Is Buy and Hold Dead?

Adherents to a “buy and hold” investment strategy believe that the best way to invest is to hold a diversified portfolio of different asset classes over a long time frame. Here is a simplification of the buy and hold investment process:

1. Analyze your goals, risk tolerance, time horizon, etc.,
2. Select an appropriate asset allocation (mix of asset classes),
3. Select individual investments to use for each asset class,
4. Regularly rebalance your portfolio back to the original asset allocation, and
5. Change the asset allocation as your goals, time horizon, etc. change.

The problem with buy and hold - as with any investment strategy - is that there are times when it doesn’t work. Even with all dividends reinvested, a $10,000 investment in theS&P 500 on March 24, 2000 would only be worth $8,510 as of July 12, 2010!

That’s the kind of performance that has many people declaring that buy and hold is dead.

Performance of the S&P 500 Index*

(10 Years Ending 7/14/10)

The chart above shows the performance of the S&P 500 index over the past 10 years. You can see that while the “buying” part might be easy, it’s the “holding” part that can test your nerves.

Believe it or not, even though the S&P 500 is still in negative territory, other asset classes have had positive growth over the past decade. A properly diversified portfolio with exposure to US small-cap, developed international, and emerging market stocks, bonds and REITs would have realized positive returns over the past 10 years.*

Even if you had only invested in the S&P 500 over the past 30 years - a strategy I certainly wouldn’t recommend! - you would have still made money if you had been patient enough to ride out the ups and downs. The chart below shows the S&P 500 index over the past 30 years.

Performance of the S&P 500 Index*

(30 Years Ending 7/14/10)

Many people view the negative performance of the S&P 500 over the past 10 years as proof that buy and hold will never work again. This viewpoint is shortsighted, in my opinion, because no single investment strategy can be expected to outperform all of the time.

In fact, buy and hold actually worked over the past 10 years for asset classes other than large US stocks. The moral of the story is to hold a diversified portfolio with multiple asset classes, rebalance regularly, and avoid bailing out at the first sign of trouble.

Buy and hold is an excellent strategy as long as you are aware of, and comfortable with, the pros and cons associated with it.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com.

*The performance figures and charts in this post are for informational purposes only. Past performance can't and shouldn't be used to predict future returns.

The "Single Basket, Multiple Eggs" Quandary

After closing at a record high on October 9, 2007, the Dow Jones Industrial Average proceeded to lose over 53% of its value over the next 16 months. As if adding insult to injury, the ‘07-’09 losses occurred just a few years after the Dow fell close to 38% during the dot-com debacle of ‘00-’02.

It doesn’t matter that the intervening five years were good for stock investors. The combination of these two huge bear markets within the past decade has probably caused many individuals to give up on stocks forever.

Modern Portfolio Theory to the Rescue

Individual investors have been told that market losses like these can and do occur, and the way to prepare for these losses is to diversify your portfolio. While I don’t doubt that smart investors have always avoided “putting all their eggs in one basket” so to speak, most investors - individual and professional alike - currently use Modern Portfolio Theory (MPT) as the basis for their diversification decisions.

The basic idea behind MPT is that investors face two types of risk: the individual risk of each holding (unsystematic risk) and the risk of the entire market (market risk). MPT states that the individual risk of each holding decreases as the number of individual holdings increases.

According to MPT, if you hold a sufficient number of individual investments, unsystematic risk will be diversified away and you’ll only be left with market risk. Harry Markowitz, the father of MPT, argued that the more diversified a portfolio, the lower the risk.

Most advisors - myself included - heed this advice and recommend mutual funds (and ETFs) over individual securities and recommend holding a mix of different asset classes like US stocks, international stocks, bonds, real estate, etc. The idea is is to have one investment that “zigs” when another one “zags” in order to cut down on risk and increase your potential return.

In Summary

Many investors that have given up on stocks after the last two bear markets were either chasing "hot" investments or had too much money in stocks rather than in more secure holdings like bonds. Although it's not foolproof, the MPT theory of investing across multiple asset classes and holding a diversified mix of investments in each asset class can reduce the risk of suffering large investment losses.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com.

Our Fiduciary Statement

One of the biggest things that differentiates us from other financial advisors is that we, as Registered Investment Advisors, are held to a fiduciary standard by federal and state law.

Below you will find a copy of our fiduciary statement. The purpose of this statement is to outline the responsibilities we have toward our clients in easy-to-understand terms.

Does your advisor have a fiduciary statement? If not, feel free to offer ours as a guide.

If he or she will sign it, then you know you're working with a fiduciary. If not, then maybe it's time to look for a new advisor.

Fiduciary Statement

I will act as a fiduciary at all times as defined by federal law.

I will put the interest of my client first at all times - ahead of my own and my firm’s interest.

I will disclose all compensation in writing.

I will not receive any third-party compensation contingent upon the purchase or sale of a financial product.

I will not receive any fees from the referral of client business.

I will disclose potential conflicts of interest and will manage unavoidable conflicts in the client’s favor.

-Neil Vannoy, MBA, CFP®

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com

Stimulus, response.

The current market volatility has me thinking of one of my favorite Far Side cartoons that features an amoeba yelling at her husband for never "thinking", only "responding".

It's human nature to want to "respond" (e.g. sell your stocks) when you encounter a "stimulus" (e.g. your stocks just declined in value). Unfortunately, the stimulus-response method of investing is one of the surest ways to lose money over time!

That's not to say you shouldn't make changes to your investments. It's possible you could have too much of your portfolio in stocks and need to reduce your exposure to the day-to-day risk of losing money known as "market risk".

Or it could be that you're facing a large amount of "inflation risk" because you responded to the 2008 market crash by moving your money to CDs, treasuries, and other "safe" vehicles that might not keep up with inflation over time.

(On a side note, I think the idea of investors having to choose between "returns" and "safety" is somewhat of a false dilemma used by salespeople to push financial products. To avoid this and other conflicts of interest, make sure your advisor is held to a fiduciary standard.)

If you've read previous blog posts or newsletters - or have seen a couple of the weekly "Smart Money Segments" I do for the local NBC station - you've probably heard me mention the importance of following an investment strategy when analyzing your portfolio for possible changes.

As an investor, you owe it to yourself to have a clearly defined investment strategy based on your risk tolerance, time horizon, and goals. That's the only way to make sure that any "stimulus" you encounter in the markets will be followed by a "response" based on logic and not emotion.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com

The Basics of Stocks

This is from one of my recent weekly "Smart Money Monday" Segments on Waco/Temple/Killeen NBC affiliate KCEN 6.

1. What is a stock?

Stocks – also known as equities – are securities that represent ownership in a corporation. And if you’re a “shareholder” of a business, you have a claim to part of the company’s earnings and assets.

2. There are two basic types of stock - common and preferred shares. What should someone know about each type?

Shareholders of common stock usually have voting rights and investors purchase common shares for growth potential. While preferred shareholders usually don’t have voting rights, they have priority over common stock if a company goes bankrupt. Investors purchase preferred shares for income since they pay higher dividends than common shares.

3. What are some of the basics involved in purchasing a stock?

To buy stocks you’ll need a brokerage account either online - where commissions and fees tend to be lower – or through a traditional stockbroker.

The most important aspect of buying stocks is thoroughly researching companies. You can use research from companies like Standard & Poor and Value Line, and www.morningstar.com is a useful website.

4. What are some of the types of stocks investors should consider?

Location (Domestic vs. Foreign) – Most investors should have a mix of US and international stocks since foreign markets can do better than the US market at times (and vice versa).

Style (Growth vs. Value) – The earnings of “growth” stocks are expected to grow at above-average rates and “value” stocks are thought to be undervalued. It's usually a good idea to have a mix of both styles in your portfolio.

Size (Market Cap) – Larger companies tend to be more stable and pay higher dividends while smaller companies have been more volatile but have performed better historically. Since past performance is no guarantee of future results, consider having exposure to both large and small stocks.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com

Cash Reserves

This is from one of my recent weekly "Smart Money Monday" Segments on Waco/Temple/Killeen NBC affiliate KCEN 6.

Why is important to have a cash reserve?

You should have a cash reserve for three reasons: (1) to avoid running up credit card debt to cover unexpected expenses, (2) to have funds on hand to cover your living expenses for a while if you lost your job, and (3) to have money available to take advantage of an investment or other buying opportunity.

How much should someone keep in a reserve?

A good rule of thumb is to have from 3 to 6 months of living expenses in a reserve. If your income is steady and your job is secure, then 3 months might be fine. But if your income fluctuates or your job isn’t secure, then you should err on the side of caution and build a larger reserve.

How should someone balance the need to keep the funds liquid so they can be accessed quickly with the desire to earn higher returns?

Your cash reserve should have several levels in order to strike a balance between liquidity and higher returns. Consider using the following types of accounts and investments for your reserve funds:

Checking Account – Keep enough in your checking account to avoid bouncing checks and overdraft fees.

High Yield Savings or Money Market Account – This should be the next level of your reserves and can be kept at your local bank or online. Make sure it’s linked to your checking account so you can transfer funds back and forth easily.

Certificates of Deposit (CDs) – CDs earn higher interest rates but most have early withdrawal penalties. You can ladder CDs so you have one coming due every month, quarter, or semi-annually depending on your needs.

No-Load Short-Term Bond Fund – A short-term bond fund will have a higher yield but your principal balance will fluctuate so it shouldn’t be used for money you’re planning on spending soon.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com

IRAs

What is an IRA?

An IRA (Individual Retirement Account) is an investment account that receives favorable tax treatment and is designed to help individuals save for retirement. While there are many different types of IRAs, Traditional and Roth IRAs are the two most common types.

What’s the difference between Traditional and Roth IRAs?

Contributions to Traditional IRAs are tax-deductible when made and withdrawals are taxed as income in retirement. While contributions to Roth IRAs don’t reduce your taxes now, they can provide a source of tax-free income in retirement. Regardless of the type of IRA you have, the account balance will grow tax-free while in the account, helping you accumulate more over time than you would in a taxable investment.

Is it true that Roth IRAs are better for younger investors and that older investors should opt for a Traditional IRA?

There are a lot of exceptions to that “rule of thumb”. For example, Roth IRAs avoid required minimum distributions at age 70 ½ that could force you to pay taxes on money you don’t even need. Roth IRAs also offer certain estate-planning benefits.

What’s the maximum that someone can contribute to an IRA?

The maximum contribution for 2009 and 2010 is $5,000, or $6,000 if you’re 50 or older. But the actual amount you can contribute will “phase-out” at certain income levels, and Traditional IRA contributions aren’t deductible in certain situations, so get advice if you don’t understand the specifics.

Is it too late to make a contribution for 2009?

You can make a 2009 contribution up until April 15, 2010 and can make a 2010 contribution from now until April 15, 2011.

To learn more about our company - and find out how we are different from other financial advisors - call (210) 587-6433 or visit www.VannoyAdvisoryGroup.com