Market Volatility - My Letter To Our Clients

This is a letter that I sent to our clients on August 22, 2015, to address the current market volatility. 

"Our goal is to help people overcome their worries and concerns about money and investing so that they have more time to focus on what's most important to them."

That's a quote from a marketing brochure that Simone and I put together when we started our business back in 2007. Although we haven't used those brochures for years, that sentence still summarizes what I try to do for each of our clients. My sincere hope is that the financial planning we've done has reduced your financial worries and brought more enjoyment to your life.

I'm writing this to address last week's volatility. I realize that even if our clients don't pay attention to the day-to-day movement of their investments (which is never a good idea!), it's impossible to escape the constant barrage of negative headlines that accompany market downturns. This is my response to all of the do-something-now-before-it's-too-late-this-time-is-different articles that you'll come across now and in the future.

I thought it might be helpful to put together a list of the main points that I'd like to make about why we do what we do. This would probably be easier to follow than writing it in paragraph form, and it would be something that you could refer to easily in the future.

In addition to reviewing the list below, I think it would wise to reread all of the Company Updates, Client's Corner, and other articles that I've uploaded to your web portal during the time that we've worked together. These documents were selected to reinforce what we discuss during meetings. It would also be helpful to review past meeting agendas, your meeting notes, financial plans, etc. 

Problem: It's impossible to predict the future.
Solution: Develop a financial plan and update it as needed.

The good news for clients reading this is that your financial plan has prepared you for things like the volatility we experienced last week. During the planning process we discuss what might happen in the future and then built an investment strategy to prepare for it so you don't have to react every time the market swings.

Problem: It's impossible to time the market.
Solution: Stay invested, focus on the long-term, and don't panic and sell during downturns.

Was the downturn last week the start of a new bear market? Or was it just a short-term overreaction to current events? Only time will tell, but reacting to it is the wrong thing to do. Getting out of the market or reducing your stock exposure in response to downturns might feel like a good strategy, but it's a sure way to turn a decline in value into a realized loss. There's no shortage of studies showing that market timing leads to increased costs, higher taxes, and lower performance.

Problem: It's impossible to pick the best investments.
Solution: Select diversified, passively-managed mutual funds and ETFs.

Just like it's impossible to predict the short-term direction of the market, it's also impossible to predict which individual stocks or bonds will do best at any given time. You can eliminate the risk of losing a large percentage of your portfolio in a single holding by investing across a diversified portfolio consisting of thousands of stocks and bonds. Even professional fund managers fail to beat their respective benchmarks. Only around 1 in 5 mutual funds outperform over 10+ year time periods, and it's impossible to know which fund will outperform in advance. Selecting mutual funds and ETFs that track an index of stocks and bonds - instead of trying to pick the best individual holdings - helps make sure that you get as much of the market's return as possible.

Problem: The stock market is volatile.
Solution: Don't put short-term money in the stock market.

It's a fact that the stock market is volatile. It's also a fact that you can't lose money in stocks if you avoid selling when stocks are down. Although there's never a guarantee, you can limit the chance that you'll have to sell stocks during a downturn through regular planning. For clients that aren't retired, we regularly review their cash reserve to make sure they shouldn't have to touch their investments for an emergency expense. For retirees, we regularly review their spending needs and withdrawal strategy to make sure they have enough in cash and bonds to support their projected spending needs in a downturn.

Problem: Your money is worth less each day.
Solution: Invest for long-term growth.

Some individuals avoid the volatility of the stock market in favor of "safe" investments like cash and bonds. A common misconception about these types of holdings is that at least this money will be "safe," but that's not true. I believe that inflation is a larger danger to investors than volatility, especially since it's a danger that many don't "see" until it's too late to do anything about it. For example, retirees that don't get enough growth to outpace inflation might have to make huge reductions in their spending later in life.

So to summarize these points, your financial plan and investment portfolio were designed with market events like last week in mind. Reacting to these events might make you feel better over the short-term, but could do permanent harm to your financial situation.

Please contact us if you have any questions or concerns about the funds we manage for you. Likewise, let us know if your financial needs or goals change.

Best regards,

Neil

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.

How To Avoid A Ponzi Scheme

On August 17, 2012, the SEC shut down ZeekRewards, an alleged $600 million online Ponzi scheme. This is yet another reminder that investors need to do their homework before trusting someone with their life savings. Fortunately, there are a few simple steps you can take to protect yourself from investment scams.

Beware of the promise of high returns and low risk.

A lot of investment scams attract investors by promising very high returns will little or no risk. After all, everyone wants to make a ton of money but none of us enjoy investment loses! Unfortunately that’s not how things work in the real world. If you want to earn higher returns, you’re going to have to take on more risk.

Be leery of consistent returns.

All investments fluctuate in value. The higher the expected return of an investment, the more volatility you should expect. Be leery of anyone that promises large positive returns on a consistent basis regardless of the market environment.

Check for registrations.

Many Ponzi schemes involve unregistered securities, so make sure any investment you buy is registered with the SEC or state regulators. Also, if you’re getting advice from someone, make sure that he or she is registered and licensed with the appropriate agencies. Here in Texas you can contact the Texas State Securities Board to research an investment or financial advisor.

Check your statement.

You should receive a statement on a regular basis that lists each investment you have as well as the market value at the time the statement was generated. Review the statements for inaccuracies and ask about anything you don’t understand. Also, these statements should come from an independent, third-party custodian, not directly from your advisor (see next tip).

Don't give someone custody of your money.

Never give an advisor custody of your money. Making sure your money is held with an independent, third-party custodian will make it impossible for your advisor to walk off with it like Bernie Madoff did. For example, we use TD Ameritrade as our custodian. Our clients deposit money directly into their own accounts at TD Ameritrade - not at Vannoy Advisory Group - and TD Ameritrade provides them with regular trade confirmations, statements, and other important account documentation.

Avoid complex or secretive strategies.

Warren Buffet’s advice is to never invest in a business you can’t understand, and that’s good advice to apply to investments as well. Swindlers often use complex or secretive strategies as a smokescreen to cover up what they’re doing.

Get a second opinion.

When in doubt, get a second opinion from someone that’s not directly related to the investment like a CPA or a fee-only financial advisor that works by the hour. You can go find a fee-only advisor through NAPFA or the Garrett Planning Network.

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.

Investing On Margin (Beware The Double-Edged Sword!)

Investing on margin is similar to purchasing a home. Most home buyers borrow money to be able to purchase a larger home than they could afford if they had to pay cash for the entire purchase price. Investors that use margin borrow money to increase the amount of stocks they're able to buy.

The primary reason investors use margin is to increase their investment returns. Unfortunately, using margin can work against you just as easily as it can work in your favor.

Investing Without Margin

Let's start by looking at an investment made without the use of margin. Assume you purchase 100 shares of ABC Industries when it's trading at $50 per share. Your total investment would be $5,000 (100 shares x $50 per share = $5,000 investment).

Assume the stock price of ABC Industries climbs to $55 per share and you sell your total holdings for $5,500 (100 shares x $55 per share = $5,500 proceeds). This would give you a profit of $500 ($5,500 proceeds - $5,000 investment = $500 profit) which represents a 10% gain on your initial investment ($500 profit / $5,000 investment = 10% gain).

Using Margin To Magnify Gains

Now let's assume you used margin for your initial investment in ABC Industries. Assume you invest $2,500 of your own money and borrow $2,500 from your brokerage firm for the initial investment. You then purchase the same 100 shares for a total of $5,000 (100 shares x $50 per share = $5,000 investment).

You would still realize a profit of $500 if ABC Industries climbs to $55 per share and you sold your shares (100 shares x $55 per share = $5,500 proceeds - $5,000 initial investment = $500 profit). However, due to the fact that you only used $2,500 of your own money, that $500 profit now represents a 20% gain on your money ($500 profit / $2,500 investment = 20% gain).

In this scenario, borrowing 50% of the initial purchase amount doubled your gain from 10% to 20%! Of course in the real world you'd pay interest on the money you borrow and might pay trading commissions, but you'd still end up better for using margin in this scenario.

Stocks Don't Always Go Up 

Margin is a double-edged sword. Using margin is great when stocks go up, but even a small drop in price could be enough to wipe out your initial investment if you are using a lot of margin.

To illustrate this risk, assume you purchase 100 shares of ABC Industries on margin at $50 per shares as you did in example above, but this time the price of the stock declines. You would realize a -$500 loss if you sold your holdings when ABC Industries was at $45 per share (100 shares x $45 per share = $4,500 proceeds - $5,000 investment = -$500 loss).

You only invested $2,500 of your own money since you borrowed 50% of the initial investment using margin, but this loss now represents a 20% loss on your investment because you used margin (-$500 loss / $2,500 investment = -20% loss)! Investing on margin looks great when stocks go up, but it doesn't take much of a price decline to realize how dangerous using margin can be!

Some Of The Risks Associated With Buying On Margin

(1) Stocks don’t always go up – Using margin magnifies your losses when stocks decrease in value.

(2) You can lose more than you deposit – If the securities you purchase decline in value, you may be required to deposit additional funds to cover the losses. This is called a margin call.

(3) Your brokerage firm can force the sale of securities – If you are required to deposit cash to cover your losses, your brokerage firm has the right to sell securities in your account to meet the margin call if you don’t deposit money in time.

(4) You pay interest even if you lose money – Interest will be charged on your margin balance whether or not you make money on the trade, and paying interest to lose money just adds insult to injury!

Using margin as a way to increase returns is one of the biggest mistakes that investors make. Make sure you know what you're doing - and understand all of the risks involved - before using margin in your accounts.

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

You Might Be Your Own Worst Enemy, Part III

(This is the third part of a three part series. The first two parts were published in our last two newsletters.)

Your behavior as an investor is the single largest determinant of your long-term investment return.* In our last two newsletters we discussed several common mistakes that investors make - greed, panic, overdiversification, underdiversification, speculating, and letting cost basis control your investment decisions.

This final installment will conclude with two additional mistakes you should avoid if you want to increase your chances of achieving investment success.

Focusing on Yield Instead of Total Return

Investment returns are the result of two things: capital gains and yield. A capital gain occurs when an investment appreciates in price, and yield refers to the dividends and interest paid by an investment.

Investors tend to shift their portfolios toward higher yielding securities and away from stocks as they approach retirement, but focusing on yield can be problematic since investments with high yields - like CDs and bonds - historically have not kept up with inflation over long time periods.

According to TIAA-CREF, a couple aged 65 has a 50% chance that one of them will be alive in 30 years. That’s a long time and a lot of inflation! Instead of focusing solely on “yield” investors living off of portfolio income would be better served focusing on “total return” and making sure they have a plan to keep up with – or outpace – inflation.

Buying on Margin (Using Leverage)

Investing on margin is similar to buying a home. Investors borrow money from their broker to purchase more of a security than they could afford to purchase without using borrowed funds for a portion of the total purchase.

The problem with margin is that it’s a double-edged sword. Buying stocks on margin is great when prices go up because it magnifies your return. But, when stocks go down, your losses are magnified as well!

The use of margin can get out of hand not only during long bull markets - like the one we experienced in the late ‘90s - but also during volatile markets like we’ve experienced over the past several months.

In a bull market, the mistake investors make is believing that stocks only appreciate. Trying to increase your return using margin during long bull markets can lead to large losses when the market eventually turns around. In a volatile market, investors trying to earn huge returns on the next upward swing can be wiped out completely if a downturn comes first.


*A study conducted by Dalbar found that investors captured less than 40% of the actual market return during the 20-year time period that ended 12/31/2007. This is a phenomenon that has been repeated over and over with surprising regularity!


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.