gains for 2015.

Those losses stemmed from the fact that Valeant accounted for 20% of TRC’s U.S. holdings. But they weren’t alone. Many well-respected funds, including the mighty Sequoia Fund, and hedge fund manager Bill Ackman’s Pershing Capital also had extensive exposure to long time Wall Street darling Valeant and suffered losses not only of value – but of face as well.

The dramatic losses came as quite a shock to many of the investors who own these – and other affected – funds, and who assumed that the funds were diversified – when in fact they weren’t. By going out on a limb and investing too much of their allocation in what has been one of Wall Street’s hottest stocks for years, many respected “hedge” funds experienced huge capital losses that it will take years to recover from.

In fact, of the 1,000 hedge funds tracked by Symmetric.IO, approximately 12% had a position in Valeant. A startling 32% of Valeant’s shares were held by hedge funds.

When Diversification isn’t Diversification

Having 20% of your portfolio in one stock is a huge risk for anyone. You never know when the next Enron or Worldcom may be and, because of accusations of unorthodox practices, it may very well be Valeant.

On the other hand, Valeant could still turn out to be a home run and deliver big time. No one really knows, which is why diversification is so key.

Many investors diversify with ETFs and mutual funds. But how many investors are absolutely certain that the mutual funds they are counting on to provide diversification, are, in fact, properly diversified themselves?

When that Hot Stock is Too Much of a Good Thing

When a “hot stock” or fund keeps climbing, it’s tempting to want to jump on the bandwagon, and the same is true for a hot sector. That’s no doubt why so many otherwise experienced fund managers over-exposed themselves to Valeant and to the health sector in general.

But while a portfolio with correlated assets that tend to do well together, is also a portfolio with assets that can tend to do poorly together when the winds shift. As Ben Carlson put it in a recent blog post: “Diversification requires finding the right balance between eliminating unsystematic risk (risk that’s specific to single securities or industries) and di-worsification by adding too many overlapping funds.”

Put another way: it’s not enough to put your eggs in different baskets, the eggs themselves need to be diversified, some plain, some speckled, and the speckled ones should be speckled in different ways.

A properly diversified mutual fund or ETF allow you to invest in a sector or a “hot stock” while mitigating risk. Which is no doubt what the investors who held Tiger, Pershing, and Sequoia thought they were doing.

The Moral of the Story

Due diligence. While you and your financial advisor are most likely diversifying your holdings, make sure that your holdings are also diversifying their holdings. Review your mutual funds frequently to make sure that their strategies, risk tolerance, and diversification standards align with yours and that they are not over-weighted chasing impressive returns from a couple of current wall street darlings.

The jury is still out on Valeant and on the funds that held it. It may in fact recover, although it would have to recover quickly to make up for the loss of momentum for the funds and investors that held it.

Nonetheless, it’s an important lesson for individual investors. A truly diversified portfolio is made up of truly diversified assets.

 

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This analysis is provided for informational purposes only and is not to be considered investment advice. The securities mentioned herein are for illustration of the concepts discussed and are not a recommendation to buy or sell any security. Please see additional disclosures.