Tag Archives: diversity

Your Financial Future: Our Annual Attempt at Predicting the Future in 2012

  By petillo | December 18, 2011 - 9:33 am | 401k, bonds, debt, economics, ETFs, exchange traded funds, financial impact factor radio, financial planning, index funds, mortgages, Mutual Fund Investing, Paul Petillo, personal finance
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You begin the process of wondering about 2012 even before it actually is here. My approach has been to first see if I was right about 2011 and then to build on those predictions for 2012. When it comes to how you approach personal finance, retirement planning and investing, the mistakes you make are what you seek to correct and the triumphs you experience are what you want to replicate. Yet, time is more of a factor that it ever was. So we begin by looking back, then looking forward and finally, what to do.

In a piece titled: 2010: It just has to be Better I lamented “So where does this leave us for the coming year? Until your children, relatives or friends begin to move out of your house, 2011 will be a carbon copy of 2010.” And why not. It was easy to predict that the social shift in how we live our life would not experience any major swings. I began by wondering if the movement of recent college graduates and those recently unemployed would stop moving back in with their parents.

While this shift made total economic sense (multi-family dwellings are financially prudent, sharing the cost of what the residence costs), our attitudes toward it made us vulnerable to a our retirement dreamscape. Those dreams weren’t realistic when things were good and when they are not so good, the dream of a picturesque retirement seemed more absurd. The reality is that you wanted something that may not have been possible.

Retirement has been influenced by ads and you have bought the concept. In 2011, your offspring moved home and you thought: “I’ll never retire” or “I’ll have to rethink this idea” or “What went wrong”. If you were contributing to your retirement plan in the right volume (that’s a minimum of 10%) then you know the goal you may have set in the previous decade needed some serious financial adjustments. Lowering expectations is not without its sleepless nights. But better to have them now while you are employed than when the term fixed income become part of your vocabulary. In 2012, your kids aren’t going anywhere.

So when I wrote: “That moment in time, when you finally set forth into the world is what drives the economy” in reference to your newly swelled household and the cost of this movement, I saw economic recovery in the hands of the young. Which is where it has been for decades. Without this group forging their own independence, we will see more of the same, at least on a local level as we did in 2011.

From your door step I looked globally and made a not-too-difficult prediction about Europe. I wrote: “Expect the Euro-zone crisis to get worse instead of better which will have the effect of making things here in the US more troublesome. If the financial issues currently plaguing Ireland spill over in Spain or Portugal, the euro will fall and the dollar will rise and we won’t have anything left in the financial arsenal to deal with it.” Without mentioning Greece, Germany’s role as a strong arm member of the euro-zone committee or the austerity measures that needed to be put in place, I was right on the money. Until I actually mentioned money. The euro was kept afloat even as the bonds issued in that part of the world lost their previous ratings and the dollar didn’t rise; and it didn’t actually fall either. In 2012, Europe will still provide enough turbulent news to keep our domestic markets roiled with indecision. (And in a couple of paragraphs, I’ll offer some suggestions on what to do.)

I also quipped: “The markets have been breathing the smell of their own success and have risen according to a formula that makes no sense: profits without hiring, without much innovation and then, using the money investors throw their way to buyback shares and declare dividends. This jobless recovery will run out of steam.

“And the markets will stumble. Not a lot; but enough to scare some near retirees and in doing so, keep new investors out of the market. The era of Wall Street distrust will continue.” Did I see Occupy Wall Street occurring? I wish. But the movement, which seems without a specific goal has found the headwind of protest in this country is met with a look of youth lost. It is as if we have forgotten how reform is achieved, how greatness is created and small groups become large and representation becomes a little more representative. In 2012, the middle class loss will plateau (which is better than losing additional ground).

Your retirement will be put under a microscope and the industry that surrounds it will not like what it sees. It will look for ways to make it easier and in doing so, fail to acknowledge that it the “you” in the process that will still need better understanding. I wrote: “It will be a tough sell to keep suggesting you continue to invest in your retirement and do so without taking the current conservative bent. You will still need risk and there will be plenty of it but finding profitable risk will not be so easy.”

The focus on your behavior and how to overcome the inner you will find 401(k) plan sponsors scrambling, innovators suggesting that 401(k) plans go all ETF and that you will still not invest enough. Auto-enrollment will get you invested – if you were recently hired – but will not convince the under-invested to cough up higher percentages of pay. You will blame housing. You will point towards inflation (which is benign unless you are buying something you need). You will acknowledge your risk fears. You will throw up your hands and say working is the only option.

2012 will bring us opportunity. If you’re contributing to your retirement, you will need to contribute more. The plans you use are not likely to change all that much. If you have access to index funds: use them and spread your investment across at least six of them covering as many markets as possible (domestically an index of S&P500, mid-caps and small-caps along with bonds and internationally with exposure to the established countries and the emerging markets). While balance is the key in 2012, if you fail to do so, at least your risk will be spread as wide as possible. If you have exchange traded funds in your 401(k) plan portfolio, which would be a major shift for many plans, use them the same way.

The markets will continue to roil but that should point us toward investments that provide dividends and stability. Risk will always be present in investing and we will bring our behavioral biases with us. But the smartest investors won’t react for two reasons: we have now accepted a longer time frame to retirement and time is what helps every plan and two, jumping around, in and out of cash for instance, will keep any potential gains (from diversity) away from your portfolio.

2012 will offer a glimmer of hope in housing. Which means that there will be some improvement in jobs. Each of these will be small and below our expectations. Nonetheless, it will make us feel better. Sure, the cost of insurance will rise (that’s an easy call) as will the price of goods we need but we will have had three years of steeling ourselves to this inevitability to muddle our way through.

2012 will be the year of self-understanding. And that is the scariest prediction of all. Knowing who you are, what your place in as one columnist called the Google-flat world will be more defined by the habits you have newly developed and embracing your revised image of your future was a wake-up call for all of us. Let the world bow to you in 2012 (by continuing to tweak your budget). Just keep investing – steadily and with optimism.

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Investing: A Human Endeavor that Requires Super-Human Effort

  By petillo | September 21, 2011 - 5:36 am | 401k, bonds, financial planning, index funds, Mutual Fund Investing, personal finance, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025
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I want to talk a little bit about Sponge Bob and probability. Both of these seemingly unrelated topics are in fact tied together because of the way our brain deals with them. Sponge Bob was recently the subject of a test on children to determine their ability to delay gratification. The test went something like this: there was a group of kids who got to watch Sponge Bob, a group who watched something educational and a third group who was simply given a coloring book and some crayons. After being exposed to these activities each group was asked if they wanted two treats. But they were also told if they wait five minutes, they could have ten treats. So the Sponge Bob group, stimulated with the rapid fire scene changing and what the researchers referred to as the “onslaught of fantastical events” chose the two treats over the ten. The researchers then concluded that Sponge Bob impacted delay gratification.

There was an eighteenth century Presbyterian minister who wondered whether we should or perhaps did modify our beliefs if we received new information. Thomas Bayes wondered if we hold on to our assumptions based on old information, which may no longer be true, or do we abandon them as we hear the whispers of doubt. Bayes theorem as it is known suggests that in order to assess the strength of our beliefs given the evidence we have, we must also assess the strength of the evidence given those beliefs. If you think you are right in your original hypothesis, any new evidence to dissuade you from those self-truths is often not considered accurate.

Now Bayes theorem is a mathematical one and you ware not expected to know what it is. But the question it asks crosses over into the world of investors. Yet investors believe they can make some absurdly accurate conclusions about probability without considering the simplicity of what they are doing.

Once we latch on to something, the evidence is not often considered and new evidence is even more often rejected. Oddly, not a single guest we have had on the show has mentioned Bayes in part because they don’t even realize that they may have embraced what he suggested or because just as many rejected the notion. Our actuarial tables are based on Bayes. The fact that we could crack the German codes in WWII was based on Bayes. When John Maynard Keynes said: “When the facts change, I change my opinion. What do you do sir?” He was invoking the heart and soul of Bayes theorem.

Sponge Bob represents a whole host of new information, driven into us at such a rapid fire pace that we either jump at the first thing we are offered or bury our heads in the proverbial sand. Bayes understood this, wrote a mathematical formula explaining why and even more coincidently, explains what happens in our world full of probabilities and an “onslaught of fantastical events”. We’re not children by any means. But our brains do some very interesting things that make our decision-making processes somewhat similar.

Making decisions in turbulent marketplaces, where the outside influences can range from the political to the global, is no easy task. Each new “event” seems to trigger something inside of us. The triggers push our biases to the forefront. We are optimistic when we should be questioning our feel-good feeling. We tend to trust those who seem like they have some sort of insight, even as we know full well, that any insights might be tainted by other agendas (such as to keep you busy trying to position yourself for whatever has already happened).

In Bruner, Goodnow, and Austin’s example in the psychology classic A Study of Thinking, they examine the bias od disbelieving what we believe in, even if it is incorrect. We don’t really want to disprove what we believe is true. Referred to as the congruence bias, we ignore any other possibility and simply assume that what we know is all we need to know. Give yourself a half-hour of any business news channel to test this thinking on yourself. You will leave that broadcast wondering is there is more than meets the eye but because you already believe that the course you are employing is fine, you will ignore any additional decisions that you might make as the result of new information.

But what if the broadcast confirms your stance? What if what they are speaking about simply makes you feel correct in your own assumptions? If you have panicked and gone into an all-cash position for example, following the advice of the talking heads who suggest that this is the only place you should be when there is market unrest, you will feel your conformity bias kick in. This bias simply affirms that if the group says it is the thing to do; then you have done the right thing. Group-think does not affirm group right. An all cash position instead suggests that by abandoning diversity, you will have done something no other investor has done: protect what you have.

There are basically three things you can do to combat these biases. The first is healthy skepticism. Is the information you are getting from trusted sources too general or too specific or perhaps motivated by other reasons. The second involves having the strength to identify who you are and what you need. With so few people actually able to make a confident statement about their future (retirement), looking for answers elsewhere, anywhere becomes an all-consuming obsession. And the last relies on your ability to be contrarian. The group, or as it is often referred to, the herd, doesn’t have it right, doesn’t have all of the information and if they do, the information is dated. Following will make you feel better. It won’t necessarily make you money.

Picking a diverse portfolio covering numerous asset classes (six index funds: three equity, one international, one bond, and one emerging market) will keep you invested for a very small amount of money. And in doing so, you will have fought these biases successfully. But it won’t be easy.

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Are Dividends the Way to Go in a Turbulent Market?

  By petillo | September 8, 2011 - 8:57 am | financial planning, index funds, Mutual Fund Investing, personal finance, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025
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Most of us have more than a passing knowledge of what dividends are. Those that do have some concept of what they can do to a portfolio understand that not all dividends are created equal. And none are guaranteed. They offer nothing spectacular and yet what they do offer has become much shinier in the last couple of weeks: more safety than the general marketplace, lackluster price gains which translate into lack of volatility in most cases and a market equaling return. And even with all of that, you can still muck it up in short order if you don’t know what you are doing.

Dividends are essentially the money older, established companies return to shareholders for their loyalty. Older/established are key words for dull and boring, predictable and steady and because of that, often ignored by those who believe that stock growth is the only way to make money in any market. These shareholders expect this compensation for two reasons: the companies are profitable and too much in the way of profits that can’t be channeled into new enterprises or development should be returned.

A lot of companies pay dividends but few can really afford them. The right recipe for a good dividend is simple: companies pay out what they can afford but not more than they should to keep those profits coming in – and the payouts going out. Some companies understand that the dividend is what may attract new investors. They offer juicier than affordable dividends to attract new money and investors would be careful to run those dividend percentages through some filters.

What is the dividend yield? If the company is paying a dollar and the share price is $10, the yield is 10%. Sounds good but is too high by most measures. Then calculate the dividend payout ratio. This basically pits the earnings against the dividend. Not enough money coming in usually means that dividend won’t continue in its current form forever. How many years has the dividend increased? Up and down dividends don’t exactly signal stability. And of course, consider the Price/Earnings ratio, a measure of the stock price divided by the earnings.

Are we in a dividend rich environment? Yes and the current volatility is to blame. Getting away from a short-term focus on performance and shifting to a pre-1980 view of long-term and stable is probably the biggest hurdle. This involves investor focus that looks away from the rest of the market – but not completely. Dividends offer some relief one part of your portfolio but like all things, it shouldn’t make up the whole of your strategy.

To buy dividends successfully, the old standby is still the mutual fund or its newest incarnation, the ETF. Fund managers will run the numbers more successfully than the individual investor more than likely has time to do. It can be done but with great care. Look away from dividend yields and towards dividend increases over the years. This is the single best indication that the dividend is where it ought to be instead of a way to attract new investors.

Not to confuse the issue, but beta plays a role. Beta is basically a measure of volatility. Too high (over 1.0 which is basically the beta for the S&P 500 as a whole) and you add to the risk that your stock price will not sustain the higher dividend. Low beat (below 1.0) will signal a stock that is considered a staple – dull and boring and profitable. Add beta and you add risk and this will satisfy some investors. Others, looking to hold on, will find comfort in know ing that there isn’t much risk, adequate payout and achievable diversity in their portfolio.

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