Monday, August 24, 2015

Be careful out there

The market had a rough day today, to say the least. At one point, the Dow was down more than 1,000 points and ended up down 588 points, or 3.6%. Personally, I checked our account balances and we are down over $10,000 in the past few days. It's important to remember though that we haven't lost anything because we haven't sold anything. I've recently reflected back to 2008 when we last saw these types of declines. I didn't sell back then, but remember my investment accounts getting cut in half from ~$25k to ~12k. Now that I have a considerable amount more invested I have been reflecting on how to make sure I keep the same discipline given that the dollar amount represented by the same percentage movement would be >10x what we experienced in 2008. In the back of my mind, I always know that a 6-figure loss is possible, but the dollar amount makes it feel like a lot more than saying "25%". The best answer I have for myself at this point is to remember that I am working with a long time horizon, that it is impossible to time the market, and that I shouldn't even try.

I used to tell clients that they should have the most aggressive portfolio that they were comfortable sticking with through all the ups and downs. Even if it is in an investors best interest long-term to be heavily invested in stocks, I knew that if they didn't have the fortitude to stick with the strategy they may actually be better off avoiding stocks. No matter what portion of your portfolio you have targeted to be invested in stocks, the recent selloff is likely an opportunity to rebalance and buy more. I didn't get the chance to buy more stocks today, but plan to do so shortly.

I have previously documented my intentions of allocating more of our assets to stocks, so any buying I do was already planned before recent large market movements. The most important thing to remember in this type of market is to make sure any transactions you make are not based in fear. As a co-worker used to always say: "Be careful out there". Don't be like far too many other people who make the mistake of selling stock positions AFTER big losses.

Sunday, August 23, 2015

Book Review – Simple Wealth, Inevitable Wealth

Image result for simple wealth inevitable wealth

I recently finished reading 'Simple Wealth, Inevitable Wealth' by Nick Murray and highly recommend it. This book had been highly recommended by a respected source, but it sat on my 'to read' list for a year or so. I'm glad I finally got around to reading it, because it really caused me to re-think and re-evaluate some of my investment strategies unlike many other personal finance books I've read. I won't give away all the details, but I definitely recommend you pick up a copy. It's worth adding to your library, but you'll probably have to buy a used copy since I doubt any libraries will have it.

Below, I'll highlight some of the key takeaways I got from the book and what I intend to do (or keep doing) as a result.

  1. Everyone needs a good financial advisor.

    The author believes that no matter how much you think you know about investing and the markets, you need a financial advisor. The main reason for this need is to protect you from yourself. Even the savviest of investors, without a good advisor, may fall into the trap of making THE BIG MISTAKE, which is to sell stocks based on fear. If a good advisor ever talks you out of doing this, they are worth whatever expenses you pay them (typically no more than 1% of your assets annually). I wholeheartedly agree that you should avoid THE BIG MISTAKE, and will concede that most people could use a trusted confidant to occasionally talk sense to them. Although I consider myself to be a complete DIY investor, I still do have a financial advisor. My advisor is a close friend who works for my former employer that I don't have to pay for because of the amount of assets I have invested. While I don't rely on him as much as many of his other clients, and he isn't actually managing my investments on a daily basis, it has come in handy to have a single point of contact with whom to discuss my strategies and to get recommendations for ways to implement said strategies.

    This advice is especially timely considering the recent 500+ point decline in the Dow. These types of big movements in the markets always seem to cause investors to want to sell out of stocks and sit in cash "until things get better". The problem is that once you're in cash, it's feels so good not losing any money that you won't typically get back into the market until it has recovered all the losses you potentially avoided and more, such that you buy in at a higher price than where you sold. I used to call sitting in cash the 'warm safety blanket that is secretly smothering you and killing your wealth accumulation potential'. This behavior is common enough that an annual study is published each year showing that the average mutual fund investor significantly underperforms the market, largely due to poor timing. See here for an example of the DALBAR study.

  2. Asset allocation is a poor strategy for wealth accumulation – true wealth can only come from disciplined investing in 100% equities.

    This part of the book was one that I had to sit and think about for a bit. I agree that over time, stocks (in the form of mutual funds) outperform bonds or cash. Therefore, adding bonds and cash to a portfolio will necessarily reduce your long term returns. That being said, it is also true that adding bonds and cash to a stock portfolio will reduce your short-term volatility, which can make it easier to continue to hold your investments and not make THE BIG MISTAKE. Stocks are a great long term investment, but I have generally advised that you would be better off avoiding stocks if you aren't able to stay invested through volatility. Asset allocation, to me, has been a way to get some of the benefit of stock growth in a long-term portfolio, while minimizing the short-term volatility that causes investors to want to abandon ship.

    I clearly remember the last major downturn in the markets of 2008-09. I did not sell out of my portfolio, but I have held bonds in my portfolio for a long time. I have never been the type of investor to panic or sell, and my wife has been a strong voice of reason if I ever lament about short-term losses. Since I know that I am unlikely to sell stocks at inopportune times, and given that I have a good relationship with a trusted advisor and level-headed spouse, why then do I continue to hold bonds in my portfolio that is designated as 'long-term'? The only difference between now and then is the magnitude of the potential losses, a 40% decline for me now would be 10x the dollar amount as it would have been just 7 years ago.

    Just as important as it is to not sell stocks, it is also important to have a disciplined approach to investing. The simplest example of a strategy to avoid is to change your investments every year to be whatever funds did the best in the previous year. This strategy is generally a poor one because there is no individual sector or investing style that is consistently the best to invest in, and chasing the latest hot fund will cause you to get in to an investment after the gains have already been made (and not by you).

    Since reading this book, I have begun the process of shifting some assets from bonds to stocks, with the intention of permanently and significantly reducing my bond holdings. I don't know that I'll go 100% to stocks, but definitely will be increasing my stock exposure. Because of this, I welcome the recent sell-off in stocks. I generally would be indifferent with short-term market sell-offs, but it pleases me to see things getting cheaper as I have begun to re-allocate some of my bonds to stocks.

  3. Investors should stick with stock mutual funds and not individual stocks.

    No convincing was needed for me to agree with this thought. The odds of an individual building a diversified portfolio with individual stocks that could outperform even a poorly managed stock mutual fund are extremely low. The few instances where I've see client accounts with good historical performance that were all in individual stocks, the portfolios tended to be not very diversified and heavily concentrated in just 2-3 stocks, which means it was luck that it had done well and there was a high risk of a future devastating blow to the portfolio. The majority of the time when I would see a lot of individual stocks, the performance of the overall portfolio was generally unimpressive.

In summary, I recommend this book to anyone looking to learn more about the philosophies and long-term strategies of investing. I'd also recommend it to financial advisors looking to hone their craft since the author was once a financial advisor himself, but now has made a career coaching financial advisors. Don't read this book if you are expecting specific details on how or what to invest in. He gets into some basics, but the book primarily discusses financial missteps to avoid and some of the emotion and fear based decisions that could negatively impact your wealth building ability.

Wednesday, August 19, 2015

New Toy

I've been wanting a new laptop for a while now, but have continued to tell myself that it is just a want and not a need. Since we are saving and investing for other things, most 'wants', especially those with hefty price tags, are put on hold. But you know how sometimes a want just won't go away? Yeah, that's what happened to me with this desire. I seemed to find myself dreaming up reasons that I could justify the purchase as a need. I also began to try to justify the purchase since we could easily buy it without having to dip into savings. Even with all the justification going on, the practical side of me continued to win out.

After some handwringing and thought, I brought the idea up to my wife, who again helped me realize that this was definitely a want and not a need. We continued to talk about it over the next few days though and came to the conclusion that we would buy a new laptop if I found a way to pay for it other than just reducing the amount we planned to save this month. Enter Craigslist.

As time goes on I've gotten more and more apprehensive about using Craigslist (there's a lot of crazy people out there), but I figured this would be a good use of it. Like many people out there, I have several things lying around the house that I rarely, if ever, use. Curious to see how much I could potentially sell them for, I went over to eBay and searched for 'completed listings' of the items to see what other people have been able to successfully sell things for. Imagine my surprise when I found that by selling 4 things that I never use, I could bring in about the same amount of cash I needed for the new laptop!

Thankfully, the rest of the story is pretty boring and I don't have any stories to share of crazy people I met up with from Craigslist who tried to rip me off, rob me, or worse. To help keep things safe, I always make sure that I meet people in public areas (this morning I met someone inside a CVS where our entire interaction would be witnessed by a cashier and security cameras), and never give out my home address.

So far, I've only sold two of the four items I originally identified, which together brought in around 60% of the funds needed. I still have a few things outstanding, but have now begun to think of other things I have that I could be selling to get all the way there. For now, it's close enough that I did go ahead and make the purchase. I view it as a win-win-win situation. I got a new laptop (win!), de-cluttered the house a bit (win!), and paid for the laptop mostly with Craigslist cash (win!).

Monday, August 10, 2015

This is news somehow?

I've come across a few articles recently that I really hope aren't actually news to anyone reading them.
The basic theme of the articles is that you may find it harder to qualify for a mortgage if you have a lot of student loans. Really? That's supposed to be news? Just because your debt is a student loan doesn't mean it all of the sudden isn't debt. Just like you'd have a hard time buying a house if you already spent half your income on car payments, if a large portion of your income is used to cover payments on student loans, banks will be hesitant to loan you even more money for a house.
One of the authors went so far as to say you may be better off not even going to college since you can still make a decent income without a college degree and you wouldn't be saddled with mountains of student loans.

Taking a step back, I decided I wanted to look at this problem through a finance lens. In finance, when evaluating between two decisions, an easy analysis can be done called NPV, or Net Present Value. The purpose of the analysis is to compare two alternatives, and to account for the fact that having some money today is better than having the same amount of money in the future. In this case though, the question is whether going to college is worth the extra time and energy required versus just finding a job right out of high school and skipping college.

U.S. News reported that, on average, a 25-32 year old with a college degree earns about $17,500 per year more than their peers who only have a high school diploma and the average starting salary for a college graduate is around $45,500. Assuming that each person's income grows at 3%, you would actually expect that gap to widen over time. Looking at those numbers, it's no wonder that most people agree that getting a college education is worth the investment. Even foregoing four years of income in order to study you can expect to earn upwards of one million dollars more over the course of your lifetime just for having a college degree. But what about those four years of school where you aren't earning any income? That's where this handy little NPV analysis comes in. This allows us to judge between two decisions by discounting the income from future periods to a 'present value'. Here's what I came up with:

A few things stood out to me from this chart. First, how crazy is it that a college graduate could earn about $1.5M more over the course of their lifetime?

Now, when comparing alternatives with NPV analysis, a higher NPV is better. As you can see, going to college without incurring any debt is your best long term strategy. The way I think about it though, whether to go to college is not a $1.5M decision, but rather a $80,000 decision (the difference between NPVs, not the difference between lifetime incomes). This is because even though (on average), you can make more income, a lot of the extra income is later in life and so not as valuable as income today.

Lastly, it is worth noting that this analysis shows that a getting a degree with some debt is still better than not going to college at all. The average student that graduates with debt has about $28,000 in debt. What these numbers show us is that, while still a higher NPV, by taking on debt to fund education, you effectively give up 20% of the benefit of the increased income.

I'll be honest, when I first read that the average loan balance of college graduates was $28,000, I was surprised that it was so low. Financial news sites seem to only highlight cases where people borrow $100k+ and get a degree in a low paying field and then use these extreme examples to show that college isn't worth the investment. What's sad is that this same analysis shows that they are probably right. If you do happen to borrow $100k to get a degree that can only help you get an average paying job, this analysis would show that the act of borrowing heavily to finance an education negates the majority of the additional earning potential.