Tag Archives: psychology

Get Off The Roller Coaster With Vanguard Total Stock Market ETF

Roller coaster start for investors in 2016 This year, evidence of stress came early as the market dropped like a brick before swinging back up like a rocket. Rampant, wrenching, volatility is maddening for many investors who see no choice but equities for financial gains in the current low interest rate savings environment. Picking individual stocks is risky in a traders’ marketplace. For the long-term investor, a maximally diversified ETF may reduce stress helping to weather short-term shocks like those that were seen last January while offering modest gains across a 5 to 10 year time horizon and greater peace of mind. Volatility and Downside Risk Recent Fed commentary and behavior can only confuse the Markets, and that spells continued and perhaps even greater volatility . The contradictory nature between the ” Fed speak” of the Chair, Janet Yellen, and other members of the FOMC has sent mixed messages about removing unprecedented accommodation from U.S financial markets. Yellen’s dovish response to maintain low interest rates in the U.S. signals a fear of declining global economic growth. The picture concerning the future direction of interest rates is clouded and that presages the possibility of a continued roller coaster stock market ride. At Fortune’s Global Forum, JPMorgan (NYSE: JPM ) CEO, Jamie Dimon, hinted at expected greater volatility stating that, “markets will be scary until a normal interest rate environment returns.” This view is mirrored in the recent low interest rate of the 10 year U.S. Treasury Bill which has fallen to 1.77% as scared money retreats from the markets. For some savvy traders, volatility may translate into higher short-term returns, but this isn’t always the case because the psychology of greed, and more importantly, in my experience, of fear, can reverse markets on a dime. This can result in devastating losses for some market segments as well as individual stocks. On the other hand, the average investor, by nature, tends to be a long-term animal, and that means having to contend with both volatile whiplash swings as well as the fear of downside market risks. It has always been a maxim for me to take both volatility and downside risk into consideration when I am in investment mode. I have also come to believe that volatility does not always translate into higher returns. Diversification is a great tool for dealing with both volatility and downside risk. Vanguard Total Stock Market ETF The Vanguard Total Stock Market (NYSEARCA: VTI ) ETF is a significantly diversified proven winner. It seeks to track the performance of a benchmark CRSP U.S. Total Market Index. The investment approach is focused on: Large-, mid-, and small-cap equities diversified across growth and value styles. A passively managed, index sampling strategy. Maintaining a fully invested fund utilizing low expenses to minimize net tracking errors. Accurately representing the U.S. equity market while delivering low turnover. Key Fund Facts Clearly, a key fact for investors to consider is the expense ratio for purchasing the ETF. As of 04/28/2015 it is 0.05% and compares very favorably with the Lipper peer average expense ratio of 1.17% as of 12/31/2005. Total net assets are $389.8 billion as of 02/29/2016. Outstanding shares are 560,322,004 as of 03/31/2016. The risk and volatility Beta based on the 5 year Primary benchmark and the Broad-based benchmark is 1.00. Sector Weightings Courtesy of the Author As noted in the chart above, at present the heaviest sector weightings are in Financials, Technology and Consumer goods while the lowest are in Basic materials, Telecommunications and Utilities. Comparative Performance Courtesy of the Author Of the 13 funds listed in the table above, VTI leads the group with a ten year average return of 6.13% while maintaining a maximum level of diversification. The 3 and 5 year returns are 8.21% and 8.63%, respectively. Short-Term Performance The fund’s overview is described by the table below. It is highly capitalized and provides a 2.2% dividend yield as well as capital gains. Click to enlarge Courtesy of the Author Although VTI shows a loss for the first three months of this year and an -8.2% one-year return, it sports a 10% total market return for the last three years during a period of exceptional market volatility. Cumulative Long-Term Performance Click to enlarge Courtesy of the Author Long-term cumulative performance over 10 years is 97.52% with a cumulative performance of 133.12% since inception on 05/24/2001. VTI 5 Year Chart A 5 year weekly stock price chart shows strong performance. Extrapolating data from the chart shows a low close of 51.04 on October 3, 2011 and a close on April 4, 2016 of 105.04 for a share value gain of 51%. This corresponds to an approximate 5 year annual gain of 8.3% seen in the Betterment Comparative Performance chart provided above. Click to enlarge C ourtesy of the Author VTI Bounce-Back As Market Recovered Courtesy of the Author VTI showed a strong bounce-back in mid-February of 2016 following the volatile 10% market decline that took place during January 2016. Additional data supporting VTI which is also available as a mutual fund can be reviewed on the Vanguard site . Where Should We Be In The Market? Nobody can call the market; we can only consider economic variables and try to place ourselves in the best situation to profit from our investments, and most importantly, to avoid significant financial loss. We can also learn from past experience if we are in a position where we are personally vulnerable to the stressful impact of severe market swings. I am not sanguine in my near-term expectations that stock markets can continue to rise in the current cycle . I make no predictions, but point out the following for your consideration: U.S. Market Indices are nearing highs in a climate of weak global economic conditions. But, I cannot know what will happen in the longer term and therefore the choice of selling my portfolio and exiting the stock market is a poor choice in my opinion. I consider the U.S dollar to be the strongest currency and the U.S. economy to have the greatest potential to generate wealth given better economic policies. The question for all investors now is, where do you feel the most comfortable putting your money? Conclusion Remaining invested for the near term, in my opinion, requires the broadest diversification in the strongest companies, and I consider the U.S. the best place to be at this time. The Vanguard Total U.S. Market ETF may be a place for some investors to seek refuge. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VTI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: The information and data that comprise the content of this article came from external sources that I consider reliable, but they have not been independently verified for accuracy. Although I reserve the right to express points of view, they are my reasoned opinions, and not investment advise. I am not responsible for investment decisions you make. Thank you for reading and commenting.

Seth Klarman On Value Investing In A Turbulent Market

Investors must employ an investment philosophy and process that serve as a bulwark against a turbulent sea of uncertainty and then navigate through confusing and often conflicting economic signals and market head fakes. Amidst the onslaught of gyrating securities prices, fast and furious corporate developments, and an unprecedented volume of data, it is more important than ever to maintain your bearings. Value investing continues to be the best (and perhaps only) reliable North Star for those who are able to remain patient, long-term oriented, and risk averse.” – Seth Klarman year-end 2015 letter to investors. 2015 was a bad year for Seth Klarman and his Boston-based hedge fund Baupost. The fund lost money for its investors, a rare event – it’s only happened three times since the fund’s founding in 1982. Click to enlarge Off the back of such a terrible performance, Seth Klarman devoted the majority of his year-end letter to investors explaining that value investing isn’t a precise science in his usual calm and philosophical manner. It’s unlikely that Klarman would have been aware what was in store for the markets in the first few months of 2016, but as it turns out, his words couldn’t have come at a better time for value investors seeking reassurance in a turbulent market. Seth Klarman: Take advantage of Mr. Market Value investors gain clarity by thinking about their investments not as quoted stocks whose prices whip around on a daily basis, but rather as fractional ownership of the underlying businesses.” – Seth Klarman year-end 2015 letter to investors . To be a successful investor, you must be able to take advantage of Mr. Market’s bipolarity. You must be able to step in and buy shares when Mr. Market offers them to you at a knock-down price, but you need to be able to ignore his calls to sell at lower levels. Klarman writes that the two extremes of human nature, fear and greed drive market inefficiency. Fear is primal, the effect of confronting the apparent loss of what you have. Your shares still represent the same fractional ownership in a business as when they traded higher yesterday, however, people are now en masse delivering the verdict that your shares are actually worth less. You have to find a way not to care or even to relish this eventuality. Warren Buffett has written that one should not invest in stocks at all if uncomfortable with the possibility of a 50% drawdown. The mistake some investors make is to accept the market’s immediate verdict as fact and not opinion, and become disappointed, even frustrated.” — Seth Klarman year-end 2015 letter to investors . Losses can cause people to lose their bearings. It’s natural to want to sell everything after your portfolio has been marked down sharply. Watching your net worth evaporate in front of you as the market falls isn’t a pleasant experience. However, this is the wrong way of thinking about equities. Klarman writes that for an investor to overcome the desire to sell at the bottom and take advantage of Mr. Market’s erratic movements, they must think not about what the market will pay for the securities today, (the stock price) but rather the true value of the securities you own based on such attributes of the underlying businesses as free cash flows, private market values, liquidation values, downside protection, and growth prospects. Klarman continues, saying that when the market, in the absence of adverse corporate developments, drives an undervalued security down in price to become an even better bargain, that’s not a reason for panic, or even for mild concern, but rather for excitement at the prospect of adding to an already great buy. When tempted to sell: Investors must think not only about what they would be getting (the end of pain that accompanies the certainty of cash) but also what they’re giving up (a significantly undervalued security which, emotion aside, may be a far better buy than a sell at today’s market price).” – Seth Klarman year-end 2015 letter to investors . This is why conducting your own rigorous due diligence is essential. The insights gained from due diligence give you the justifiable confidence to maintain your bearings – to hold on and consider buying more – even on the worst days in the market. Seth Klarman: Don’t be greedy Greed works alongside greed to eat away at your confidence and push you to make decisions that are hazardous to your wealth. The angst felt when others are succeeding while you are not can lead you to make poor decisions, on this topic Klarman cities J.P. Morgan, who said “Nothing so undermines your financial judgment as the sight of your neighbor getting rich,” and Gore Vidal who dryly noted, “Whenever a friend succeeds, I die a little.” What’s more, the fear of missing out can be a kill switch for risk aversion in that it tempts people into paying up and then holding on too long. Fear of missing out, of course, is not fear at all but unbridled greed. The key is to hold your emotions in check with reason, something few are able to do. The markets are often a tease, falsely reinforcing one’s confidence as prices rise, and undermining it as they fall. Pundits often speak of the psychology of markets, but in investing it is one’s own psychology that can be most dangerous and tenuous.” – Seth Klarman year-end 2015 letter to investors . To show just how dangerous (and damaging) fear and greed can be to investors’ returns, Klarman lets the figures do the talking. The data shows that over the 30-year period from 1984 to 2013, the S&P 500 Index returned an annualized 11.1%. However, according to Ashvin Chhabra, head of Euclidean Capital and author of ” The Aspirational Investor ,” the average returns earned by investors in equity mutual funds over the same period was ” a paltry 3.7% per year, about one-third of the index return .” Bond investors were dealt even more pain. While the Barclays Aggregate Bond Index returned an annualized 7.7% over the 30-year period from 1984 to 2013, bond funds produced an annualized return of 0.7%. The underperformance in both cases was a direct result of investors pulling money out of the funds at precisely the wrong times. In short, by letting fear and greed take over their emotions, retail investors have underperformed both the markets and the very funds in which they were invested since 1984. That’s a statistic that’s difficult to ignore. So to conclude: In the moment, public market investors have no ability to control investment outcomes, but they can control and improve their own processes. We never shoot for high near-term investment returns. Trying too hard to earn positive results, or assessing performance too frequently, can drive anyone into short-term thinking, herd-like behavior, and incurring higher risk…We believe that by remaining focused on following a well-conceived process, we will make good risk-adjusted, long-term investments. And we know that if we do that, we will indeed earn good returns over time.” – Seth Klarman year-end 2015 letter to investors. Disclosure: None.

A View From The Beach

Why should we diversify? Click to enlarge Photo: Petr Kratochvil. Source: Public Domain Pictures The reason to diversify is simple in some ways. Don’t put all your eggs in one basket, because that basket may fall. Spread things out – you don’t know what disaster lies ahead. And the math of diversification is pretty straightforward: your average risk is the average of all your asset returns, but volatility goes down based on how uncorrelated those assets are. If one stock zigs when the other zags, the overall portfolio is a lot more stable. By combining a lot of assets with different characteristics, you get an efficient portfolio. Click to enlarge Efficient Frontier: Source: Wikipedia But the psychology of diversification is hard. By holding assets in different asset classes from different industries that sit at different places in the capital structure, you can pretty much guarantee that some of your investments will look lousy. Consider the mid-2000s. Emerging markets were hot, generating 30% returns several years in a row. Growth stocks were dogs. Now, things are reversed. Emerging markets are beset by falling commodity prices and weakening global demand, while growth stocks shine. Click to enlarge Periodic Table of Investment Returns. Source: Callen Associates The temptation is to get rid of the assets that aren’t doing so well – like cutting the slow kids from a sports team. But that’s the mistake. Asset prices are adaptive – they adjust to our expectations. By avoiding assets with low expected returns, you make it a lot harder to beat the market’s expectations. The surest way to underperform is to sell assets when they’re down. No one knows what the next hot sector will be. Asset returns are like the wind: they blow in one direction, then change. We just don’t know when that change will happen. And whether the next breeze will be a light zephyr – or a hurricane!