In Market Turbulence, Focus on Financial Aspects You Can Control
September 13, 2015 | John J. Klobusicky CIO, CFA®, CAIA
By John J. Klobusicky, Chief Investment Officer, CFA®, CAIA
As published in the Central Penn Business Journal, September 11, 2015.
Recent turmoil in global markets has the media in high gear with investment professionals making and questioning predictions, and investors struggling to fight behavioral biases that lead to bad outcomes. Professionals are caught up in the expectation of owning the ability to make predications and to consistently pick stocks or managers that “beat” the market.
These are lofty aspirations for outcomes that we have little or no control over. Investors are better served to cast aside what they cannot control, and focus on building a sound investment foundation anchored in a simple, time-proven approach.
In the midst of the media’s frenzied information dump, let’s revisit what investors and investment advisors cannot control.
1. Future outcomes. Remember Biff from the movie “Back to the Future Part II”? Biff discovers Grays Sports Almanac and travels back in time to lend the issue to his younger self, hoping to bet on future sporting news. What would investors do if they were handed an Investor’s Almanac of Future Events back in 1970? Predictions would have included the Arab oil embargo, the Savings & Loan crisis, the Iraq invasion of Kuwait, the Asian and Russian currency crisis, the Dot-Com Crash, 9/11, and the sub-prime crisis. Knowing nothing of price levels or timing, just the impact of the event, would any anxious investor even consider entering the market in 1970 and hope for the long term to smooth things out? Likely not.
Yet the patient investor who invested $10,000 in 1970 in the MSCI World Index, including dividends, would have $450,000 today. For the long-term investor, trying to time these events is often futile and very costly. The Vanguard Group’s founder, Jack Bogle, argues for an approach to investing defined by simplicity and common sense. “In 55 years in the business, I not only have never met anybody who knew how to do it, I’ve never met anybody who had met anybody who knew how to do it,” he says.
2. The ability to beat the market. A Vanguard study from 2013 found that of the 1,540 actively managed equity mutual funds at the beginning of 1998, only 55% survived by the end of 2012. And of that 55%, only 18% of these funds outperformed their respective market indices. If you are looking for consistent years of outperformance to select managers, good luck. It gets worse. Only 6% of the original 1,540 funds in the study beat their benchmarks and avoided three consecutive years of underperformance.
3. The financial press. Do not confuse entertainment with sound investment advice. Investors would be wise not to make investment decisions on information provided by individuals or professionals who are paid to talk. Along with the crises mentioned above, another event was a 1979 Business Week headline titled “The Death of Equities.” Ironically, this happened to be the beginning of one of the biggest bull market runs in history.
What can an investor or manager do? Focus on what you can control.
1. Fiduciary oversight. Investors looking for help should hire a Fiduciary to manage their assets. Fiduciaries are held to a higher legal standard of care in managing your assets. They are required to act in your best interests, whereas the brokerage industry is held to a lower suitability standard. Be sure to ask this very direct question when interviewing advisors.
2. Diversification. Although it’s an over-used term in the investment world, historical record shows that spreading your risk across asset classes and focusing on building a growing cash flow stream is an approach that offers a higher probability of success. Identifying and rebalancing underperforming asset classes can tamp down volatility and increase expected long-term returns.
3. Expenses. In a recent New York Times article, Jeff Sommer illustrated the impact of fees on a $10,000 initial invesment growing for 50 years. With no fees, the investment would grow to $294,570 at the end of this period; the same investment with a 1.19% management fee would yield $168,398. Fees matter, especially when you consider the percentage of your investment return. For example, with an expected long-term return on equities of 9%, a 1.75% fee costs the investor 19% of the gross return.
4. Taxes. Investment managers can control and manage tax impact on portfolios by employing a low turnover approach that manages taxes through loss harvesting and employing asset location strategies to minimize the tax bite.
5. Discipline. Finally, we have control over designing and sticking to our game plan. Once the welldiversified, low-cost portfolio is in place, our discipline should include regular rebalancing, review, and confirmation of investment goals. Market turmoil can be gut-wrenching and has a propensity to lead to emotionally driven investment decisions.
By focusing on what we can control, our chances at achieving success with our investment goals will be greatly enhanced in spite of market turbulence.