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What is Risk? – Investment Sense April 2015

Index Returns Through 3-31-15

Index Returns Through 3-31-15

In the investment world risk is most often defined in statistical terms as something called “standard deviation”. In laymen’s terms we call this volatility; the measurement of the ups and downs of the market, an entire portfolio, or an individual investment such as a mutual fund or stock.

Most often standard deviation is measured as volatility experienced over a one year time frame.

For the average person saving for retirement, or already retired, this standard deviation measure of risk over one year has little, if anything, to do with their financial goals. That is why we look at risk a bit differently.

We think of risk in terms of the odds that someone will not achieve the lifestyle they desire over their lifetime.

There are numerous factors that go into achieving a specific amount of retirement spending, and most of them have nothing to do with what the market did yesterday, last week, last month, or last year. (The grey bars in the graph above reflect the returns that sector of the market delivered in March 2015. The brighter orange bars reflect the annualized annual returns that sector of the market delivered over the past ten years.)

Nor does the market’s performance tomorrow, next week, next month or next year matter a whole lot.

What matters a bit more is what the market does over the next decade. The challenge we have is that without a copy of 2025’s newspaper, we don’t know exactly what the next decade will look like.

In light of that reality, what we focus on is what we do know.

  • We do know that how much you save and how you manage your expenditures has a big impact on your success.
  • We do know that those who consistently monitor and review their financial plans make more progress than those who don’t.
  • We do know that managing taxes increases the after-tax cash flow available to you. Managing taxes includes advising on what types of accounts to fund (Traditional IRA or Roth IRA for example) as well as what accounts to withdraw from, and how to rebalance your portfolio without causing you a hefty tax bill.
  • We do know that there are numerous ways to construct a portfolio and that there is no free lunch.

If you are going for maximum returns you are increasing the risk that you will not achieve your goals.

If you are going for an approach that brings additional security to the outcome than in strong markets you will be leaving some returns on the table. That is just the way it works.

Or as one famed finance professor puts it, “There aren’t $100 bills lying around for the taking.”

The problem is a lot of finance shows, magazines, and news articles lead you to believe that there are $100 bills lying around for the taking – and that the “right” trading strategy is what it takes to find them.

Every week we are asked questions about other approaches such as, “I read I shouldn’t own bonds; shouldn’t we sell our bonds?” Or, “I read the stock market is overvalued; shouldn’t we get out of stocks?”

We can assure you the advice you read in a magazine, see on TV, or hear on the radio was not constructed around the risk/return framework that applies to your life.  It can’t be—these finance buffs don’t know your financial situation. It doesn’t mean what they say isn’t valid—it simply means most often, it doesn’t apply to you. I expand upon this concept in my MarketWatch article Why One Size Fits All Investing Never Works.

What makes sense is to build a plan based on your financial circumstances. This is what we do. Once we know your goals we choose to use an approach that we believe gives you the highest probability of achieving those goals over your lifetime. It’s not based on some arbitrary measure of risk that has nothing to do with your life circumstances – it is based on your cash flow, life and family circumstances. That’s the way to look at risk.


*Returns data in graph above from Advisor Intelligence. When possible we report index fund returns to show performance net of fund fees. As such in the graph:

Total Bond Market Index is: Vanguard’s Total Bond Market Index Fund(VBMFX)
US Large Cap is: Vanguard’s 500 Index Fund (VFINX)
US Small Cap is: Vanguard’s Small Cap Index Fund (NAESX)
Real Estate is: Vanguards’s REIT Index (VGSIX)
International Large cap is: Vanguard’s Total International Stocks Index (VGTSX)
International Small Cap is: MSCI World Ex USA Small Cap Index (not a fund)
Emerging Markets is: Vanguard’s Emerging Market’s Index Fund (VEIEX)

(Investment Sense is a monthly posting of market commentary with a common sense twist. For all our latest commentary follow us on Facebook.)

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May’s Online Class: The Key to Retirement Success

May's Class: The Key to Retirement Success

The Key to Retirement Success – Click pic above to register.

In this free online retirement class we’re going to discuss the retirement risks that you can’t control such as longevity, market returns, inflation, the economy, and how they affect how much money you will need in retirement.

Then we’re going to show you how you can adjust the items you can control, such as spending, tax management, investment risk, and your retirement date, to maintain a stable life-long standard of living.

This class will be live. It will run about one hour followed by questions and answers. It will be offered on a Tuesday evening. Specifics below.


  • Tuesday, May 19th, 5 p.m. PDT (and AZ time)/6 p.m. MDT/7 p.m. CDT/8 p.m. EDT

Registration Required

What You Will Learn

In addition to learning about retirement risks and what you can do about them you will learn:

  • The 10 worst money mistakes near-retirees make.
  • Why investing the same old way doesn’t work in retirement.
  • Decisions that can help protect your income well into your later years.
  • Why paying attention to taxes is critical between ages 55 and 70.
  • Investment strategies that protect you in a down market.
  • The retirees that will be most affected by inflation.


  • You: Those of you age 50 – 70 who are within 5 years of your desired retirement date will benefit the most from this class.
  • Your presenter: This is a live one hour presentation followed by Q&A hosted by retirement expert Dana Anspach.

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Investment Sense – Feb 2015 – Diverging Returns

Index Returns Through 12-31-14

Index Returns Through 12-31-14

This month we want to provide a quick snapshot of 2014 results and talk about how things are shaping up as we begin 2015.

Diverging Returns

In 2014, while U.S. equity returns were high relative to those of other regional markets, returns within various U.S. market segments diverged. U.S. large cap stocks significantly outperformed small cap stocks.

In addition, for the third year in a row the U.S. large cap market avoided a 10% market correction (which historically on average occurs about every 8 months). This unbroken streak of positive U.S. large cap performance is unusual; it has only happened three other times since 1951.

Non-U.S. developed stock markets experienced negative performance across almost all major indices. Over the past two years, U.S. large cap stocks outperformed international markets by a significant amount. The relative outperformance of U.S. stocks vs. international stocks is also unusual; it has occurred less than 20% of the time (going back to 1970 for developed international and 1988 for emerging markets).

Considering that markets go in cycles, now is not the time to change strategies and overweight U.S. large cap stocks.

As a matter of fact, as I am writing this (Feb. 3rd, 2015), so far for the year U.S. stocks are down while international and emerging markets stocks are showing positive returns for the year. (Granted we are barely one month into the year. We don’t know how the year will turn out.)

U.S. markets comprise about half of the world’s total investment opportunity set. By only investing in U.S. markets we would miss the other half. Last year, that may have worked out well, but given a long-term view (looking back to all 10 year periods going back to 1970) over 70% of the time a globally diversified portfolio would have delivered higher returns than the S&P 500. Countries are in different stages of their market cycles and at any one point in time one market can and will outperform others.

Declining Oil Prices

Oil prices fell by almost half during 2014. This is largely attributed to an excess supply due to rising production—particularly in the U.S., where production soared to its highest level since 1986. In the U.S. prices dropped from $107 per barrel in June to just over $53 at year-end. That downward trend has continued into 2015, with oil at about $44.50 a barrel at the end of January.

Overall this is viewed as a positive sign, as it means both consumers and businesses have additional money available to spend.

Soaring Dollar

In 2014, the U.S. dollar rose against every developed markets’ currency. Overall, it gained 12.5% against a basket of widely traded currencies, measured by the Wall Street Journal dollar index. This was the dollar’s best gain since 2005 and second-best on record. The rise was attributed to stronger U.S. economic data, falling global oil prices, expectations of higher interest rates, and weakened currencies resulting from monetary easing by the Japanese and European central banks.

This trend has continued into 2015 with the dollar experiencing additional gains through January of this year.

As discussed in our quarterly printed newsletter, a strong dollar may reduce the price of imports for us, and reduce the cost of traveling abroad. It may also hinder U.S. exports and thus corporate profits of U.S. companies. Thus, another reason to maintain a globally diversified portfolio.

Weak Inflation

Average US inflation remained low throughout 2014. In November, year-over-year inflation fell to 1.3%.

Across the world’s largest economies, inflation eased for the sixth straight month in November, with the Organization for Economic Cooperation and Development (OECD ) reporting average annual inflation for its 34 members at 1.5%.

Overall, this is viewed as a positive for the U.S. economy, although deflation is a concern for overseas economies.

Diverging Economic Policies

While the Fed (the U.S. Central Bank) is indicating a tighter monetary policy (quantitative easing has ended and the Fed may initiate a rate hike later in 2015), other major central banks are heading the opposite direction. The Bank of Japan increased its quantitative easing (purchasing of bonds), the Bank of China cut interest rates, and the ECB (Eurpean Central Bank) announced new actions in 2015 to stimulate the Eurozone economy.

Slightly higher interest rates would be welcome for retirees, as cash would begin to earn something more than zero.

Focus on the Orange Bars

While we stay up-to-date on what is going on in the market, our focus remains on the darker orange bars you see in the graph at the top of this page. Those represent the ten year annualized returns of each asset class. You can see how the one month returns (in dark gray) and even the five year returns (in lighter orange) vary from the ten year returns.

We don’t know which asset class will deliver the highest return over the next month, five years, or ten years, which is why we maintain exposure to many asset classes. What that means is we are not betting with your retirement money.


*Returns data in graph above from Advisor Intelligence. When possible we report index fund returns to show performance net of fund fees. As such in the graph:

Total Bond Market Index is: Vanguard’s Total Bond Market Index Fund(VBMFX)
US Large Cap is: Vanguard’s 500 Index Fund (VFINX)
US Small Cap is: Vanguard’s Small Cap Index Fund (NAESX)
Real Estate is: Vanguards’s REIT Index (VGSIX)
International Large cap is: Vanguard’s Total International Stocks Index (VGTSX)
International Small Cap is: MSCI World Ex USA Small Cap Index (not a fund)
Emerging Markets is: Vanguard’s Emerging Market’s Index Fund (VEIEX)

(Investment Sense is a monthly posting of market commentary with a common sense twist. For all our latest commentary follow us on Facebook.)

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Investment Sense – 2014 Year-End Edition

Asset Class Performance Diverges

Different parts of “the market” do not always deliver the same results.

To share our approach on portfolios and the current investment climate, we thought we’d present this edition of Investment Sense in a Question & Answer format, reflecting some of the questions our clients have asked recently.

Q. I have not been watching our accounts real closely but I did notice something that seems very strange to me. In early September the DOW was around 17300. Later in September and October the DOW dropped to about 16000 and the account dropped accordingly. Today the Dow is at 17800 but our account did not recover with the DOW. I understand that we also withdrew money during this time. Nevertheless, I would expect based on past history that our account would have gone up more. Did I miss something or am I not looking at this right? Did one or more of the funds take a big hit? If you can enlighten me.

A. It is a great question. Let’s start by looking at your household equity allocation. (By equity we typically mean mutual funds that own stocks). Of the amount you have allocated to stocks about 47% is U.S. stocks, 14% international, and 14% emerging markets. (Each client’s household allocation is slightly different.)

The Dow represents only 30 stocks in the U.S. market. There are about 6,500 publicly traded stocks in the United States. Your allocation includes exposure to most all of the publicly traded stocks in the U.S. which provides exposure to small and mid-cap stocks as well as to the larger companies (such as those in the DOW).

The graph above was created on Yahoo Finance and shows the performance of several asset classes over the last few months. You see the DOW represented by ^DJI, then EEM which represents emerging markets, ^RUT (which represents US small cap stocks), and EFA which represents developed international.  You can see on this graph how the DOW shot up while the other indices did not.

Your portfolio has all these asset classes in it… it is not weighted toward the 30 stocks in the DOW.

This is one of those times where on a short term basis, diversification delivers a rather sluggish result.

Q. If diversification delivers a sluggish result right now, why don’t you change the allocation? Can’t you move things around to capture better returns?

Our equity allocations are designed for a long-term time horizon; meaning seven years or more. We believe sticking with a long-term approach increases the odds of success.

Each investment manager has their own approach. Many (or most) have a much shorter-term time horizon than we do. One firm may make investment decisions based on what they think will happen tomorrow, another is looking at next week, and yet another is looking at next year. Each of those manager’s decisions will be based on data relevant to the time frame and risk/return objectives they have established – which are often very different than the time frame and risk/return objectives set for your family. That’s why it can be confusing deciphering the investment advice you read on the web – you don’t know the time-frame and risk objectives behind the advice.

The last thing we want to do is chase what’s been working recently – which means buying high and selling low. This leads to tepid long-term returns. 

Q. For what period of time should clients anticipate returns lower than the benchmark as a result of diversification, or risk-reduction? 

To answer this question, we’ll quote Advisor Intelligence, one of the research companies we subscribe to,

“This question kind of reminds us of the old saying: Tell me where I am going to die so I won’t go there. In other words, if we knew the answer as to what period of time we anticipate lagging a benchmark, then we would position our portfolios differently now, i.e., we’d take on more risk right up to the point where being more aggressive won’t help us and then we’d become defensive and benefit from it. But of course we don’t believe that type of market timing is possible on a consistent basis.

We have no conviction in how all of these variables will play out over any short-term horizon. However, we do have conviction that our investment process and positioning will add value over a long-term investment horizon. Investing is a long-term process, or at least it should be in our view, typically spanning decades for most of us. Those who are seeking certainty with regard to short-term investment results are likely fooling themselves.”

Q. What should we expect over the long-term?

There is a perception that over time stocks should deliver higher returns than safer choices like bonds or cash. This is not a certainty. Stocks give you the possibility of earning a higher return, but if it were a sure-thing then risk would be irrelevant.

The best twenty years in the S&P 500 Index ended in March 2000, and over that time frame you would have averaged gross returns of 18% a year. The worst 20 years ended in February 2009 and over that time frame you would have averaged gross returns of about 7% a year. (Gross means no fees, trading costs or taxes have been subtracted out.)  That represents a broad range of possible outcomes you could experience over the next twenty years.

We base your planning projections on the low end of that possible range of outcomes, because that is one of many realistic possibilities.

From where we are today, if we had to guess, we’d say it makes more sense to expect long-term results (over the next 7 – 10 years) that are closer to the lower end of historical ranges. But that tells us nothing about what to expect next month, or next year.  And, it’s just a guess. As you well know by now, we don’t believe in our ability to predict the direction, timing, or magnitude of market moves. We believe in a more balanced approach to portfolio construction.

Q. I’ve seen transactions in my account lately. What is going on?

Near year-end there are many things we look at. Here are a few of them:

  • Tax gain/loss harvesting. If you have a taxable account (meaning it is not an IRA or other type of retirement account) we look at intentionally harvesting capital gains if you will be in the 0% capital gains rate, or intentionally harvesting capital losses if that will benefit you. You can read more about why we do this in: Capital Gains Tax Management.
  • Tax projections. We finalize tax projections to determine if an additional tax payment may be needed, and to estimate cash flow needs for taxes next year.  If needed, we place trades to raise cash for these distributions.

All of the above items can result in transactions that are needed in your accounts.

We wish you all a happy holiday season.

As always, feel free to call or email us at any time with questions, and be sure to keep us in the loop on any changes in your financial circumstances.

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