Why We are Bullish and Selling

For most people, one of the hardest parts of investing is deciding when to buy and when to sell stocks and mutual funds. Our firm has a disciplined and rational investment philosophy which eliminates the hard part of these decisions. For our clients, this creates peace of mind and simplifies their lives.

Long term, we are bullish on stocks worldwide. However, throughout the year, we may be selling certain asset classes. Can this be consistent?

Managing a portfolio starts with developing an individualized Investment Policy Statement (IPS). An IPS is a guide for a client’s portfolio. An IPS is based on your specific life situation, such as your age, assets, time-frame and need for income.

The first part of developing the IPS is deciding the overall allocation; how much is to be invested in stocks and fixed income. The next decision is how much of the stock allocation is to be invested in broad asset classes, such as US and International. We structure the portfolio to include specific asset classes, such as US Large, US Large Value, US Small Value, Real Estate, International Small Value and Emerging Markets.

By using asset class mutual funds and an Investment Policy Statement, we can be bullish and selling at the same time. For example, assume that the US Large Value asset class has outperformed most other asset classes during 2014. Due to good performance, it’s percentage of the stock portfolio has grown from the target allocation of 10% to 15%. We would take advantage of the growth and sell the amount which exceeds the target allocation of the US Large Value fund.

This process is called “rebalancing.” Done throughout the year as needed, we provide our clients with investment discipline and the benefit of buying low and selling high.

Investment rebalancing is one way that we adhere to the IPS that we develop for each client. The IPS guides how much risk you want to take. For example, a 60% allocation in a globally diversified stock portfolio may be appropriate for someone. If we were not disciplined and did not adhere to the IPS stock allocation, the stock percentage may grow far beyond your planned 60% stock target allocation. If we did not adhere to the IPS and do our regular rebalancing, you would be taking much more risk than you desired or is necessary.

For example, as the stock market increased significantly during 2013, we selectively sold parts of certain asset classes. We did this to maintain the proper overall stock allocation as well as the specific asset class targets.

When we consider any rebalancing transactions, we are very aware of the potential tax implications. As CPAs, this is another added benefit we provide to our clients. When clients have retirement assets, we try to do rebalancing sales in these accounts first, so there are no tax implications.

When clients add money to their account, we use this as another opportunity to rebalance their portfolio and ensure alignment with their desired asset allocation targets. For example, rather than selling an asset class, we can use the new money to purchase asset classes that have not done as well. This provides the continued discipline and benefit of buying low and selling high.

It would be very difficult to implement this rebalancing concept if you own primarily individual stocks. A key to effectively implementing this strategy is to use asset class mutual funds (similar to index funds), not owning individual stocks.

Rebalancing is a key benefit that we provide to our clients. Rebalancing is dictated by market movements, so we may not be buying and selling to rebalance every month. However, we are continually looking to rebalance so that we can adhere to your investment plan. By taking the emotion out of the selling process, we provide you with greater comfort and security, as well as a more successful investment experience.


How Would Your Investment Advisor Respond to a Nobel Prize Winner?

When I received a survey from 2013 Nobel Prize winning economist Robert Shiller of Yale University on Monday, I thought it would be worth completing. It is not everyday that I get mail from a Nobel Prize winner.

The survey wanted to know my “opinions and attitudes regarding the stock market.” They were requesting the opinion of 500 investment professionals to be used “for analysis appearing in economic journals and for securities analysis.”

Completing the survey reinforced the fact that we cannot predict the future. Maybe some investment professionals think they can accurately forecast the future and base their investment decisions on their predictions (or their guesses?). We are more realistic and accept that we cannot consistently and accurately predict the future. Answering the survey reinforced our firm’s globally diversified investment strategy, which is the foundation for our success as investment advisors. Which philosophy makes more sense to you?

In the long term, we are confident in the future and think that global stock markets will be higher 10 and 20 years from now. However, if we want to provide our clients with the comfort and security they desire, we have to be realistic with them. We do not know what will happen in the short term. So we talk and plan for short term uncertainty, so you can live comfortably and sleep well at night.

The survey asked what we “expect” in various scenarios. My immediate reaction was: how could I know? How could I accurately tell Professor Shiller what I expected the “Dow Jones Industrial Average” would be 1, 3 and 6 months from today, as well as one and 10 years from now?

I looked up the definition of the word “expect.” Expect means to “regard as likely to happen” and it “…implies confidently believing, usually for good reasons that an event will occur.” So how did I respond? They wanted the expected percentage increase or decrease, but also gave an option to “leave blanks where you do not know.” Of course, I left the spaces blank, as I had no basis to confidently know what the expected increase or decrease would be in the future.

I wonder what basis the other respondents used to provide their answers. Did they just guess? I think my responses were the only possible replies, as there is no way to know what the future will be. This approach is more realistic and actually benefits our clients. It is our role to plan and make investment recommendations for our clients while dealing with the uncertainty of the world that we live in. Uncertainty has always existed and will exist in the future.

We can invest wisely and provide our clients with a better investment experience by recognizing that the world is uncertain. We think this makes more sense than providing them with investment predictions that are really just guesses.


Having Your Investment Cake and Eating It Too!

When buying a top of the line automobile, you want outstanding performance, reliability, great design and excellent customer service.

When investing, you should want excellent performance, a well designed investment plan, high quality advice and responsive service with attention to details.

To get this top of the line vehicle, it is going to be very expensive. There is a significant performance and luxury difference between a $30,000 car and a vehicle costing $75,000 or more.

With our investment philosophy, you can have outstanding investment performance, but with costs that are far below industry averages. You can get top quality investments at a lower price, without sacrificing anything. You can have your investment cake and eat it too.

Investment costs deserve more attention. Over the long term, the cost differential has a great impact on your long term performance and investment success.

Mutual funds and money managers generally charge at least 1% annually. According to Investopedia.com, “the average equity mutual fund charges around 1.3%-1.5%. You’ll generally pay more for specialty or international funds…”

Because of their outstanding long-term investment performance and philosophy, we recommend mutual funds managed by Dimensional Fund Advisors (DFA). The excellent performance of their funds is partially attributable to the very low expense charges of their funds. The expense ratio of a fund reduces the net return to the client. For example, if a fund had a return before fees of 10%, an expense ratio of 1.5% reduces the net return to 8.5%. If the expense ratio was only .4%, the net return would be 9.6%. We recommend funds with a built in advantage of much lower fund fees. And you receive this benefit every year.

Per Morningstar.com, “low costs also set DFA apart. Because its funds do not track an index, it is not forced to trade when doing so would not be cost-effective. DFA’s low expense ratios build on this structural cost advantage…” DFA has over time consistently reduced the cost of their funds.

DFA’s real estate fund is a good example of this fee advantage. Morningstar commented that “the fund is one of the cheapest in its peer group, where the median expense ratio of a real estate fund is 1.12%. Two years ago, DFA cut the fees on this fund to 0.18% from 0.30%.”

DFA’s top performing funds generally cost .80% – 1.0% below the 2013 mutual fund expense ratio average for each respective category. For example, in the US Small category, the industry average is 1.38%. The DFA Small Cap Value fund has an expense ratio of .52%. Among US Large company funds, the industry average is 1.09% and the fund we recommend charges .09%. DFA’s International Small Cap Value fund is .77% less than the industry average of 1.46%.

So if you desire excellent investment performance with low costs, it turns out you can have your cake and eat it too.


Which is better: Big or small?

A good book leaves a lasting impression.  It makes you think. The author may even change your mind about long held thoughts and opinions.

Malcolm Gladwell has accomplished this and more in his thought provoking book David and Goliath.

Do not be misled by the title. I thought the entire book was going to be about David and Goliath. It isn’t.

Gladwell writes intriguing stories. The theme throughout David and Goliath is what initially appears to be an advantage is not always an advantage. What appears to be a disadvantage may really be a positive. He shows that what you initially see or think may not be reality. Gladwell’s research and writing covers a wide range of topics, including education, the impact of wealth on parenting, overcoming obstacles (especially childhood adversity), how to coach a group of unskilled basketball players and how David defeated Goliath.

A major takeaway from this book is that we should challenge conventionally held thoughts, to see if they are actually supported by facts.  Gladwell shows that counter-intuitive thinking is worthwhile. I will highlight a few of the topics that Gladwell wrote about.

Would you like your child or grandchild to be in a class with 10, 15, 20, or 30 students?  What is the optimal class size for learning? Why?

Most people would think smaller is better. A class size of 10 or 15 students should be better than 20 or 25 students, right? Many private schools appeal to parents with the benefits of very small class sizes. But Gladwell presents statistical and anecdotal evidence that around 20 students in a class is actually better than much smaller classes, especially those with less than 15 students.

Gladwell shows that class discussions are the key to academic success.  Class discussions are the life source of learning. Particularly at the middle school and high school levels, you need a “critical mass” of students to get vibrant, diverse and energetic participation. As one teacher stated, 18 is “enough bodies in the room that no one needs to feel vulnerable, but everyone can feel important.”  When the number of students falls below 18, the quality of the discussions drop.  Getting class participation gets more difficult. Shy students participate less. Teaching actually becomes harder, not easier. So while we think really small class sizes are beneficial, they may not produce statistically better educated students.

Gladwell challenges the conventional thinking of going to the very best college you can get into.  He tells the story of a high school student who wants to go to a top Ivy League college to pursue her love of science.  The young woman goes to Brown University, an elite institution, rather than go to a large public university that does not have such a top reputation.  Up against all these other top students, she does not get top grades. She thinks she is not succeeding. Though she was still quite smart, she struggles, at least based on the grades she was receiving.

This woman would have been a star student at the University of Maryland, but changed her career choice after “not succeeding” at Brown. Gladwell wants the reader to consider that an elite institution versus a public college is really “a choice between two very different options, each with its own strengths and drawbacks.”  The advantages of a selective and prestigious institution can also make it problematic. Better may not really be the best place to be.

Gladwell writes about the impact that wealth has on parenting.  After a certain point, having too much money can make parenting more difficult. Teaching “down home values,” a strong work ethic and the value of money can be harder for wealthy families than for families of more modest means. He shows that in many circumstances, too much of something is not always a good thing (an advantage can become a disadvantage).

He conveys a simple, yet powerful point about many family discussions. If a family has limited resources, children realize their family limitations. When a parent says that we cannot afford something, especially a luxury item, the child learns to understand that no means no. There is just not money available. “No, we can’t” is simpler.

For a wealthy family, this situation is much more complicated. When the child asks for something, such as a teenager wanting a fancy car at age 16, the child is much more likely to challenge the wealthy parent. The parent cannot say “no, we cannot afford it.” The wealthier parent’s reply is “no, we won’t.”  The child can argue “why can’t you buy this for me?” This requires a conversation. This requires a set of values and the ability to articulate the values to the child. This is much harder. The less affluent family’s more clear cut resolution can become a major source of challenge and conflict for wealthy families. Gladwell explains that there is a “point where money starts to make the job of raising normal and well-adjusted children more difficult.”

Gladwell has caused me to really think about these topics. I have sent my children to a high school with small class sizes. There are benefits to this school, but he has made me aware of some potential negatives I had not thought about. The effects of wealth on parenting is a real challenge. I put myself through college, have always worked since high school and know the value of money. It is harder to tell my children “no, I won’t” than my mom telling me “no, we can’t.” I knew we couldn’t afford many things growing up and I probably didn’t even ask. Gladwell’s points about choosing a college are interesting. We don’t always succeed by putting ourselves in the most competitive environment. Getting all A’s in an undergraduate program at Michigan State University may be more advantageous than B’s and C’s at a school like Harvard.

Bigger may not always be better.  Advantages may turn out to be dis-advantages.  But reading to expand our ideas is beneficial.  Reading David & Goliath is truly worthwhile.

How to have a long-term investment advantage


“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

~Charles Munger, speaking of himself and his partner, Warren Buffett

Munger and Buffett emphasize the importance of minimizing your investment mistakes. In baseball, they would not recommend swinging for home runs and getting lots of strikeouts. They would think it is advantageous to get lots of singles and doubles.

Our long-term investment philosophy is structured to help eliminate bad investment decisions.  By following this advice, you will be far ahead of most people. We are continually learning, studying and reading, so you and your family can benefit.

Don’t invest in funds and stocks that usually underperform their benchmarks

This sounds simple. You should invest in funds that beat their benchmarks. You should hire the best money managers. However, you may be surprised to learn how difficult this is to implement. We are proud that the funds we have recommended have consistently outperformed their benchmarks and their peers, over the short and long term.

Some recent evidence that most mutual funds and money managers consistently underperform their benchmarks reiterates a huge amount of similar data:

  • “So far in 2014, more actively managed mutual funds are trailing market benchmarks than in any full year since 2011, according to data from Morningstar.”*
  • “More than 74% of actively managed funds that invest in shares of big US companies are lagging behind the S & P 500 index, up from 50% last year…The story is similar across many categories of funds investing in small and midsize stocks.”*
  • Since 2004, in 8 out of 11 years, more than 50% of the large stock US funds did not beat their S & P 500 benchmark.  And even more startling, in 7 of those 8 years, 60-80% of the funds each year underperformed their benchmark.*

We understand this data about the consistent underperformance of most mutual funds.  This is the basis of the investment philosophy we have utilized for over 10 years. This is why we utilize primarily DFA mutual funds, as well as select others. But many investors do not realize these facts and they don’t incorporate this information into their investment portfolio.  The data for 2014 should make our clients even more confident that our style of investing is the right approach.

  • These facts should encourage you to really understand your investments. We can help you do this.
  • You should know how each fund or stock that you own has performed, over many years.
  • If you are a current client, you will be pleased that the funds we utilize in various assets classes (such as US large, US large and small value, US small cap, International small value, Emerging markets, real estate and others) all have excellent performance data compared to their peers and their respective benchmarks.
  • You should know the cost of your investments. All too often when we evaluate a prospect’s current portfolio, we find underperformance and high fees.
    • Do you know the real costs of the mutual funds that you own or money manager you use?
    • The investments we recommend outperform and are among the least expensive in the financial industry. And their costs have decreased over the years.

You will be more successful by avoiding certain types of investments

Hedge funds are alternative investments “pitched” to the wealthy as great investments and diversifiers, but the facts tell another story. As of June 30, 2014, Hedge funds are on track for their sixth consecutive year of underperforming the S & P 500, according to the WSJ and research firm HFR, Inc.  Almost 10% of hedge funds close every year, according to HFR, Inc.*

It is very difficult to pick which hedge funds will be successful, in advance, consistently and for a long time. And hedge funds are very expensive. This is why we do not recommend investing in hedge funds.

As Munger and Buffett would say, you can get a long-term advantage by adopting an investment philosophy which avoids many investment mistakes. We are confident that our approach to investing meets this criteria.

*Source:  Wall Street Journal, June 30, 2014, Section C, various articles