Relative Portfolio Returns Influence Happiness

Posted on May 29, 2014 | AAII Journal

How a portfolio performs relative to your expectations may impact how happy or unhappy you will be.

Whether an investor is happy or unhappy with his performance is significantly influenced by how his portfolio performs relative to the market. Investors are likely to be happy even if they lose money as long as their portfolio declines by a smaller magnitude than the broad market. Conversely, the proportion of investors likely to be unhappy rises during periods of strong market returns.

This conclusion is based on a study of British individual investors. Over 600 self-directed investors at Barclays Stockbrokers were surveyed during the period of September 2008 through September 2010. Respondents had a median age of 53 and median wealth of approximately $252,000. Answers were compared against actual returns.

The average threshold for anticipated happiness was a three-month gain of 5.4%. The average threshold for anticipated unhappiness was a three-month decline of 0.2%. Expectations for the level of returns that would lead to happiness did not alter much after the initial quarterly survey period, even though the FTSE All-Share Index (benchmark for the UK equity market) rebounded strongly from the financial crisis. Individual thresholds varied greatly; some respondents were happy even with a modestly negative return, while others required returns in excess of 20%. A strong positive relationship existed between return expectations and the minimum return an investor would be happy with.

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10-K Filing Size Impacts Volatility

Posted on May 27, 2014 | AAII Journal

The size of a 10-K report, an annual filing required from public companies by the Securities & Exchange Commission SEC, is correlated with a stock’s price volatility. Stocks of companies with larger 10-K file sizes experience more price volatility in the period immediately following the filing date. These stocks also experience larger earnings surprises and have a greater dispersion of forecasts by the covering analysts.

These were the conclusions reached by two University of Notre Dame professors, Tim Loughran and Bill McDonald, in a forthcoming Journal of Finance paper. The two professors proposed replacing The Fog Index, a commonly used measure, with file size as a gauge for determining how readable a 10-K filing is. The professors believe the goal of readability should be “the effective communication of valuation-relevant information, whether it is directly interpreted by individual investors or assimilated and distributed by professional analysts.”

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Do’s and Don’ts of IRA Investing

Posted on May 23, 2014 | AAII Journal

Individual retirement arrangements (IRAs) are supposed to be simple and flexible investment vehicles, but their investment rules are more complicated and restrictive than many investors realize.

When you invest only in publicly traded stocks, bonds and mutual funds, there are no special issues. However, the tax law prohibits or penalizes some other investments by IRAs. Though part of the law for a long time, these pitfalls are becoming more important as the investment options available to mainstream investors increase and as investors are attracted more to “hard assets” and other non-traditional investments.

The restrictions on IRA investments are not well-known and, as a result, investors often stumble into penalties or other problems. The most common mistake is using a retirement account to hold an investment that falls under one of three categories: prohibited investments, taxable investments and transactions, and prohibited transactions.

The prohibited investment rules apply to IRAs and also to other self-directed accounts, such as 401(k)s. The main category of prohibited investments is “collectibles” as defined in Section 408(m) of the Internal Revenue Code.

When an IRA acquires a collectible, the amount used for the acquisition is treated as a distribution to the IRA owner. It does not matter whether the collectible is held or eventually sold.

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ETFs and ETNs: Knowing What You Own

Posted on May 20, 2014 | AAII Journal

The liquidity composition of a fund’s underlying assets, the historical tracking error and fees are important characteristics to consider when investing in an ETF.

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Researching Adviser Fees Gets Easier

Posted on May 16, 2014 | AAII Journal

The U.S. Securities and Exchange Commission (SEC) has made it easier for investors to look up and compare financial adviser fees and policies. The Form ADV Part II Brochure now discloses information that advisers previously did not have to include in regulatory filings.

Perhaps the most notable information is the disclosure of fees. Clear information is provided on what the firm charges and what is required for clients to qualify for discounted fees. (Most typically, certain minimum dollar amount thresholds must be exceeded.) Also included is information on investment strategies, research methods, disciplinary actions, and whether the adviser receives commissions.

Though the filings are open to the public, accessing them at the SEC website is not straightforward. These instructions from should get you to them…

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The Danger of Getting Out of Stocks During Bear Markets

Posted on May 13, 2014 | AAII Journal,

One of the biggest risks to investors’ net worth is the portfolio decisions they make.

Failing to adhere to an appropriate long-term strategy has a significant damaging impact on wealth. Since wealth is generated from the compounding of returns, actions that severely reduce an investor’s portfolio balance can have a long-term impact.

A common dangerous action is panicking and pulling out of stocks during a bear market. Such an action limits the immediate damage to a portfolio, but can cause an investor to miss out on the big rebound that follows a large drop by not jumping back into stocks soon enough. Even being out of the market for just one or two years can cause a considerable amount of wealth to be forfeited.

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Confusion About Retirement Income Taxes

Posted on May 12, 2014 | AAII Journal

Many middle-income Americans age 50 and over do not understand the tax rules regarding retirement savings, according to a Banker’s Life Center for a Secure Retirement survey. While 94% of respondents could correctly explain how lottery winnings are taxed, only 29% could explain the tax rules for 401(k) plans.

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Reduce Stock Exposure in Retirement, or Gradually Increase It?

Posted on May 1, 2014 | AAII Journal

For the past 20 years—due to the growing research on safe withdrawal rates, the adoption of Monte Carlo analysis (a method of considering many simulations), and just a difficult period of market returns—there has been an increasing awareness of the importance and impact of market volatility on a retiree’s portfolio.

Dubbed “sequence of return” risk, retirees are cautioned that they must either spend conservatively, buy guarantees (e.g., annuities), or otherwise manage their investments to help mitigate the danger of a sharp downturn in the early years.

One popular way to manage the concern of sequence risk is through so-called “bucket strategies” that break parts of the portfolio into pools of money to handle specific goals or time horizons. For instance, a pool of cash might cover spending for the next three years, an account full of bonds could handle the subsequent five-to-seven years, and equities would only be needed for spending more than a decade away. This “ensures” that no withdrawals will need to occur from the equity allocation if there is an early market decline.

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John Maynard Keynes as an Investor: Timeless Lessons and Principles

Posted on April 23, 2014 | AAII Journal

As an active investor, I am always searching for guideposts that would help me avoid the perennial mistakes most investors make.

How do I avoid buying at the top of a market or jumping out when my entire portfolio gets whacked? How do I keep the faith when there’s turmoil aplenty, as was the case in 2008? How important are dividends in a downturn?

In the portfolios of the great economist John Maynard Keynes, I found some answers and reinforcement. Like Keynes, I did nearly everything wrong for years until I discovered a durable path to investment success. I speculated in commodities, dove into individual stocks on a whim and held onto losers far too long.

I found solace, though, when I examined Keynes’ investments, which span two world wars. Even though I and millions of others have weathered brutal markets in this century, they had nothing on Keynes, who was investing money for King’s College (Cambridge University), two insurance companies and private accounts for himself and his famous Bloomsbury friends.

Although he’s better known for his sweeping—and controversial—economic theories, Keynes was a fervent practitioner of capitalism. His rousing success as an investor shows how he embraced markets nearly all of his life.

Viewing his record as an investor, it’s ludicrous to call Keynes a socialist, which he wasn’t. Keynes genuinely enjoyed being a speculator and investor. He called his favorite stocks his “pets.” In addition to thinking through the ideas that would rescue Western economies (as well as Japan and eventually China) after two devastating cataclysms, he managed money for his own portfolio, his friends and several institutions.

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Finding Value and Financial Strength Based on “What Works on Wall Street”

Posted on April 16, 2014 | AAII Journal

Investors seem to be programmed by nature to fail at investing, pouring money into last year’s hot stock, industry or asset class.

James P. O’Shaughnessy provides a detailed examination of investment strategies in the fourth edition of his book “What Works on Wall Street: The Classic Guide to the Best-Performing Investment Strategies of All Time” (McGraw-Hill, 2011).

O’Shaughnessy argues that the majority of investors fail to beat market averages because they do not follow a disciplined approach to investing. Instead, investors let the emotions surrounding the market overpower their judgment and push them off their planned investment course. Investors tend to chase investments with the best recent performance, while ignoring anything that happened more than three to five years ago. Furthermore, O’Shaughnessy makes the case that the markets are not random. The stock market does not move around without any rhyme or reason; it “rewards certain investment strategies while punishing others.”

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