Market Analysis Video –
November 2014

Stocks started their historically strongest six-month period (November to April) with gains. U.S. stocks managed to produce a return of 2.7% in November according to the S&P 500 Index. Foreign stocks, as measured by the MSCI EAFE Index rose 1.4%. It was the seventh consecutive month of underperformance for foreign stocks relative to domestic stocks, confirming that the U.S. stock trend is firmly entrenched. Since the start of May, the MSCI USA Index has outperformed the MSCI EAFE Index by 14.3%.

We exited the remainder of our exposure to European stocks last month. While we continue to have concerns about the valuation of the U.S. stock market as a whole, there are areas within the U.S. stock market that are not overvalued, such as the technology and health…

Please watch the video below for our complete Market Analysis.

Click here to read our complete Market Analysis.

Gifts That Give Back

‘Tis the season. The holidays are a great time to experience the joy of giving to friends and family. It is also the time of the year when people opt for gifts that benefit the greater good.

For philanthropic and aspirational shoppers, there are plenty of gift options from companies that produce “sustainable products” (conservation of natural resources, sustainable farming) or products designed for “social good” (handmade products that support women and children in the developing world).

It used to be that values-based investing was exclusive to large private foundations and very affluent individuals. But our world is changing in dramatic ways, and there is a heightened global awareness. Investors and companies recognize that doing good and doing well financially should go hand-in-hand. People want to invest in companies with values and business practices that are congruent with their own. With a values-based objective, investors are willing to exchange financial benefits for the greater good.

In 2015, we will introduce a series on values-based investing. Our objective is to leverage our practice by seeking options for our clients who desire to align their personal values with their investment portfolio. We invite you to be part of this conversation.


Don’t Believe Everything You Read About Investing

A client of ours forwarded us an email she received from a financial news organization to which she subscribes. It reads as follows:

A handful of billionaires are quietly dumping their American stocks . . . and fast.

Warren Buffett, who has been a cheerleader for U.S. stocks for quite some time, is dumping shares at an alarming rate. He recently complained of “disappointing performance” in dyed-in-the-wool American companies like Johnson & Johnson, Procter & Gamble, and Kraft Foods.

Buffett’s holding company, Berkshire Hathaway, has been drastically reducing his exposure to stocks that depend on consumer purchasing habits. Berkshire sold roughly 19 million shares of Johnson & Johnson, and reduced its overall stake in “consumer product stocks” by 21%. Berkshire Hathaway also sold its entire stake in California-based computer parts supplier Intel.

With 70% of the U.S. economy dependent on consumer spending, Buffett’s apparent lack of faith in these companies’ future prospects is worrisome.

She was scared, and who wouldn’t be after reading that? Warren Buffett is a legendary investor, and if he is worried about stocks perhaps you should be too.

The only problem is that Mr. Buffett is not selling Intel or cutting back on Johnson & Johnson now. He already did that—in the summer of 2012. Although the email was dated November 3, 2014, it contained “news” from 2½ years ago.

If you want to know what Mr. Buffett thinks about stocks today, all you have to do is run a quick internet search. During last month’s stock market pullback, he told CNBC he was buying stock in “names you’d recognize.”

Whatever the author’s motivation, the content is misleading. But don’t let it be damaging to your portfolio by blindly following it. Do a bit of research to check out the author’s claims. Or do what our client wisely did: forward it to your investment advisor for his or her opinion before you act on an impulse.

Market Analysis Video –
October 2014

It is not unusual for stocks to experience a wild ride in the month of October. Since 1970 nearly one day in three in October has produced a +/-1% move in the S&P 500 Index. In comparison, all of the other months are in the one-in-four to one-in-five range. The 2014 version of October generated even more volatility than usual as over half of the trading days last month saw the S&P 500 move by at least 1%.

Despite the heightened volatility, U.S. stocks managed to move ahead last month with the S&P 500 Index gaining 2.4%. Foreign stocks continued their run of underperformance versus U.S. stocks. The MSCI EAFE Index declined -1.4% in October…

Please watch the video below for our complete Market Analysis.

Click here to read our complete Market Analysis.

Ben Bernanke Makes a Bold Forecast About Inflation

Former Federal Reserve Bank Chairman, Dr. Ben Bernanke, is not worried about inflation. Before an audience of over 3,000 Registered Investment Advisors, Financial Planners and Investment Managers at the Schwab Institutional IMPACT Conference in Denver on November 5, 2014, Dr. Bernanke was remarkably confident about the future of tame inflation in the USA for years to come.

He has been widely criticized for executing the Quantitative Easing (QE) programs at the Fed which allows the U.S. central bank to buy longer term bonds in the open market thereby raising their market price and lowering their yield. Many fear that the QE programs already executed will lead to rampant inflation, but after five years since the beginning of QE, inflation is still very tame at 2% or less. Dr. Bernanke speculated that it could be another five years before inflation becomes a problem, and when it does appear, he believes the expanded toolkit now available to the Fed will make future inflation easier to control.

Dr. Bernanke also asserted that the Troubled Asset Relief Program (TARP) invented during the 2008 financial crisis was one of the most successful government programs in the history of the United States while simultaneously being one of the least popular. The TARP loans and asset purchases have been repaid at a significant profit to the U.S. government.

Another controversy is that the Fed allowed Lehman Brothers to fail in 2008 and chose to bail out American International Group, Inc. (AIG). Dr. Bernanke explained that AIG had capital so that it could be rescued while Lehman Brothers had no capital.

Dr. Bernanke is simultaneously proud and humble regarding his legacy as Fed Chairman. He is humble by nature. He is proud that the U.S. economy has the strongest recovery in the world from the 2008/2009 financial crisis, and he is proud that all of his hard work and the hard work of the Federal Reserve Bank staff contributed to this result.

The Failed Succession “Plan”
of Bill Gross

We have been engaged in succession planning at Bell Investment Advisors for the past
14 years. We also offer workshops and write about succession planning to help other business owners with the process. Naturally, we enjoy learning about other succession plans—the ones that work and the ones that fail.

Take Pacific Investment Management Co. (PIMCO) as an example. Bill Gross founded the company 40 years ago and built it up to a $2 trillion investment management giant. Bill is such a superstar among bond managers that he is often referred to as the “Bond King.” Superstars have special challenges when it comes to succession. The most successful successions occur when an organization has achieved institutional independence, its strength and reputation established beyond its identification with a superstar. This requires founders to develop and delegate power and recognition to their younger teammates, and Bill Gross tried to do this by bringing in Mohamed El-Erian, another titan in the investment management world. Soon El-Erian was appearing on television more than Bill Gross. This was a smart move—sharing the power and press with someone else.

Earlier this year, however, El-Erian left under sudden and strained circumstances. Bill Gross is apparently not very good at relationship management. In addition, because of the trouble he was having getting along with people, Gross, himself, suddenly also left the firm he founded—before he was pushed out by the management team. (Mr. Gross promptly hitched his wagon to Janus, a smaller fund manager where he can focus more on investment and less on management.) Founders and superstars are rarely good at succession planning. They stay in place too long. Letting go and building relationships
are crucial skills.

We believe that the team remaining at PIMCO without a superstar is deep and strong. We believe PIMCO will prevail with greater sustainability now that it can more easily achieve institutional independence. On October 4, The Economist commented: “Analyzing the global bond markets, with their many different countries, currencies, maturities and credit ratings is not a one man job.”

The Endowment Effect

Deciding when to sell a stock or a mutual fund can be difficult, especially when that unwanted stock or mutual fund resides in a taxable account. To be sure, there are a number of strategic reasons to hold positions you want to sell. This is the time of year, for example, when many investors resist the urge to sell because they would prefer to push the capital gains into the next tax year. But many of the reasons that investors hold onto positions are not so strategic in nature.

In their book, Why Smart People Make Big Money Mistakes, Gary Belsky and Thomas Gilovich examine a host of psychological mental tendencies that make selling any investment, even a bad one, so challenging. Research demonstrates, for example, that most investors tend to overvalue whatever it is that they already own. This is described, according to behavioral finance, as the “endowment effect,” and its influence is very powerful.

To illustrate the power of the endowment effect, Richard Thaler divided a Cornell economics class in two. Half the class received school coffee mugs as a gift; the other half received nothing. Then Thaler held a coffee mug auction. The students who did not own a coffee mug already, on average, were willing to pay only around $2.75 to acquire a mug. The students who already owned a coffee mug, however, had much greater sense of the value of their mug. On average, these students needed to be offered around $5.25 to sell their mug. This study and others like it, demonstrate that one of the primary side-effects of already owning an asset is the owner values that owned asset as much as twice as much as it is actually worth.

With the endowment effect in mind, it is easy to understand why so many portfolios are littered with positions that should be sold but are not. The psychology behind the impulse to hang onto what you already have is understandable, but it should be kept in mind because it is not always helpful or strategic.

Market Analysis Video –
September 2014

While stocks held up well during the summer, they pulled back in the first month of fall, which is not surprising as September has been the weakest month for the stock market historically. Since 1896, the Dow Jones Industrial Average has produced an average price return of -1.1%. It is one of only three negative months on average historically, and it is the worst-performing month by a wide margin (0.9%).

In this year’s edition of September, U.S. stocks followed their historical trend by falling -1.4% according to the S&P 500 Index. Foreign stocks continued their run of underperformance versus U.S. stocks…

Please watch the video below for our complete Market Analysis.

Click here to read our complete Market Analysis.

Top Five Mistakes in Portfolio Design Part 2

This is second part of our compilation of the top five most common investing mistakes committed by individual investors. Mistakes one and two can be reviewed in last week’s post, Top Five Mistakes in Portfolio Design Part 1. Read this week’s post for mistakes three through five.

3. Overconcentration to One Sector

Sector overconcentration often stems from common investing mistake #2. Investors hold too much of a single stock, and whatever industry that stock resides in is also overrepresented in the portfolio.

The familiarity bias plays a role in this common error. People invest in what is familiar and comfortable to them. Studies show that if you work in a specific sector that you are more likely to invest in that sector. This can lead to overconcentration. Studies also show that people like to invest in local companies. Being from the Bay Area, we often see overconcentration in stocks like Apple, Google, and Pandora, which leads to an overconcentration in the tech sector. If we were headquartered in Texas, it would likely be an overconcentration in the energy sector that we routinely encounter.

Sector overconcentration is not as big an issue as an overconcentration in one stock because you still have enough diversification to avoid company-specific risk, but entire sectors do run into trouble from time to time. The Dow Jones US Technology Index lost over -80% of its value during the tech crash that occurred in the 2000-2002 bear market. During the 2007-2009 financial crisis, the Dow Jones US Banks Index lost a similar amount.

To combat sector overconcentration, we suggest keeping the sector allocations in your portfolio within 10%-15% of its market allocation. For example, the health care sector comprises 13% of the S&P 500 Index. By following this diversification rule, you would have no more than 28% of your portfolio invested in the health care sector.

4. Not Enough Foreign Exposure

This is actually one common investing mistake that we regularly see from both professional and do-it-yourself investors. We believe it stems, in part, from archaic asset allocation advice that recommended 10% to 20% of equity portfolios be invested in foreign stocks many years ago. Interestingly, most portfolios we see today still have a foreign stock allocation in this range.

The other culprit is the home bias. As described in mistake #3, people like to invest in what is familiar and comfortable to them. This means that U.S. citizens have more of an allocation to U.S.-based companies than they should. (Interestingly, this home bias shows up in other countries as well.)

This mistake has not cost U.S. investors much because the U.S. stock market has been among the best performing markets in history, but things could change in the future. The Japanese stock market performed admirably for decades as the Nikkei Equity Index gained over 16% per year from 1950 to 1989. But since the start of 1990, the index is down almost -60%. Japanese investors who fell prey to the home bias have suffered miserably.

From a diversification standpoint, it is important to have various geographic exposures as well. The U.S. comprises roughly half of the global market capitalization, so a diversified global equity portfolio would have half of its assets invested in foreign stocks.

5. Inappropriate Level of Risk

Part of the portfolio analysis we perform for each client when they first come to us is an assessment of risk in the portfolio. Often we find that the risk level of the portfolio differs greatly from the amount of risk the investor is comfortable taking and/or the amount of risk they need to be taking to reach their financial goals.

Each investor has a specific comfort level with risk. Some can tolerate lots of volatility and significant losses; others cannot. It is simply a reflection of the fact that human beings are wired differently. A well-designed portfolio reflects this with a risk level that is tailored to the investor’s risk tolerance. However, we often see portfolios that contain levels of risk that are far from the investors risk tolerance. This applies on both ends of the risk spectrum—risk-averse investors with portfolios that are full of high-risk investments and risk-tolerant investors with portfolios that are full of low-risk investments.

Not only is it important to have a portfolio within your risk tolerance, but it is important to have a portfolio that will likely produce the type of return necessary to meet your financial goals. In our analysis of portfolios, we often encounter situations in which investors who need high rates of return are invested in low-risk/low-return investments. We regularly see the flip side as well. Some investors are in such good financial shape or have such modest goals that they don’t need much in the way of return to succeed. However, these investors are often in high-risk portfolios designed to produce high levels of returns. But because they don’t need those high returns, why take the extra risk?

❯ To make sure your portfolio is in line with your risk tolerance and financial goals while avoiding common investing mistakes, it is best to consult a professional wealth manager who can help you figure out your risk tolerance and the required return to meet your financial goals with a financial plan.

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.