Dry Powder

Active stock traders need to keep some dry powder so they can buy stocks when the stock market falls. Dry powder usually means cash. Allocating a portion of your portfolio to cash will be a drag on your returns, especially in a low interest rate environment with a rising stock market.

Traders need to be nimble so they can pounce on stocks when they drop. A cash hoard gives them the opportunity to act quickly without selling another position. This strategy works well when stocks fall, and they act on their impulse. If they time their purchase correctly, they can make a lot of money. Of course, if they don’t act quickly or time their purchase correctly, their strategy is for not. In a stock picker’s market cash is needed.

Traders look for fallen angels and Boeing is a classic example. Due to their unfortunate tragedies, the stock has dropped from its high of $440. Traders felt that Boeing below $400 was a bargain. The stock went through $400 like a hot knife through butter, falling another $62 to $338. Traders took their dry powder to buy it at $400 only to see their investment fall 15%.

Timing the market is extremely difficult. According to one study, asset allocation accounts for 93.6% of your investment return with the remaining 6.4% attributed to market timing and investment selection.[1]

During the fourth quarter of 2018 the Dow Jones fell 12.5% and investors withdrew $183 billion in mutual fund assets. Investors were storing up some dry powder, I guess. This year investors have added $21 billion to mutual funds, or 11.5% of what they took out last year. Meanwhile, the Dow has risen 13.8%. Dry powder?

A better strategy for most investors is to own a portfolio of low-cost index funds, diversified across asset classes, sectors and countries. This portfolio will give you exposure to thousands of securities doing different things at different times. It will allow you to stay fully invested because you never know when, where, why, or how the stock market will take off. It reduces your risk of market timing and eliminates the cash drag on your performance.

But what if, or when, the market falls? In a balanced portfolio you will own bonds of different maturities. For example, during the Great Recession stocks fell 56%. Long-term bonds were up 16.6% while intermediate bonds stayed steady at 2.94%. Dimensional Fund Advisors Five-Year Global Fixed Income fund rose 4.9%. True, they did not offset the entire drop-in stocks, but they did hold their own.

It’s possible, and recommended, to rebalance an index portfolio on a regular basis. When your asset allocation changes, rebalance your portfolio to return it to its original allocation. This strategy allows you to buy low and sell high on a regular basis. I once heard an advisor compare rebalancing to getting your haircut. When your hair gets too long, cut it back to its original length.

Shouldn’t stock pickers make money in a stock picker’s market? According to Morningstar only 24% of active equity mutual fund money managers beat their passive index over a 10-year period.[2] Is it possible to pick the top quartile funds every year for the next ten years? Doubtful.

Dimensional Fund Advisor’s found that over a 20-year period only 42% of equity funds survived. Their database started with 2,414 funds and only 1,013 survived twenty years. If more than half the funds fail, how will you be able to pick the top 25%?[3]

Rather than keeping dry powder or trying to time the market, focus on your financial goals and invest in a balanced portfolio of low-cost index funds.

Don’t let dry powder blow up your portfolio!

My mission in life is not merely to survive, but to thrive; and to do so with some passion, some compassion, some humor, and some style. ~ Maya Angelou

June 19, 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.

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.

 

 

 

 

[1] Determinants of Portfolio Performance, Financial Analyst Journal, July/August 1986, Vol 42, No. 4, 6 pages; Gary P. Brinson, L. Randolph Hood, Gilbert L. Beebower.

[2] https://office.morningstar.com/research/doc/911724/U-S-Active-Passive-Barometer-7-Takeaways-from-the-2018-Report, Ben Johnson, February 7, 2019

[3] file:///C:/Users/parro/Downloads/2019%20Mutual%20Fund%20Landscape_%20Report.pdf

What if I’m Wrong?

Being wrong is no fun just ask the referees from the recent NFC playoff game between the Los Angeles Rams and New Orleans Saints.

Timing is everything and sometimes the difference between right and wrong is a split-second decision. Of course, no one wants to be wrong, but it’s a part of life.

I believe stocks will generate wealth for years to come, but what if I’m wrong? What if you invest at the wrong time and lose money? Can you recover from a sharp sell off? Since 1926 stocks have risen about three quarters of the time and generated an average annual return of 10%. They’ve created wealth for legions of investors but what if it’s different this time?

Let’s look back at four difficult times for investors: 1929, 1973, 2000 and 2008.

1929

On January 1, 1929 an investor who started with $1,000,000 and allocated their holdings to 60% stocks, 40% bonds lost money for six straight years before recovering in 1935 with a value of $1,018,082. The stock component of $600,000 fell 65% to $207,961 by the end of 1932. The bond portfolio never dipped below $400,000. The returns weren’t great, but over 20 years the portfolio generated an average annual return of 3.8%.  From 1929 to 1949 stocks rose 50% of the time, bonds 85%.  At the end of 1949 the portfolio was worth $2,188,086, a gain of $1,188,086.

1973

An investor with a $1,000,000 portfolio and an allocation of 60% stocks, 40% bonds in 1973 had to wait until 1976 before their account was profitable. The combined portfolio generated an average annual return of 7.05% from 1973 to 1983. Stocks fell 37% in the first two years, but they made money 63% of the time, bonds made money 54%. The $1,000,000 portfolio was worth $2,114,774 at the end of 1983, a gain of $1,114,774.

2000

An investor with $1,000,000 and an allocation of 60% stocks, 40% bonds had to wait until 2003 before their portfolio recovered. Stocks fell 37% from 2000 to 2002 and their bonds never lost money. In fact, from 2000 to 2018 bonds outperformed stocks by a wide margin. Stocks averaged 4.65% annually while bonds returned 6.87%. The combined portfolio turned $1,000,000 into $2,834,987 at the end of 2018, a gain of $1,834,987. Stocks rose 74% of the time, bonds 79%.  The combined portfolio generated an average annual return of 5.64%.

2008

An investor with $1,000,000 and an allocation of 60% stocks, 40% bonds had to wait two years before their portfolio recovered. In 2008 stocks fell 37% and bonds rose 26%. Stocks rose 81% of the time, bonds 63%. The combined portfolio returned 6.44% per year and the portfolio grew to $1,987,575 at the end of 2018, a gain of $987,575.

Despite investing during some of the worst times in history, these portfolios still generated positive returns over time. A courageous investor made money by staying the course. Trying to time the market and panicking during downturns will do more harm than good. If you’re a long-term investor, ignore the short-term ripples in the market.

Now faith is confidence in what we hope for and assurance about what we do not see. ~ Hebrews 11:1

January 23, 2019

Bill Parrott 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.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.  The returns were calculated based on the data from the 2015 Ibbotson® SBBI® Classic Year Book.

 

Losers

The Washington Generals have been playing basketball since 1952. During their tenure they’ve won three games, one in each of the following years – 1954, 1958 and 1971.[1] Despite their lackluster output they repeatedly play in front of sold out crowds at over 450 events per year. Why? It’s because their primary opponent is the Harlem Globetrotters.

The Globetrotters win most of their basketball games and, as a result, the Generals must endure a constant thumping. They are perennial “losers” because of their role, however, they’re really winners because of their long-term association with the Globetrotters.

Some investors are classified as “losers” because they routinely purchase stock at the wrong time. They buy stocks when the market hits an all-time high or just before a correction.

The last three corrections in the stock market have been the Great Recession, The Tech Wreck, and Black Monday. If you invested 100% of your money in the stock market on the eve of these three catastrophic events, how would your portfolio have fared?

The Great Recession occurred from October 2007 to March 2009 and the S&P 500 fell 57%. A $100,000 investment in October 2007 fell to $43,000 in March 2009. If you sold during the dark days of the recession, you would’ve lost 57% of your investment. If you held on, your original investment is now worth $226,000 – a gain of 127%! You generated an average annual return of 7.84% from 2007 to 2018.[2]

The Tech Wreck happened from April 2000 to October 2002. During this rout, the S&P 500 dropped 43%. A $100,000 investment in April 2000 fell to $60,000 by September 2002. You lost 43% if you sold at the bottom.  If you held, your original investment is now worth $263,000 – a gain of 163%.[3]

The stock market crash on October 19, 1987 was frightening. The market fell 22% on Black Monday after falling 4.5% the previous Friday. If you invested $100,000 on Thursday, October 15, 1987, you were down more than 26% by the market close on Monday. After two days of investing you lost $26,000. However, 31 years later, your original investment is now worth $1.64 million. You made 1,543% on your investment, or 9.5% per year![4]

If you happen to be a loser and buy stocks at the wrong time, hang on, because, like the Globetrotters, the stock market usually wins in the end.

“I have never known anyone who could consistently time the market. And in fact, I’ve never known anyone who knows anyone, who was able to consistently time the market.” ~ Burton Malkiel

August 26, 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.

Photo Credit: Andrey Popov

[1] https://en.wikipedia.org/wiki/Washington_Generals#Beating_the_Harlem_Globetrotters, website accessed 8/28/18.

[2] Morningstar Office Hypothetical – results as of 7/31/2018.

[3] Ibid

[4] Ibid