March 3, 2016


Dear Friends,

On February 27 I had the privilege of addressing over 350 investors at Retiremeet, a one day conference in Bellevue, WA, put on by Vestory, a local investment advisory firm. While I made three presentations, my keynote address was entitled "The habits and attitudes of successful investors." Of course these habits and attitudes are driven by our emotions, which can lead to disaster, if not controlled, or great success with a better understanding how those emotions impact our decision-making process. I was pleased how many people approached me afterwards for my recommendations on learning more about the topic.

For the most serious students I recommend Thinking, Fast and Slow, by Daniel Kahneman. According to Amazon, this book is the #1 best seller on cognitive psychology. Kahneman, the 2002 Nobel Memorial Prize winner in Economic Sciences, takes us on a tour of the mind and explains the two systems that drive the way we think. System 1 is fast, intuitive, and emotional; System 2 is slower, more deliberate, and more logical. Based on several decades of academic research, Kahneman suggests that people place too much confidence in human judgment. Of course, those who have studied the challenges of successful investing know that overconfidence has lead most investors to earning way less than they should have. Read this book and you are well on the way to understanding a topic that is far more important than the short-term direction of the market.

For those who want a lighter read, but every bit as useful as Kahnemans's book, I heartily recommend, "Your Money & Your Brain" by Jason Zweig. I have read this book at least five times and each time is a joy. There is no question in my mind that when it comes to sex, food and money, it's not an intellectual exercise. Zweig's book makes that very clear.

I encourage you to understand how both the mind and heart can trick us into making risky and impulsive decisions and thereby take action to implement sound saving disciplines and buy-and-hold strategies that will serve you no matter what the trends and emotions of the day.
 
By the way, my hope is I will be able to share either the audio or video of my presentation. Stay tuned!
 
Below please find 10 Q&A's from my last "Ask Me Anything" chat session at Scutify.com. To read all 30, click here. My next chat will be March 10 at 1:00 p.m. ET. To participate, please go to this link.

To your success,
Paul
 
Q: Is this a good time to invest in international equity stocks?
 
With the US Dollar exchange rate at high levels relative to most international currencies, is this a good time to invest some money into mutual funds that focus on international equity stocks? Any special caveats on making such investments?
 
A: If you check out my mutual fund and ETF recommendations at Vanguard, Fidelity, T Rowe Price, Schwab and TD Ameritrade, you will see that I advocate a 50% position in international equities. Over the 46 years ending Dec. 31, 2015 the additional return over a 100% U.S. equity portfolio is about .9% a year. This difference is very clear in a new article (The Ultimate Buy and Hold Strategy). The academics think the addition of internationals reduces overall volatility, but my study shows a slightly higher standard deviation than an all U.S. portfolio. Your question has the feeling of a market-timing question rather than a buy-and-hold concern. In the market-timing portion of my portfolio I presently have less than 50% international equities because the trend following timing systems have triggered sell signals.
 
Q: Can you compare Vanguard's international small cap funds?
 
I've heard you recommend "DLS" for an International small cap fund. I've been looking at your recommendations for Vanguard mutual funds, and I see it has VFSVX listed for International small cap. Could you explain how these compare? I'm planning to use your mutual fund recommendations from Vanguard, but am not sure if there is any advantage to including DLS, or if using VFSVX would cover international small cap just as well.
 
A: As I compared the two securities, I focused on the expenses (lower is better), average size company (smaller is better), price to book ratio (lower is better) and the performance (higher is better). DLS wins in every category except expenses. VFSVX charges .31% vs. .58% for DLS.  One of my beliefs is we shouldn't take a risk that doesn't produce a premium. A higher expense is a risk and the premium (for the last 5 years) for the higher risk was a compound rate of return 3,9% for DLS and a loss of .6% for VFSVX.  Five years is not very long but given that all the differences in size and value point to higher returns for DLS, I believe it should do better in the longer term.
 
Q: What are your best suggestions for an Emerging Markets Value ETF and an Emerging Markets Small Cap ETF?
 
A: Both TD Ameritrade and Schwab offer EWX on a commission-free basis. While EWX is not officially a small cap value fund, according to Morningstar, it's very close. The average company size is only $720 million, with a price to book of .98 and an expense ratio of .65%.  The other ETF that could qualify as small cap value is EEMS, available at Fidelity.  The EEMS expense is a little higher than EWX, the average size company is $70,000,000 larger and the price to book is slightly higher.  So the return of EWX should be higher than EEMS.  So far that has been the case as EWX has outperformed EEMS by 1.3% a year over 3 years. None of the commission free ETF sources offer emerging markets large cap value ETFs, but all of them offer large cap ETFs that are at least 50% value. For my recommended Commission-Free ETFs, click here.
 
Q: What fund do you suggest for short-term cash?
 
A: I hold the Vanguard S-T Investment Grade Bond Fund (VFSTX) in my taxable short-term cash-need account. The current yield for this fund is 1.99% vs. .5% for the Vanguard Short-Term Tax Exempt Fund (VWSTX). The after tax return is much higher with VFSTX.
 
Q: Should we trust these advisors regarding annuity advice?

We received a letter from AARP about NY Life AARP Lifetime Income Plan with Cash Refund Annuity. I called my Financial Advisor and he suggested "a better plan" with an Index Annuity, while another broker suggested Phoenix Index Annuity with no down-market exposure. We have money sitting in the bank earning almost nothing. We are tempted but not sure because we think these financial advisors are biased and not sure if they want what is best for us. Your input will be much appreciated. 
 
A: These are all very complicated investments and most of them are of greater value to the salesman than you. The person I think will give you the best advice is Stan Haithcock. Stan offers an amazing amount of free educational material on all kinds of annuities, along with a free consultation. You don't have to buy anything from Stan, but I wouldn't buy any annuity without getting his guidance and his quote first and/or last. I suggest you go to him last, as you would be able to compare him to all the others. On the other hand, if you go to him first his educational material will prepare you to get the most out of your other conversations.
 
Q: If we need an advisor, is it good enough to get an RIA (registered investment advisor) who has a fiduciary responsibility to his clients?
Aren't many RIAs also advocates of individual stock picking and sellers of insurance? I noticed some in the Garrett Planning Network are licensed to sell insurance and believe in individual stocks.
 
A: Your point is very important. I have a free e-book that lists all the things we should know about an investment advisor before we do business with them. In "Get Smart or Get Screwed: How to select the best and get the most from your financial advisor," I recommend we understand what the advisor believes about the investing process. 

My wife and I have an investment advisor. He believes in low cost, no-load, passively managed mutual funds. He believes in balancing the equity portfolio between many asset classes that have a history of long-term success. He does not hold himself out as being able to predict the future or know what company, industry or country is going to be most profitable. If he could predict the future he wouldn't recommend the massive diversification he advocates. He believes in including enough fixed income to address my willingness to lose money in a bear market. In 2008, for example, the combination of our buy and hold and timing strategies and asset classes lost less than 20%, well within our risk limit.
 
He will never receive a commission on any transaction. He helps with making insurance decisions but uses a firm that works only with investment advisors, (Low Load Insurance Services). This firm can cut the costs of insurance by as much as 50%. I trust my advisor will take good care of my wife, should I die first. When I die, I suspect he will reduce the risk of our portfolio. While 90% of my investments are arranged to earn 6% to 8% long term, the other 10% is invested in a hedge fund that is built to make over 12%. That position will not be appropriate for my wife. 
 
My advisor knows everything about me and I think I know everything he believes about how to invest successfully. I think investors who don't know how investing works are at risk of getting well-meaning advice that isn't likely to produce the best unit of return per unit of risk.
 
I don't think an investor should be working for a firm that sells any commissionable products. Or, if you work with an advisor who can choose between being a fiduciary (and not take a commission) or selling products with commissions, get it in writing that they are acting in a fiduciary capacity and will never take a commission or any other compensation (including free trips to warm climates during cold winters) other than the hourly fee or asset based fee (a percentage of money under management).
 
I recently recorded a podcast about an advisor who promised he was not receiving a commission on the products he was recommending. It turns out he received over $11 million dollars in commissions! Check out this podcast for more on this scam. 

In my free e-book, "101 Investment Decisions Guaranteed to Change Your Financial Future," I list almost every important fork in the road you are likely to face. Those are the same forks in the road you and your advisor will face in constructing your portfolio. I hope you check out those 101 decisions. It's a very quick read and, in many of the cases, taking the right fork in the road could make you millions more over a lifetime. Let me know if it helped.
 
I do have one bias, after over 50 years in the industry. I would only work with a RIA who can access DFA Funds, as I think they are better than Vanguard. For do-it-yourself investors, I recommend Vanguard funds and ETFs at Vanguard, Schwab, Fidelity and TD Ameritrade.
 
Q: Why do you suggest, in your recommended portfolios, allocating a large amount of fixed income to short-term bonds?
 
A: The reason for using short to intermediate bond funds is to minimize losses during falling equity markets and/or during periods of rising interest. I have no problem with having all the bonds in intermediate bond funds. I have a number of followers who use my Vanguard Monthly Income Portfolio for the fixed income part of their portfolio. That's okay but they are taking a lot more risk. In 2008 the Monthly Income Portfolio lost money while the all-government portfolio made money. 
 
A: What do you mean by "mechanical plan" and can you please explain "timing the market"?
 
Q: The term mechanical means finding a way to invest that eliminates as many of the emotional decisions as possible. For example, investing the same amount automatically every month in a 401(k) (dollar cost averaging), rebalancing the holdings once every year or two, and investing in index funds that eliminate all emotional decisions for you and the manager. The more emotional steps to the decision-making process, the lower the likely return.
 
Market timing is simply making buy or sell decisions based on one of 100 different ways or reasons to be in or out of the market. Most market timing decisions are made by intuition based on feelings of fear or greed. Others, like the ones in my accounts, make all buy and sell decisions based on mechanical systems that indicate a change in market trend. "All About Timing" does a good job of explaining mechanical market timing. Here are a couple of articles on timing I have written: How Market Timing Reduces Volatility and Why Market Timing Doesn't Work.
 
Q: What role, if any, should a stable value account play in a retirement portfolio?
 
I retired a few years ago and left a portion of my portfolio in a 403B. This portion is invested in a stable value account currently paying 2.75% and I am treating this as fixed income in lieu of bonds. Good move or bad?
 
A: A very good move. Most stable value funds pay higher rates of return than short-term bond funds and have lower volatility. The risk with a stable value fund is that the guaranteed payment is made by an insurance company. In most cases they are highly rated insurance companies, so there should not be a concern of default.
 
Q: If someone has an investment horizon of 30 years, does it make sense to risk missing the premium pay off on small caps?

You recommend overweighting small cap equities. Isn't there a strong argument to be made that the return premium on small cap in the past may have been due to illiquidity in this asset class, and now that small cap stocks are much more liquid there may not be this premium? Also, it seems that at times the return premium on small cap doesn't pay off for a long time. If someone only has an investment horizon of 30 years does it make sense to risk missing it?
 
A: Your worry about small caps losing their size advantage is exactly what was being said about them in 1999, after the small cap asset class underperformed large cap blend for 30 years. The conclusion: Everyone knows about the advantage so it won't work anymore. For the next 16 years the premium for small cap was one of the largest in history.
 
As you know I recommend many different equity asset classes. I have no idea which ones will be best in the future. Maybe large will beat small. That's okay because about half the equity portfolio is in large cap. Maybe growth will beat value. I'm covered. U.S. might beat international. I'm covered. I'm not counting on any one thing being the best. But I think almost all of these asset classes will do better than someone who places a bet on one stock, one industry, or one asset class.
Do you think you have enough money to retire?
This is one of the most-often-asked questions posed by people in their 50s and 60s. There are simplistic answers (formulas, actually) that can tell you either "no way" or "maybe" or "for sure."  More


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