Trifecta

Picking a trifecta is difficult, at best. Identifying the first three winners of a horse race, in order, is called a trifecta. The 2019 Kentucky Derby had 19 finishers, so you had to choose from 5,814 potential combinations! If you were correct, the $2 trifecta paid $22,950.

During my career in financial planning, I’ve found three things to be true: individuals aren’t aware of the type of investments they own, how much risk they’re taking, or what level of fees they’re paying.

After meeting with someone, I’ll review their investments to give them an idea of their financial situation. Often, they’re surprised how they’re allocated, their risk level, and the fees they’ve paid. I’ll then compare the results to their financial plan to make sure all three (allocation, risk, and fees) are in sync. The goal is to achieve a financial balance.

Let’s look at the three components.

Asset allocation. Your asset allocation determines most of your returns and your risk level. You might be able to improve your results by investing when the market is low; However, the odds of picking a bottom are extremely rare.

For the past 45 years, a portfolio of 100% stocks generated an average annual return of 12.9%. A portfolio consisting of 100% bonds produced an average annual return of 6%. A balanced portfolio of 60% stocks, 40% bonds made an average annual return of 10.4%.[1]

The returns varied depending on the market conditions. The 100% bond strategy never lost money from 1973 to 2018. The returns have dropped dramatically since 1999; the average annual return has been less than 3% for the past 20 years.

The 100% equity portfolio has produced the best returns, but with the highest risk. From 1973 to 1974, it dropped 41.5%. In 2008 it fell 41.8%. Last year it was down 11.8%. To achieve double-digit returns, you need to take some risk.

The balanced portfolio had considerably less downside than the all-equity portfolio. From 1973 to 1974, it dropped 20.8%. In 2008 it fell 24.8%. Last year it was down by 6.2%. The losses have been about half those of the all-equity portfolio.

Risk level. Risk has several definitions. Losing money is a risk. Volatility is a risk. Longevity is a risk. Inflation is a risk. Liquidity is a risk. Investing all your money in a fixed income portfolio will expose you to inflation and longevity risk. Investing everything in the stock market exposes you to volatility and principal risk. It’s hard to identify your risk level, especially after a 10-year bull market. One test is to review your trading during the 2008 Great Recession. When stocks fell 50%, what did you do? Did you sell your shares? Did you buy stocks? Did you buy bonds? Did you do anything?

Using a service like RiskAlyze or Finametrica can help you determine your risk tolerance. If you’re curious, you can take a quiz on my website by clicking on the “free-portfolio risk analysis” tab located on the upper right-hand corner of my website. Here’s the address: www.parrottwealth.com.

Fees. The fees you pay for your investments matter. Of course, the lower your costs, the higher your return (all things being equal). If you and your brother-in-law own the same fund, but your advisor charges you 2% per year, and his advisor charges .5%, he’ll have better returns. Fees vary, so be aware. Your advisor may bill you by the hour, charge a flat fee, assess a percentage of your assets, or take a commission. Regardless, a fee is a fee. Also, your investments may include other charges if you own mutual funds, exchange-traded funds, or insurance products. If your investment is sold with a prospectus, you’re paying a fee.

If you’re not sure about your investments, then hire a Certified Financial Planner® to help you figure it out. But, before you do, ask your planner how they get compensated and what type of investments they recommend.

Last, completing a financial plan will help you organize and quantify your goals, so they’re in sync with your asset allocation, risk level, and fee structure – a trifecta!

A horse gallops with his lungs perseveres with his heart and wins with his character. ~ Federico Tesio

August 13, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

[1] 2019-Dimensional Matrix Book returns from 1973 – 2018.

Timing

Timing is everything.

Justify won the 150th running of the Belmont Stakes to capture the Triple Crown with a winning time of 2:28. If Justify had raced Secretariat in the 1973 Belmont, he would’ve lost by 4 seconds.

Carl Lewis set the world record for the 100-meter dash in 1991 with a time of 9.86 seconds. In 2009, Usain Bolt lowered his own world record to 9.58 seconds, .28 seconds faster than Lewis.[1]

Jules Verne wrote Around the World in Eighty Days in 1873. An 80-day trip in 1873 was a record. Today, the Space Shuttle can orbit the Earth in 90 minutes.

An investor who purchased the Vanguard 500 Index fund on March 9, 2009, the market low, generated an average annual return of 18.51%. His $10,000 investment is now worth $47,971. If he bought the same fund on October 1, 2007, the market top, his return fell to 7.54% per year. A $10,000 investment is now worth $21,726. He still doubled his money by investing at the top but not as impressive as if he had caught the low.

In reality, you won’t invest at the top or bottom of a market cycle. A more realistic scenario is that you’ll invest in between the two. For example, if you invested $10,000 per year from 1998 to 2018, you made 8.14% per year. Your $10,000 annual investment is now worth $547,321.

Investors seeking safety may look to the bond market. If you invested $10,000 in Vanguard’s Total Bond Fund on March 9, 2009, your average annual return was 3.59%. A $10,000 investment is now worth $13,846. Investing in this same fund on October 1, 2007, generated an average annual return of 3.80%. A $10,000 investment is now worth $14,887.

A bond fund is more stable than a stock fund, but the returns are considerably less. Despite the volatility in the stock market, it still pays to own stocks for the long run and hold them through all market conditions. If your time horizon is 3 to 5 years or more, you need to own stocks.

Time is more important than timing.

Time is on my side, yes it is. ~ The Rolling Stones

June 28, 2018

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

 

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

 

[1] https://www.topendsports.com/sport/athletics/record-100m.htm

Are You Diversified?

Diversification is a blessing and a curse.  Diversification is a great way to manage risk in your portfolio without trying to time the market.  It will also keep you invested during good times and bad.  In a truly diversified portfolio you’ll own a mixture of investments with some up and some down.  If all your investments are up or down, your portfolio isn’t diversified.

It’s human nature to want to own a portfolio of investment winners.  Investors are quick to sell losing positions to chase the winners, a classic strategy of buying high and selling low.  The Denmark stock market rose 23% in 2015 leading all developed markets.  The Canadian stock market fell 24% in 2015 and was the worst performing global stock market.   What do you think happened in 2016?  In 2016, Canada was the best market by gaining 24% and Denmark was the worst by losing 15%.  These two global markets exchanged places from 2015 to 2016.

This year emerging markets are leading the way while small cap stocks are turning in a sub-par performance and international stocks are outperforming U.S. stocks.  Last year, the opposite occurred with U.S. stocks and small caps outperforming international investments.

Trying to identify the best investment from year to year is challenging, like trying to pick the best horse in a field of race horses.  Sham was a great race horse in the 1970s finishing in the money 85% of the time but had the unfortunate event of being born in the same year as Secretariat.[1]   In thirteen starts, Sham finished first, second or third eleven times.   Secretariat beat Sham in each of the Triple Crown races and won the Belmont Stakes by 31 lengths.    To win in the long term, bet on more than one horse.

Here a few hot tips for your diversified portfolio.

  • Own large and small U.S. companies. Since 1926, large stocks have generated an average annual return of 10% and small stocks have averaged over 12%.
  • Own growth and value companies. Growth companies typically have stronger earnings and higher valuations than value companies.  Growth and value companies will zig and zag depending on economic conditions.  In the early stages of an economic recovery, value stocks will outperform but will lose momentum to growth stocks as the economy matures.[2]
  • Invest internationally.  International markets make up 46% of the global market and often outperform the U.S. market.
  • Invest in developed and emerging markets. Develop markets include the United States, Canada, Great Britain, Germany, Australia and Japan.   Emerging markets include countries like Brazil, Russia, India and China.
  • Buy Bonds. Bonds will generate income and provide a blanket of safety for your account.  For example, when the stock market fell 37% in 2008, long-term government bonds rose 25%.  The gain from bonds helped cushion the blow from falling stocks.
  • Add alternatives. Adding a pinch of alternative investments will help diversify your portfolio.  Alternative investments can include real estate, gold or oil.
  • Hold cash. A cash holding will allow you to take advantage of emergencies and opportunities.
  • Rebalance. Rebalancing your portfolio annually will reduce your risk and retain your asset allocation.

Here is a sample asset allocation for a portfolio consisting of 60% stocks and 40% bonds.  Your 60/40 portfolio can have the following asset allocation.

  • Large U.S. Companies = 25%.
  • Small U.S. Companies = 10%.
  • International Developed Markets = 15%.
  • Emerging Markets = 5%.
  • Alternative Investments = 5%.
  • Bonds = 35%.
  • Cash = 5%.

A diversified portfolio will keep you in the winner’s circle by giving you exposure to thousands of investments from around the globe so stay diversified my friends.

Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it.  If it don’t go up, don’t buy it.  ~  Will Rogers.

Bill Parrott is the President and CEO of Parrott Wealth Management.  For more information on financial planning and investment management, please visit www.parrottwealth.com.

August 16, 2017

 

[1] http://www.pedigreequery.com/sham

[2] https://www.merrilledge.com/article/growth-vs-value-investing-two-approaches-to-stocks