Top Five Mistakes in Portfolio Design Part 1

When clients first come to us exploring the possibility of hiring a professional wealth manager, we ask them to bring copies of all of their investment account statements, so we can perform an analysis of their portfolio.

Being in business for over 23 years now, we have reviewed hundreds of portfolios, and we’ve seen many common investing mistakes repeated over the years.The portfolios vary widely based on who designed them. There are clear tendencies and attributes that signify a portfolio constructed by a professional money manager versus a do-it-yourself individual investor. Based on our extensive experience in analyzing portfolios, we have compiled a list of the top five investing mistakes we see from individual investors in the design of their investment portfolios:

1. Too Much Cash

“Cash is king” the old saying goes, and it still holds some truth, even in this 0% interest rate environment. Cash provides a buffer for emergencies, and a source of income in bear markets if you’re living off your portfolio and don’t want to sell at depressed values. Cash also gives you the ability to be opportunistic in declining markets by providing the liquidity necessary to buy when others are selling.

But there is a limit to how much cash you want to maintain, especially in this 0% interest rate environment. We advise keeping six months to two years’ worth of non-discretionary living expenses in cash as a reserve fund. Add a bit more if you want to have an “opportunity fund” to have the liquidity to buy into declining markets, but cash should never exceed 10% of your total portfolio. At that point, it starts to become a significant drag on your returns given that it’s likely earning close to nothing.

Unfortunately, we often see individual investors holding much more cash than that. In fact, it is not unusual to see cash comprise 30% or even 40% of an individual investor’s portfolio. The reason usually stems from a fear of losing money or an uncertainty of how to invest it.

2. Overconcentration to One Stock

Investors have a tendency to fall in love with certain stocks. This often stems from one of three factors:
a. The stock has been in their portfolio for a long time.
b. The stock has performed very well for them in the past.
c. They work for the company.

We often see situations in which one or more of these factors lead investors to hold a position in a stock that represents 50%, 60% or even 70%(!) of their investment portfolio. This is simply much too high an allocation as it flies in the face of the prudent principles of diversification, but it is unfortunately one of the most common investing mistakes we see. No matter how long the company has been around or how well it has done in the past, bankruptcy is always a risk for an individual company. That means the stock could lose all of its value at any point in time. That is why you want to diversify your portfolio across many companies as it significantly reduces your exposure to company-specific risk.

As a product of prudent risk management, we recommend that no individual stock comprise more than 10% of a portfolio. This is especially true in the case of company stock. With company stock, you run the risk of losing your job if the company runs into financial difficulty. The last thing you want is to lose a significant amount of your portfolio at the same time you lose your income and benefits. Just ask the former employees of Enron or Worldcom.

❯ Check our blog next week for mistakes three through five of the most common investing mistakes and how to avoid them.

Market Analysis Video-
August 2014

The summer weakness in U.S. stocks was confined to just one month this year as the S&P 500 Index more than recouped its losses from July with a strong performance in August—up 4.0% for the month.

Overseas the foreign-based MSCI EAFE Index fell -0.1% in August. The loss was primarily driven by Japan, where we no longer have exposure. Europe, where we continue to hold some investment, was up 0.4%. Emerging markets continued their positive winning streak, advancing for the seventh month in a row—with a 2.3% gain in August. We continued to add to our position in emerging market stocks in August…

Please watch the video below for our complete Market Analysis.

Click here to read our complete Market Analysis.

Stocks, Not Stockings

Imagine life without a checking account. Imagine walking in to your local bank and being refused service, simply based on your gender. Today women walk into financial institutions, open accounts, withdraw monies, and interact with private bankers without a second thought. However, it was not always this way.

In the 1800s most state laws made a woman the legal dependent of her husband after marriage. For the most part, a woman could not open bank accounts, enter into contracts, or apply for a loan, no matter her age or education. Gradually rights to control wealth began to improve. In 1862 California passed legislation which vastly improved the financial independence of women. For the very first time, women were allowed to open their own individual checking accounts. Yet despite the updated laws, women did not flock to banks immediately. Ladies of the time largely thought of banks as masculine and untrustworthy—not to mention the spittoons and cigar smoke. Instead of depositing their savings into a bank, women would tuck large wads of folded bills into their stockings. It is estimated that on any given day, the women of San Francisco carried around $2 million in their stockings. (The historical information in this paragraph is based on an interesting Wells Fargo Bank web posting.)

Nowadays, many of us are more concerned with stocks than stockings. More women than ever are taking control of the finances, holding 60 percent of all personal wealth. According to the Harvard Business Review, women in the U.S. control $20 billion in annual spending. So this begs the question: how do women of today build financial strength for their future?

Attend The Women’s Roundtable!
Taking charge of your financial future is what we talk about at The Women’s Roundtable. How about joining us on September 24, 2014 at 6 pm for wine and cheese? It is a great forum to share your thoughts and concerns and to see how we can provide support and guidance.

RSVP by September 22 at 800.700.0089, ext. 100 or

Pay Attention to Corporate Earnings and a “Goldilocks Economy”

For most of 2014, the market has been able to shrug off the unsettling news coming out of Ukraine and now out of Gaza. U.S. corporate earnings for the second quarter ending June 30 were 5.6% higher than the second quarter in 2013. The 5.6% earnings growth rate reflects a slower pace, but there are positive aspects to slow and steady growth. The description “Goldilocks Economy” is beginning to reappear in the business press, a reference to an economy that is neither too hot nor too cold, but just right for sustainable growth.

This steadiness in earnings growth in this so-called “Goldilocks Economy” has a parallel trend in jobs growth. July 2014 was the first time since 1997 that 200,000 or more jobs were added for the past six months in a row. This confidence and momentum is now drawing more people back into the job market. The Wall Street Journal reports that 141,000 people re-entered the job market in July because now they see evidence that they could become employed again.

These positive trends have enough wind at their back that consumer spending could produce continued steady growth in earnings, and business is showing more confidence with increased capital expenditures. Although international tensions caused one of the worst weeks for investors in a long time, the core momentum driving corporate earnings will not be turned back easily.

Not long ago, there was great fear and anxiety about the Fed beginning to taper its bond buying program. The expectation was that once the Fed began to taper, the market would sell off dramatically. The Fed has been tapering its bond buying now for several months, and corporate earnings and the market took it in stride. Beneath the horrible international drama, there is a steadiness to our economy that deserves our focus and attention.

Market Analysis Video-
July 2014

Stock markets declined globally in July. The S&P 500 Index fell -1.4%. It was the first down month for the U.S. market since January and only the second monthly loss in the last 11 months, which demonstrates how calm U.S. markets have been recently. Overseas, the MSCI EAFE Index dropped -2.0%. Europe, which is our main focus abroad, declined -3.8%.

The current bout of European weakness relative to the United States began in May, so July represented the third consecutive month of underperformance. The region has yet to trigger a sell signal within our discipline, but continued weakness may lead to that soon. While valuations in Europe still remain attractive, we need the performance momentum to improve soon to justify investment there. Cheap valuations are always appealing, but investing on value factors alone can often take years to pay off if it ever does at all…

Please watch the video below for our complete Market Analysis.

Click here to read our complete Market Analysis.

Saving for Retirement: The 4% Rule

Most people’s primary concern about saving for retirement is outliving their money and facing poverty at the end of life.  For that reason, a lot has been written about the so-called 4% Rule.  Essentially what the 4% Rule suggests is that, upon retirement, you should be able to withdraw 4% of your portfolio balance and do so annually for 30 years with the confidence that you will not run out of money during retirement—even if you had the bad luck of retiring into the worst equity markets in U.S. history. The research that supports the 4% Rule assumes an allocation of 60% stocks and 40% bonds.

However, most Americans have not saved enough to meet their retirement needs with a 4% withdrawal. For those who have not saved enough for retirement, their withdrawal rates will likely be too high to support 30 years of retirement. But even those who have saved well enough to live by the 4% Rule will be disappointed to learn that withdrawal rate rules are precarious at best. If we look abroad for a moment, we can test the fragility of such rules. Relative to other stock markets around the world, the U.S. stock market has a very good history. Many stock markets in other countries do not have a market history strong enough to support even the oppressive sounding 4% Rule.

If a citizen of Italy, Belgium, France, Germany or Japan, for example, unwittingly retired into a historically bad time for that county’s stock market, sticking to the 4% Rule would have run their portfolio into the ground. To safely fund 30 years of retirement in those countries in the worst market environments would require withdrawal rates of 2% or less.

This is not to bash foreign stock markets. It is more to point out that generic guidelines have hidden flaws. To our knowledge, the best way to safely fund 30 years of retirement is to  create a financial plan and use it as an instrument to strategically vary withdrawals overtime. This tactic allows one to adapt to whatever kind of market one retires into as it unfolds. No one knows the future, but by being responsive to it, one creates the chance of withdrawing significantly more than 4% in many years without compromising the ability to fund 30 years of retirement.

“The Women’s Roundtable: Taking Charge of Your Financial Future” September 24.
6 – 7:30 pm at the Oakland office of Bell Investment Advisors, 1111 Broadway, Oakland, above the 12th Street BART station. For more information about The Women’s Roundtable and how to register for the wine and cheese gathering, click here.

Saving for Retirement:
What Will Be Your Story?

Many websites and financial professionals touting retirement savings plans offer little more than off-the-shelf plans that express the end result as a dollar amount. Generally, the instructions for achieving the goal are common sense—such as: max out your 401(k) contributions, invest your money wisely, create a budget and live within your means. A key ingredient often missing is the very personal and unique part of the plan that recognizes and honors your vision of retirement. You can save for a target amount, but in the end, it’s an arbitrary number unless you know you are saving for the life you want.

“Saving for Retirement: Never Too Early, Never Too Late” was the topic at The Women’s Roundtable June 25 wine and cheese gathering at Bell Investment Advisors. While the discussion included the obligatory checklist (e.g., “maximize your 401k contributions…check!”; “don’t leave any employer matching contributions on the table…check!”), what resonated most with the group were the personal stories of women who put their retirement dreams to the test with a customized financial plan.

An example was Nancy, a life-long saver, who has contributed the maximum amount allowed to her retirement account. She received a contribution from her employer each year. She was also able to put away excess cash into her savings account each month. She could see her savings balances increase each month, yet she was not sure when, or if, she could retire. In the end, adding up all the numbers gave her just a number, not a plan.

When Nancy signed up for financial planning, the exercise began with her vision of retirement, not with a photo of a beach or a woman taking an art class, or someone else’s dream of retirement. Her plan focused on the life she wanted to live. Her financial plan was grounded with the real goal of creating the life she envisioned. Certainly the success of Nancy’s plan was dependent on the amount she had saved for retirement, but what she found in the process was:

  • She is a great saver but keeping too much in cash.
  • She needed to put her money to work more productively.
  • She saw the importance of seeking investment advice, as in other areas of her life, from a professional.
  • The life she envisioned in retirement required a specific income that was attainable if she stayed true to her plan.

So, what’s your story? Are you ready to stop wondering, and hoping you can retire? Join us at the next gathering of The Women’s Roundtable this fall, and take charge of your financial future.

“The Women’s Roundtable: Taking Charge of Your Financial Future” September 24.
6 – 7:30 pm at the Oakland office of Bell Investment Advisors, 1111 Broadway, Oakland, above the 12th Street BART station. For more information about The Women’s Roundtable and how to register for the wine and cheese gathering, click here.

Market Analysis Video-
June 2014

Stocks continued higher in June with the S&P 500 Index producing a gain of 2.1%. Foreign stocks, as measured by the MSCI EAFE Index, also rose but by not as much, gaining 1.0%. Europe, which is our sole developed-market focus outside the United States, declined last month, posting a loss of -0.1%.

While Europe has displayed some short-term weakness relative to the U.S., it has been just two consecutive months of underperformance. Our outlook on the region remains unchanged as two months hardly represents a trend. Since we first entered Europe in late 2012, we have witnessed numerous bouts of underperformance from the region relative to the U.S. Despite these periods of short-term underperformance, the longer-term trend in Europe has remained intact, and since our entry point, the performance of U.S. and European stocks are very similar…

Please watch the video below for our complete Market Analysis.

Click here to read our complete Market Analysis.

The Timing of Returns Matters to
Your Retirement

Developing a retirement plan used to involve a simple set of calculations. Any financial calculator could be used as a retirement planning tool: you could input a series of assumptions involving the present value of your assets, the future value needed at retirement, your retirement date, and an assumed annual rate of return. The calculator would then tell you how much you would need to save each year to accomplish that goal.

This retirement planning method—known as the “straight-line method”—is no longer utilized as the sole tool by professional planners. The reason is twofold: 1) no one earns the same rate of return every year from now until eternity, and 2) the timing of your annual gains and losses matters greatly to the ultimate success of your retirement plan.

The first reason for eschewing this method of retirement planning is obvious—financial markets are volatile; therefore the returns they produce are variable year-to-year. The second reason is not as intuitive. To illustrate, let’s look at a hypothetical example based on history (and history in reverse).

Assume an investor retires at the start of 1973 with $1,000,000 and a desire to produce $60,000 in annual inflation-adjusted income for as long as possible. With an all-equity portfolio based on the returns of the S&P 500 Index, that investor would run out of money two months into his 31st year of retirement.

Now let’s throw history in reverse. Using the same set of retirement assumptions, let’s invert the return sequence so that the investor works backwards—retiring in 2007 and having her 31st year of retirement end in 1977. This investor does not come close to running out of money at any point, and at the end of her 31st year in retirement, she has a portfolio worth over $5,000,000.

The only assumption we changed is the sequence of returns. Otherwise everything is the same including the total return, the annualized return, and the volatility of returns.

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Clearly the timing of the gains and losses matters. The retiree who starts in 1973 and moves forward in time begins his retirement with a brutal two-year bear market that results in a decline of -37%. His portfolio never exceeds $1,000,000 again and starts out on an irreversible path to depletion.

On the flip side, the retiree who starts in 2007 and works backwards in time begins her retirement plan in a five-year bull market in which the S&P 500 gains 83%. While a serious three-year bear market follows that, the initial gains provide enough of a cushion for the portfolio to persevere. The end result is five times more money than she started with even after the 1973-74 bear market does its damage at the end of her retirement plan.

This is the reason the straight-line method is no longer utilized as the sole tool in retirement planning. Instead the core of retirement planning analysis is a Monte Carlo simulation in which return sequences are randomized to account for the fact that returns are variable and that the timing of those returns matters greatly to the ultimate success of your retirement plan.

Fear Gets in Our Way as Investors

There’s a reason that people worry about when exactly to invest in the market. As the opening keynote speaker for the 2014 Northern California Financial Planning Association Conference, Barry Ritholtz, Founder and Chief Investment Officer of Ritholtz Wealth Management, drove home the point that as human beings, we are survivors, not investors. Our brains are not designed for the capital markets, because our brains love confidence and certainty even when there is no grounding for confidence and certainty.

It would be easy to support an argument that things are getting better when the U.S. stock market continues to reach new highs, that this would be bullish for the stock market. Nevertheless, as reported in State Street’s just-released May 2014 survey, U.S. retail investors have increased their cash allocation to 36% in 2014 from 26% in 2012, despite the market being higher in 2014. Many investors develop the unfounded certainty that it is bad to invest when things are getting better, when the market is going higher. Actually, the market reaching new highs is bullish for stocks. Trying to time the market paralyzes investors and limits their future success.

Barry Ritholtz referenced a study by Dalbar showing a period where the S&P 500 had grown by 9.14% annually but that the average retail investor using that same index had only enjoyed an annual return of 3.83% for the same period. Our futures are significantly limited by our survival instincts that put fear in the driver’s seat (fear of making a mistake) and that create certainty where there is none (the market is too high to invest). Because of fear and certainty driving investment decisions, because of worries over when exactly to invest, time and time again investors miss out on the potential for more return.

The fact that so many investors are being cautious now by holding a lot of cash will help delay investor exuberance that often signals the end of bull markets. This is when markets do what they do best—improve our net worth over long periods of time as long as we do not interfere.