More Experience Won’t Necessarily Improve Returns

Posted on July 17, 2014 | Investor Update

Investor-Update
If you listen to Malcolm Gladwell, you might believe spending 10,000 hours on investing will help you make better portfolio decisions. In his bestselling book, “Outliers” (Little, Brown and Company, 2008), Gladwell cites data from a study linking hours practiced to expertise. Gladwell’s assertion of the number of hours required to gain mastery of a skill is based on a 1993 study of violinists by K. Anders Ericsson and colleagues at Florida State University. The best violinists practiced 10,000 hours, 2,500 more hours than other violinists, according to the Ericsson group.

The Ericsson et al. study is widely cited. If one were to extrapolate its results, a link between the amount of time spent investing and portfolio returns could be drawn. Similar links could be drawn between practice and other activities as well. This is not the case, however. A study recently highlighted by Business Insider argues the amount of practice actually only plays a small role in the mastery of a skill.

In “Deliberate Practice: Is That All It Takes to Become an Expert?,” six researchers analyzed the data from many studies on chess and music. The researchers describe these activities as the “the two most widely studied domains in expertise research.” They found deliberate practice only accounts for 34% of variance in chess performance and 29.9% of variance in music performance.

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Social Security’s Lump-Sum Payment Option

Posted on July 3, 2014 | Investor Update

Investor-Update
The Social Security Administration offers the chance to receive a lump-sum payment of up to six months’ worth of benefits. It’s not a well-known option, but it is available to anyone meeting the basic requirements. There are also caveats to consider.

Retroactive benefits can be claimed by a person who has reached full retirement age (FRA) and is not currently collecting benefits. FRA is currently 66 for those born between 1943 and 1954. It increases in two-month increments for those born between 1955 and 1959. Those born in 1960 or later will not reach full retirement age until they turn 67.

Full retirement age is the year at which a person first becomes eligible for the primary insurance amount. Social Security benefits can be claimed prior to the FRA, but they will be below the primary insurance amount. Conversely, if claiming is postponed, delayed retirement credits increase the benefits until age 70. The increase in benefits is why conventional wisdom calls for delaying the claiming decision until as close as possible to age 70 for those in good health.

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Social Security’s Lump-Sum Payment Option

Posted on July 3, 2014 | Investor Update

Investor-Update
The Social Security Administration offers the chance to receive a lump-sum payment of up to six months’ worth of benefits. It’s not a well-known option, but it is available to anyone meeting the basic requirements. There are also caveats to consider.

Retroactive benefits can be claimed by a person who has reached full retirement age (FRA) and is not currently collecting benefits. FRA is currently 66 for those born between 1943 and 1954. It increases in two-month increments for those born between 1955 and 1959. Those born in 1960 or later will not reach full retirement age until they turn 67.

Full retirement age is the year at which a person first becomes eligible for the primary insurance amount. Social Security benefits can be claimed prior to the FRA, but they will be below the primary insurance amount. Conversely, if claiming is postponed, delayed retirement credits increase the benefits until age 70. The increase in benefits is why conventional wisdom calls for delaying the claiming decision until as close as possible to age 70 for those in good health.

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10 Ways to Ensure Your Retirement Savings Last

Posted on June 26, 2014 | Investor Update

Investor-Update
A big financial challenge retirees face is ensuring their savings last the rest of their lives. It’s a daunting task for those making the transition into retirement as well as for those already in retirement. While saving as much as possible during your working years is important, the decisions you make in retirement are also very important. Fortunately, there are steps you can take to improve your odds of financial success. Here are 10 of them.

1. Withdraw a Safe Amount—Limiting the size of withdrawals from your retirement savings is critical for ensuring your portfolio lasts throughout your lifetime. William Bengen calculated a 4% withdrawal rate, adjusted upward annually to account for inflation, as having a very high probability of ensuring a retiree will not run out of money. You may be able to sustain a higher withdrawal rate, but the risks of running out of money will increase as well. Even bumping the withdrawal rate to 5% comes with some increased risks, though going above this level significantly increases the risk of a shortfall.

2. Allow for Variability in Your Spending—The 4% withdrawal rate is a good benchmark for determining how much to withdraw, but it’s just a benchmark. During good years for the market, you may be able to withdraw much more from your retirement savings; during bad years, much less. You will also have years when your spending is elevated (vacations, home repairs, medical bills, etc.) and years when your spending is lower. By allowing for variability in your spending, you can help to offset the blow taken from the years with bad market conditions or high spending.

3. Be Cognizant of Longevity Risk—Longevity risk is the probability of outliving your savings. The Social Security Administration estimates a 25% chance of a person turning 65 today living past age 90 and a 10% chance of living past age 95. (The average life expectancy is 84 for a man and 86 for a woman.) These numbers mean a person retiring today could potentially be looking at living off of his or her retirement savings for at least 25 or 30 years.

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Guidance for Following Portfolio Alerts

Posted on June 19, 2014 | Investor Update

Investor-Update
How fast should you act in reaction to a portfolio addition or deletion alert?

A good general rule for following any portfolio, whether it is one of ours or one run by another organization (e.g., a newsletter service), is to buy when an addition alert is issued and sell when a deletion alert is issued. If you want to mimic the performance of the portfolio, it only makes sense to follow the changes. Acting quickly is prudent.

There is a difference between ‘quickly’ and ‘immediately,’ however. In the Model Shadow Stock Portfolio stock order guidance rules, we advise members to be patient. In the user’s guides for our Stock Superstars Report and AAII Dividend Investing portfolios, we suggest generally “acting on portfolio addition and deletion alerts within the week.” We follow up this statement by saying “don’t be afraid to wait longer if you feel the stock price is moving in your favor (falling if you are a buyer or rising if you are a seller).” In other words, don’t dawdle, but don’t feel rushed either.

The amount of patience you should use depends on the stock itself. A large-cap, widely held stock likely won’t be affected by a newsletter alert. We didn’t notice any unusual trading activity in Apple (AAPL) when we added it to our dividend investing portfolio this past April, for instance. Conversely, a smaller, less-followed stock may well be affected. Before the financial crisis, I once saw Movado (MOV) move upward by more than 10% in just a few days because Jim Cramer talked favorably about it on Mad Money. Lower volume will cause a stock to move in reaction to favorable or unfavorable comments or actions, especially if the portfolio or the commentator has a sizeable following.

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Retirement Is Evolving, But Not Completely Changing

Posted on June 12, 2014 | Investor Update

Investor-Update
Two new, but separate, studies by Vanguard and Merrill Lynch revealed evolving trends among retirees. Neither study shatters commonly held beliefs, but both do show that some differences between perception and reality exist.

The Vanguard study, “Retirement Income Among Wealthier Retirees,” looked to see how sources of retirement income have changed. The firm surveyed more than 2,600 households ages 60 to 79 with financial assets of at least $100,000. The researchers requested a complete inventory of income sources and wealth holdings and then asked about the amount and movement of withdrawals.

Lending support to current perceptions, 85% of survey participants received Social Security and 71% received pension income. These public and private income sources accounted for nearly half of aggregate non-housing wealth. Ownership of retirement accounts (e.g., 401(k) plans, IRAs, etc.) was also high, with 84% of respondents holding at least once such type of account.

Where things get interesting is the composition of non-housing wealth. Among the six groups that Vanguard segmented respondents into, Social Security recipients and pensioners received about 70% of their non-housing wealth from the two traditional retirement income sources. Among the other six groups, however, the proportion of total wealth from Social Security and pensions ranged between 18% (for business Investors, who were the most reliant on business income) and 32% for annuity investors (who were the most dependent on annuity income). Even those who are the most dependent on income from stocks, bonds, funds and similar investments—retirement investors and taxable investors—still depended on Social Security and pensions for about a quarter of their total non-housing wealth. In other words, while many retirees are not solely living off of Social Security and pension payments, the two sources still account for a significant portion of wealth and income for most retirees.

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Revenues Will No Longer Be the Same

Posted on June 5, 2014 | Investor Update

Investor-Update
Sometimes a sale isn’t a sale. Under accounting rules, the date when a company can record revenues depends on what it sells. A change to rules will simplify matters and change how revenues are booked by a broad range of companies. In the process it will alter valuations and growth rates.

It’s a big change. Even if you view accounting rules as exciting as reading the phone book, you should be spend some time familiarizing yourself with the new rules. I’ll try to make the discussion as least arcane as possible.

The new rules are the result of the work by the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) to establish a unified stance on when companies should recognize revenues. Here is how the IASB and FASB described the change:

“The core principle of the new standard is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the company expects to be entitled in exchange for those goods or services. The new standard also will result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively (for example, service revenue and contract modifications) and improve guidance for multiple-element arrangements.”

The Wall Street Journal used mobile phones to describe how the rule change will impact reported revenues, and I’m going to do the same. Currently, you can buy an iPhone 5C from AT&T (T) for $99. The price is subsidized and AT&T recoups the difference between what you pay and the wholesale cost of the phone over the life of the two-year contract you sign. Under current rules, AT&T has to book its cost of the phone at the time of the sale, but recognize the revenues for the phone over the life of the contract. The new rules will allow AT&T to recognize more of the revenues related to the phone at the time of sale.

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The Difference Between Stock Screens and Portfolios

Posted on May 29, 2014 | Investor Update
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Investor-Update
Many of the more common questions I get asked pertain to our stock screens. Specifically, members ask about the performance of the screens and how replicable it is. Often, the screens are initially mistaken for being portfolios, which they are not.

I’ll use the O’Shaughnessy: Tiny Titans screen and our Model Shadow Stock Portfolio to explain the difference between a screen and a portfolio. Both target micro-cap stocks, but with different approaches. The performance figures for both also have important differences to be aware of.

A stock screen is essentially a database filter. It seeks out stocks matching a specific set of criteria. For example, the Tiny Titans screen identifies U.S. exchange-listed stocks with market capitalizations between $25 million and $250 million, a price-to-sales (P/S) ratio below 1.0 and a 52-week relative strength price rank of 85% or higher. (The last criterion restricts the screen to only those stocks whose price appreciation is better than at least 85% of all other stocks.) Any stock matching these criteria passes the screen, regardless of how positive or negative any of its other characteristics are. This is why it is important to conduct analysis beyond what the screen is designed to look for and not simply buy a stock because it passes a good screen.

The performance reported for each of the more than 60 stock screens on AAII.com is calculated based on the month-end list of passing companies. We determine what stocks pass, group them into a hypothetical portfolio, hold the portfolio for a month and then restart from scratch the next month. This monthly reconstitution works fine for giving you an idea of the type of performance of the screen has produced, but your actual real-world returns may differ. The performance calculations exclude any transaction costs—such as commissions, bid-ask spreads and taxes. They also use prices that may differ from what you would actually be able to trade it at.

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Not Updating Your Beneficiaries Can Be Costly

Posted on May 22, 2014 | Investor Update

Investor-Update
Much of the conversation about investing focuses on how to realize capital gains and portfolio income, but staying on top of the seemingly minor things is also very important. A court ruling earlier this month showed how seemingly minor missteps can have significant financial consequences. A widow was denied the proceeds from her deceased husband’s life insurance policy because the beneficiary information on the policy was never changed. The case is Hall v. Metropolitan Life Insurance Company.

Here is the summary of events. Dennis Hall obtained a MetLife life insurance policy in 1991 through his employer, Newmont. At the time, Dennis designated his son as the beneficiary. In 2001, Dennis married Jane Hall. In November 2010, Dennis filled out and signed a beneficiary-designation form naming Jane Hall as the sole beneficiary of his policy, but never submitted it. The failure to submit the form proved to be big mistake.

Dennis awoke partially paralyzed on January 26, 2011, and executed a will the next day. The will provided, according to court documents, that “the following specific bequests be made from my estate. Any and all life insurance and benefits shall be distributed to Jane Marie Hall. If this beneficiary does not survive me, this bequest shall be distributed with my residuary estate.” Dennis passed away the same day.

Newmont sent MetLife a copy of the 1991 beneficiary form, which was the most current one on file. Soon afterward, Jane sent MetLife a letter saying that Dennis had changed his will, but did not have enough time to get the approved form from the insurer to change the beneficiary. MetLife denied Jane’s request, explaining that the will had no bearing on a group life benefit.

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Blocked From Buying and Selling Mutual Funds

Posted on May 15, 2014 | Investor Update

T. Rowe Price blocked approximately 1,300 American Airlines employees from trading into their retirement plan mutual funds over the past three years due to excessive activity, according to Money Magazine. Some of the airline’s employees received lifetime bans. Southwest Airlines employees have also been warned by Vanguard to end their trading, according to Money.

Those of you who subscribe to Money may have seen the article. It’s not the first one on the subject and likely won’t be last. Though most mutual funds reserve the right to ban an investor from buying and selling its funds, it is rarely used. Investors who do get banned have frequently traded in and out of mutual funds, commonly on the guidance of a newsletter or an adviser.

It is my understanding that in order to get banned, or even to get a warning letter, a large amount of short-term trading has to occur. What prompts the warnings and the bans can often be a group of investors acting in unison, often on the recommendation of a central party (e.g., an advisory service). If enough shareholders move to buy or sell at the same time, the mutual fund could end up with more cash inflows or outflows then it is prepared to handle.

Understanding the structure of mutual funds is key to understanding why investors who trade too frequently can be banned. A mutual fund pools shareholder dollars together to buy and sell securities. It may be helpful to visualize a mutual fund as a group bucket of shareholder dollars. The fund manager, in turn, uses the cash in the bucket to buy various securities on behalf of the shareholders—while taking a small amount out of the bucket for the fund’s fees. When shares of the mutual fund are bought by an investor, new dollars are put into the bucket. When shares of the mutual fund are sold by an investor, money comes out of the bucket.

Mutual fund managers always keep a small amount of cash in the bucket to facilitate typical deposits and withdrawals by shareholders. Problems occur when the flow of cash into or out of the bucket is greater than usual. Such occurrences can give the fund manager more excess cash to work with than he planned on, or, in the case of withdrawals, can cause the fund manager to sell more securities than he would like to at a particular point in time. This is why mutual fund companies take steps to discourage too-frequent trading and ban those who ignore warnings to stop.

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