Respect Your Investments & The Process

Jason Hochstadt |

People are always seeking ways to continually grow wealth. However, just as taking pills are no substitute for diet and exercise when it comes to losing weight, throwing caution to the wind and abandoning long-term principles of investing such as (1) asset allocation; (2) diversification; (3) periodic rebalancing and (4) shunning market timing for the allure of investing in what is ‘hot’ at the moment is not a sound investment strategy that will lead to success over time. Additionally, an investor’s mindset should be not just on growing and accumulating their wealth, but, as well, maintaining, preserving and ultimately disseminating wealth in a manner that best meets one’s goals, needs and objectives – which can and often does evolve with time. While accumulating and growing are critical to this endeavor, not focusing on all of the ‘lifecycles of wealth’ may over-expose individuals, families, businesses and other entities to certain risks that were (or are) over looked and/or under-appreciated. Accordingly, it is important to consider one’s entire balance sheet and cash flow, both currently and on a projected basis, as part of the investment process – which will also change over time. While capital appreciation is often the overriding goal, it is equally, if not more, important to pay attention to risk as much as rewards. As such, capital preservation cannot be ignored given the extreme laws of math – where a 50% decline requires a 100% increase merely to break-even. An investor in the Nasdaq at the peak of 2000 would not have recouped their initial investment for approximately 17 years – meaning, after factoring in inflation, they would have sustained a considerable loss of purchasing power. A useful reminder of how to maintain a successful investment program, “The Tao of Wealth Management” (July, 2018), written by Jim Parker of DFA Funds, has been attached herein.

‘Paralysis by analysis’ is a phrase used to indicate when one is unable to make a decision given so much information at hand. When it comes to the field of investments, this is apropos. According to a Cerulli Associates contained in a June 25, 2018 article in entitled “Cerulli: Too Much Product Choice Leads Retail Investors Astray,” such an abundance of choices and ‘nearly unlimited data’ “can cause investors to become overwhelmed instead of informed. In the end, investors with too many options end up struggling to pinpoint the right solution for their own specific needs and goals.” What makes it even more challenging for investors, including advisors, is the fact that equally bright individuals, managers, teams, firms and others may offer completely different ‘takes’ or ‘opinions’ on the merits of a specific investment or asset class – yet sound so convincing that their opinions seem like guaranteed facts. In a 04/02/18 article by Larry Swedroe for Advisor Perspectives titled, “The Track Record of Market Pundits,” from 2010 thru 2017 only 27% of ‘sure things’ from market gurus actually occurred. Howard Marks, Co-Chairman of Oaktree Capital, opined a few years ago that, “People who rely on forecasts seem to think there’s only one possibility, meaning risk can be eliminated if they just figure out which one it is. The rest of us know many possibilities exist today, and it’s not knowable which of them will occur. Further, things are subject to change, meaning there will be new possibilities tomorrow. This uncertainty as to which of the possibilities will occur is the source of risk in investing.”

As part of our ongoing due diligence process, we pay attention to the ‘micro’ (minutia) in order to establish and continue to substantiate, over time, the ‘macro’ (big picture – e.g. which investments we prefer to own and, likewise, avoid). While we believe in and adhere to the ‘KISS’ principle (“keep is simple, stupid”) with investments, in order to achieve this we must delve into the weeds in our attempt to see the forest from the trees. A brief summation in May, 2018 by DFA, entitled ‘Turning Out the Noise,’ has also been enclosed and reinforces the need to maintain patience, perspective and a disciplined investment approach.

Although performance is quite important, it remains a poor judge of the underlying merits of a given investment. As contained in the January, 2018 paper by S&P Dow Jones Indices entitled, “Does Past Performance Matter? The Persistence Scorecard” – (1) out of 563 domestic equity funds ranked in the top quartile of returns as of Sept., 2015, only 6.39% managed to stay in the top quartile at the end of Sept., 2017; (2) only 4.7% to 6.5% of large-cap, mid-cap and small-cap funds maintained top-half performance over five (5) consecutive 12-month periods; (3) no large-cap, mid-cap or small-cap funds managed to remain in the top quartile at the end of the five-year measurement period; (4) an inverse relationship generally exists between the measurement time horizon and the ability of top-performing funds to maintain their status; (5) the data reflected a stronger likelihood for the best-performing funds to become the worst-performing funds than vice-versa and (6) over the five-year measurement horizon, the results show a lack of persistence among nearly all the top-quartile fixed income categories, with a few exceptions.” Accordingly, with respect to the below please note that past performance is no predictor, or guarantee, of future performance.

Interesting Facts

  • Attached are 10-pages courtesy of DFA Funds (one of the pages is from Lord Abbett).

    • P. 1: Shows how many investors have difficulty separating their emotions from investments – thereby perpetually buying high (what’s hot) and selling low (what’s not).

    • P. 2: From 1980 – 2017, the average annual return of the S&P 500 Index was 10.1%. However, on average, in a given year the stock market declined by (13.6%). That’s a 24% spread, on average, between the average drawdown and average return during this 27-year period. If we sold stocks every time there was a drawdown, how would we ever participate in its returns over time?

    • P. 3: From 1990 – 2017, we approximated a total of 6,750 trading days. During this time, the S&P 500 Index delivered a 9.81% average annualized return. However, an investor missing just the 25 best trading days, or 0.37% of the trading days, saw their investment fall to 4.53% - or 46.2% of the total. WOW!

    • P. 4: Similarly, from 1992 – 2017, a 25-year period where we approximated a total of 6,250 trading days, saw $10,000 invested in the S&P 500 Index grow to over $105,000. Yet, an investor missing merely the 10 best trading days during this period, or 0.16% of all trading days, saw their investment cut roughly in half, to $52,500. ANOTHER WOW!

    • P. 5: From 1968 – 2017, whenever the S&P 500 Index fell in a given day by between (3%) to (6%), one year later, on average, it was up 10%. Incredibly, 6 of the 10 best trading days occurred within 5 trading days of one of the 10 worst days in the market.

    • P. 6: An investor in the MSCI World Index from 1970 – 2017 witnessed excellent returns during this time despite countless scary world events and market declines throughout – including (a) the S&P 500 Index falling by over (40%) on two occasions; (b) the Dow Jones Industrial Average dropping by (23%) on a single day in October, 1987 and (c) three bear markets (in the 1970s; early 2000s and 2008, respectively).

    • P. 7: Crises throughout the world seemingly occur on a regular basis. Despite this, a balanced portfolio of stocks and bonds has, historically, delivered strong returns 5 years after such a crisis as indicated therein.

    • P. 8 – 9: Similarly, stocks (as measured by U.S. and international large-caps, respectively) have been quite resilient after both corrections (10% or more losses) and bear markets (20% or more losses) 1, 3 and 5 years thereafter.

    • P. 10: Over the 90-year period from 1926 – 2016, the stock market, as measured by the CRSP 1-10 Index, has generated positive performance in ¾ of all years (and 2017 was positive as well – so this % would be 76% thru last year). However, despite long-term average annual returns of 10%, note the uneven distribution of returns around the mean. During the 90-years indicated, in only 3-years was the total U.S. stock market return between 9% and 11%.

Key Takeaways From The Above Include:

  1. The stock market is incredibly risky over any given day, week, month or year.

    • As one increases their time horizon, they increase their chance of generating positive returns in the stock market. Yet, the average holding period for stocks is just half a year. From 1928 – 2018, the worst returns for the S&P 500 Index were (a) down (20%) for 1-day; (b) down (71%) for 1-year and (c) down (84%) for 3-years. The worst 30-year performance was 559%, or positive 6.5% annualized.

  2. It is impossible to successfully and consistently time an investment in the stock market – which requires being right twice (when to get out and when to get back in).

  3. Stock market declines do occur and can be severe. However, they typically don’t last forever and recoveries often occur when one least expects it.

  4. Even during strong performance years for the stock market, there are usually double-digit declines throughout the year that one must endure in order to generate such positive returns.

  1. If stocks only went up, there would be no risk premium, resulting in much lower stock returns where it may not make sense to take the risk of investing in equity securities.

  1. Keeping one’s cool, and remaining disciplined and consistent, is easier said than done and requires constant work. Often, we must endure short-term pain to achieve long-term gain.

    • As of 06/30/18, the % of the Russell 1000 Growth Index comprised of the largest 5 holdings was 26.95% - 2.4 standard deviations above its 30-year average and higher than its early 2000s peak. This is due to the significant outperformance of the top stocks within this Index (particularly certain information technology and consumer discretionary stocks such) relative to all other stocks maintained in the Index.

      • In a similar manner, as of mid-July, 2018 the market cap for the top 5 companies of the S&P 500 Index (the largest 1%) collectively exceeded that of the bottom 282 S&P 500 companies (the smallest 56.4% of the Index). Thus, the daily returns of these 5 companies has more of an impact on the S&P 500 Index than a majority of the Index components.

      • Roughly 50% of the S&P 500 Index returns for the first half of 2018 was derived from the ‘FAANG’ (Facebook; Amazon; Apple; Netflix; Google) stocks- with these 5 stocks comprising over 12% of the S&P 500 Index as of March, 2018 (versus barely over 5% 4 years prior).

      • Additionally, from 12/31/2013 thru 03/21/2018 the 7 largest contributors to the S&P 500 Index’s 60.1% total return represented over 59% of the returns – meaning the top 1.4% performers generated nearly 60% of the returns during this time!

  • Although the first half of 2018 was significantly more ‘volatile’ than 2017, its only been slightly more volatile than the long-term average by one measure: the # of days in the calendar year when the S&P 500 Index fell by more than (1%) was 16 during the first half of 2018 (annualizing to 32) versus 29 as the historical average from 1970. However, during the first six months of 2018 the S&P 500 Index rose by more than 1% on 20 trading days. Is there someone who accurately predicted which 20 trading days were going to be the best and which 16 trading days would be such downers during this time?

  • The difference between the top and bottom performing investments is usually staggering. As an example, in the 2nd quarter alone the spread between the best and worst performing country in emerging markets was 60.9% (with emerging market stocks, overall, down approximately 8%).

    • Separately, from 1998 thru 2017, the annual average difference in returns between the top 20% and bottom 20% of performers in the Russell 1000 and Russell 2000 Indices, respectively, was 86.0% and 138.5%. Once again, a reason for diversification – as we highly doubt anyone predicted which of the stocks in the Indices would be in the top and bottom performers during this time.

  • “If You Want To Do Good, Expect to Do Badly” (06/28/18 WSJ) addresses the desire of many to invest in ‘good’ companies – however defined: “Investors are increasingly convinced that they can buy companies that behave better than the rest and make just as much money. They are wrong.” Although utilizing screens such as environment, social and governance (“ESG”) may be incorporated by money managers, with respect to ‘socially conscious investing’ a fundamental issue is nearly everyone will have a different definition of what qualifies and constitutes as an acceptable investment.

  • While the # of listed U.S. stocks has declined from mover 7,000 in 1997 to approximately 3,400 currently, the # of foreign stocks has risen four-fold, from 9,700 in 1990 to roughly 39,000 now. In fact, ¾ of the world’s GDP is derived from all countries other than the U.S.

  • From 1928 – 2017, in only 3 years did both the S&P 500 Index and 10-year Treasuries lose money in the same year (the last being 1969). In addition, on 17 separate occasions from 1962 thru 2018 when the 10-year Treasury yield’s rate rose by more than 1%, the average S&P 500 Index returned 22%. It’s had only 3 down periods during this time, with each drawdown less than (2%). It is not a fait accompli that as interest rates rise, stocks go down (or up for that matter). This is much more involved, taking into account current market valuations, starting interest rates, the reason for rate increases, etc.

  • Although stocks historically have earned a 4%/year ‘risk premium’ relative to bonds, this is not a constant – as demonstrated by the S&P 500 Index’s (6%) loss from April, 2000 thru March, 2010 at a time when the Barclays Aggregate U.S. Bond Index rose by 84% - and with 2/3 of the volatility of the stock market during this time. Bonds have actually been in the black every down year for stocks since 1976 (7 in total).

  • For the Barclays U.S. Aggregate Bond Index (a proxy for the U.S. investment-grade market), (a) since 1976, it has lost an average of 6.3% whenever interest rates have risen >2.0% since 1976 (on 6 different occasions) with (b) the average period from trough to peak being 14 months and (c) the average post drawdown recovery taking 3.5 months to occur. Bonds can lose money – with there being an inverse relationship between bond prices and interest rates. Just as the return of a stock is based on its dividend (if any) and appreciation/depreciation, so, too, a bond’s return is driven by 2 factors – its coupon as well as principal appreciation/depreciation.

  • Interest rate spreads continue to remain below their historical averages: (1) the 2-year versus 10-year Treasury spread was down to 25 basis points in early July (avg. of 112 basis points since June, 1982); (b) U.S. investment grade corporate bonds yielded 123 basis points more than equivalent Treasuries as of the end of June (versus a 160 basis point average since 1998) and (3) U.S. high yield bond spreads at 383 basis points at the end of June, or nearly 200 basis points below its average from 1998 of 568 basis points. Short-term interest rates are typically dictated by monetary policy (such as the Fed Funds Rate set by The Federal Reserve), with long-term interest rates usually based upon expectations on future inflation and economic growth.

To conclude this section, I leave you with a quote from Ben Carlson, CFA, in a 04/23/18 article he penned titled, “Trading One Risk For Another:” “You cannot eradicate risk in a portfolio. You can only choose when and how to accept risk in different variations. Doing so will always involve balance and trade-offs.”


All That Glitters May Not Turn Into Gold

It is amazing that we read multiples time a week, it seems, about some fraudulent investment scheme that cost investors large sums of their invested assets.  Some of the themes are similar in terms of how such acts take place – such as (1) client funds not being maintained at an independent custodian, with clients having online account access and receiving account statements and correspondence directly from the custodian; (2) clients falling for promises of guaranteed (and high) returns [when they don’t exist aside from certain investments such as bank deposits and U.S. Treasury Bills]; (3) providing general powers of attorney to these supposed financial professionals; (4) investing in private, and highly illiquid, investments (with a lack of accountability and documentation) and (5) not being proactive when it comes to asking questions and reviewing one’s investments.  Not everything referenced below involves fraud; however, with respect to engaging any investment professional or owning a particular investment, as the Gipper used to say, “Trust but verify!”  

  • “Private Pension Product, Sold by Felon, Wipes Investors Out” (07/23/18 WSJ) – with investors being defrauded, collectively, over $100 million thru a ‘pension advance’ that was, in effect, a Ponzi Scheme.

  • “Death Is a Way of Life for Liquid Alternatives” (07/16/18  ‘Liquid alts’ came to prominence since 2009, subsequent to the financial crisis, designed to provide portfolio protection and offer uncorrelated, diversified and attractive returns relative to other asset classes.  Unfortunately, aside from generally high fees and uneven performance, roughly 1/3 of such funds that existed at some point during the past five years don’t exist anymore (presumably because they underperformed heightened expectations and/or they were unable to generate critical mass of assets needed to justify continuing to manage such a fund).

  • “Advisor Used Client Assets To Rent An L.A. Mansion, Prosecutors Say” (06/29/18 Financial Advisor):  Notice the bolded words in “Daryl Davis, who raised $4.7 million from investors, guaranteed the clients their money was safe and promised them at least 6% annual interest.”

  • Lisa Marie Presley claims her ex-money manager lost $100M trust fund left to her by Elvis” (06/27/18 Wealth Advisor).

  • “SEC Shut Down Alleged $102 Million Ponzi Scheme” (06/20/18 Financial Advisor), with investors ‘guaranteed dividends or double-digit returns….”

  • “Former L.I. Broke Arrested For Alleged $8 Million Ponzi Scheme” (05/31/18 Financial Advisor) – with the fraudster ‘promising that the funds would be safe and guaranteeing monthly interest payments to its clients.’

  • New York Advisor Facing 99-Count Indictment for Securities Fraud” (05/30/18 – as an advisor invested clients money in his hedge fund absent their knowledge or consent.

  • “U.S. Charges Brent Borland With $21 Million Investment Fraud (05/17/18 Financial Advisor) – with Mr. Borland ‘falsely promising a high rate of return secured by property owned by the firm.”

  • Five-Star Advisor Settles Charges of Alleged $71M Fraud” (05/16/18 Financial Advisor) – as the advisor in question lied to investors about how their funds would be invested, the investment performance and his disciplinary history in the sale of private real estate offerings which the advisor managed himself (talk about a conflict of interest!).

  • “Merrill Lynch and Advisor Sued by Ex-NBA Star” (05/11/18 Financial Advisor IQ) – with former NBA player Kwame Brown claiming Bank of America and Merrill Lynch invested his money without authorization; opened accounts without him knowing and without him having access and borrowed monies on his behalf absent his consent.

  • “Harvard Blew $1 Billion in Bet on Tomatoes, Sugar, and Eucalyptus” (03/01/18, with Harvard’s average 10-year returns thru 06/30/17 of 4.4%/year among the worst of its peers and 200 basis points below a simple 60/40 stock/bond index fund mix.  In part, Harvard’s weaker results were due to the write-down of its natural resources portfolio by $1.1 billion – including $150 million in an agricultural development in Brazil.  Sometimes, even the brightest get too slick for their own good.

  • “Wells Fargo’s Wealth Management Unit Attracts Justice Department Attention” (03/01/18 WSJ) – as Wells Fargo was accused of ‘pushing’ and ‘promoting’ products that may not have been in their client’s best interests.

  • “Whistleblower said to collect $30 million in JP Morgan case” (02/16/18 InvestmentNews) – with JP Morgan not properly disclosing that it was steering asset-management customers into investments that would be profitable for the bank.

We titled this piece “Respect Your Investments &The Process” to pay homage to the role investments play in our lives.  It is critical we have a process and plan in place to continually manage, monitor, grow and protect our portfolios as dictated by our unique facts and circumstances – which are ever evolving.  Remaining engaged and proactive is never easy – but was it the alternative? Everything in life requires effort, time and commitment – our investments are no different.   


REMINDER:  Past performance is not a predictor of future returns.  Nothing contained herein shall be construed as the rendering of personalized investment advice or providing our opinion as to the merits of a particular investment or strategy.


To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.