Here are some articles that caught my attention this weekend. Topics include: Evaluating your investment strategy, investing in low interest rates, hedge fund performance and asset allocation for young investors.
How to Evaluate any Investment Strategy
I really like this post over on millennial invest about what makes up a successful investment strategy. He explains why a simple index fund has worked, but the downsides of today’s basic cap-weighted index funds as well. Take a look at these 2 charts from his post:
We talked about this issue of large cap “underperformance” in our fund spotlight series post on Guggenheim’s Equal Weight ETFs http://begintoinvest.com/fund-spotlight-series-guggenheims-equal-weight-index-funds/
More specifically, here is an exact quote from our article:
“The typical index fund has performed very well for many investors (and will continue to do so over the long term). Index funds offers investors diversity for a very low cost and consistently beat the majority of Wall Street professionals.
But index funds do expose investors to a particular additional risk. They are constantly most heavily weighted in the biggest companies, which are potentially the stocks that are the most overvalued. As a stock’s price rises (and therefore its market cap rises as well), a market cap weighted fund will sell stocks which have gone down to buy more shares of the company’s stock that has risen.
Value investors like Ben Graham and Warren Buffett would say that investors should be doing the opposite.”
What does this mean for the average investor today?
Passive investing has become a “buzz word” in the investment world, and I am probably guilty of overusing it myself.
Passive Investing has worked because of several characteristics (nicely summed up in Millennial Invest’s post)
-Low costs (Fees, Expense Ratio, Turnover Ratios, etc)
But, adding a “smart active” tilt to your portfolio has the potential to improve returns. But that “smart active” tilt requires a little more knowledge, time commitment and certainly adds more risk. For an investor that wants to spend as little time as possible, or is brand new to the investing world, I still think a simple index fund is your best bet despite its faults. But for an investor willing to put a little more time into their investments, being smart in your investment activity certainly has its rewards.
On Investing in Today’s Low Interest Rate Environment
The Search for Income
Why This Bull Market Feels Familiar
“Income investors are in uncharted territory — and that includes the professionals. In 1982, the yield on the 10-year Treasury note was nearly 15%; since then, it has been in steady decline, barely cracking 2% by 2012. The last time interest rates rose in a meaningful way, most of today’s retirees were still working and saving for their golden years, and many of today’s experts weren’t even through Economics 101.”
New investors really don’t have a need for “income” from their investments yet, but yet many focus on finding high yielding stocks and add risk by replacing low yielding bonds with higher yielding stocks. Because of this, many try and time the market with the expectation that rates will rise rapidly and soon. And they have been underperforming the market handily.
This article in Barron’s touches on a lot of topics at once. Rising interest rates and their effects on different securities, the idea of “laddering” your fixed income investments, different types of ‘income’ investments (REITs, Munis, CDs, etc.) and more. All of which are important topics that new investors should understand.
The article on the ‘familiarity of today’s bull market’ tells a tale of investing in the 90’s bull market in a rising rate environment and the returns investors achieved. How did the market perform in lieu of rising interest rates? How many corrections did the market see? It turns out things don’t necessarily have to work out the way the financial pundits are saying they will today.
On Hedge Funds
Hedge Funds Suffer Worst Start to Year Since 2008
The Hedge Fund Manager Dilemma
I like to highlight the (under)performance of Hedge Funds not to make fun of them (I couldn’t do their jobs any better), but instead to show investors that sometimes simple and cheap investments like mutual funds and ETFs can really be some of the best investments out there. There is this vanity about being able to invest in hedge funds. Maybe pride that you can finally afford the minimum investment (which is typically hundreds of thousands of dollars at least).
But the small investor has been able to match (and beat) the performance of a large majority of hedge funds today using simple ETFs and Mutual Funds. Sometimes investors have this “sparkly object” syndrome, where they flock to what is “hot” or “fancy” and ignore things that are “boring”. But in Wall Street, boring tends to be much better.
Asset Allocation and Young Investor Strategy
The Kids are Mostly in Cash (and Mostly Wrong)
If You’re Not Saving, You’re Losing Out
“In the last 88 years, U.S. equities have returned 6.6 percent in real terms annually, as compared to 2.4 percent for government bonds, according to Barclays data. Cash has shown a real annual return of just 0.5 percent.
And while equities have done less well over the last decade, with a 5.5 percent annual real return, cash has shown a negative 0.8 percent annual return in the same period.
The bottom line is that millennials are making a terrible allocation decision at exactly the worst time, and have, to boot, largely missed out on the post-crisis rally.”
“Over the 35 years through 1984, the amount saved as a percentage of post-tax income averaged 11.1% a year, and there wasn’t a single year when it fell below 9%. In the years since, the annual savings rate has never gotten as high as 9%. The drop-off was especially sharp after 1992, with the savings rate eventually hitting a low of 2.6% in 2005. Shaken by the Great Recession, Americans boosted their savings rate to 6.1% in 2009. But as the economy has mended, our inclination to save has waned, reaching just 4.5% last year.”
Not only are young investors as a whole not saving, what they do save is mostly in cash. Even those who have significant savings ($100,000+) have 42% of their assets in cash!
One of the most popular articles on Begin To Invest is our “How much Do I Have to Save to Reach $1 million” post (found here: http://begintoinvest.com/saving-for-a-million-dollars/ )
You can see the power of getting started investing early. A 25 year old has to save and invest just over $5,000 a year to have a million dollars by age 65 (with a lot of simplifications and assumptions that I go over in the article). If that same investor waits 10 years, til age 35 to start investing, that number jumps to $10,500 a year. An investor who waits until 40 to start saving for retirement needs triple the amount of money saved by the 25 year old to reach $1 million at time of retirement!
Very few people have lots of money to save and invest when they are 25, the point is not to wait until you are rich to start investing, but to start with small sums because it really adds up. Just $50 a month starting at age 25 compounds to nearly $50,000 in 30 years assuming a 6% return.
That’s all for this weekend.