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Even if their portfolio is a disaster waiting to happen, most investors would rather false reassurance than the unflattering truth.

Why We Try

BEATING THE STOCK market over the long term is no mean feat. Only a tiny proportion of investors—professional or otherwise—manage to do it. So why do so many people think they can?
Meir Statman, a finance professor at Santa Clara University, cites eight key reasons. In a new monograph titled Behavioral Finance: The Second Generation, he slots these reasons into two broad categories—five cognitive and emotional errors, followed by three expressive and emotional benefits:
1.

Read more »

Seven Paradoxes

“THE INVESTOR’S CHIEF problem—even his worst enemy—is likely himself.” So wrote Benjamin Graham, the father of modern investment analysis.
With these words, written in 1949, Graham acknowledged the reality that investors are human. Though he had written an 800-page book on techniques to analyze stocks and bonds, Graham understood that investing is as much about human psychology as it is about numerical analysis.
In the decades since Graham’s passing, an entire field has emerged at the intersection of psychology and finance.

Read more »

Just in Time

I USED TO THINK anybody could be taught to manage money sensibly. I no longer believe that.
When I was in my 20s and scraping by on a junior reporter’s salary, I had some sense for the financial stress suffered by everyday Americans. But after a handful of years of diligently saving, I was able to escape those daily worries. Many Americans, alas, never do.
This was hammered home when I recently took the financial well-being questionnaire offered by the Consumer Financial Protection Bureau (CFPB).

Read more »

Our To-Do List

I HAVE NEVER broken a New Year’s resolution—because, until this year, I’ve never made one. But now that I’m retired, with time on my hands, I figure my wife and I ought to challenge ourselves with 10 financial resolutions for 2020:

We’ll continually monitor routine spending with the goal of reducing or eliminating at least half-a-dozen expenses this year. That’s one every two months. Phone companies, internet providers and insurers, be warned: Here we come.

Read more »

Magnitude Matters

WHY DON’T WE spend our time and energy on financial issues that have the greatest impact? We’ll drive to a more distant gas station to save 10 cents a gallon, but fail to do all the maintenance needed to extend the life of our car. What lies behind this sort of behavior? The savings from getting the best price per gallon is concrete and immediate, while maintaining our car is long term and abstract.

Read more »

12 Investment Sins

WANT TO IMPROVE your investment results? The deadly sins below are not only among the most serious financial transgressions, but also they’re among the most common. I firmly believe that, if you eradicate these 12 sins from your financial life, you’ll have a better-performing portfolio.
1. Pride: Thinking you can beat the market by picking individual stocks, selecting actively managed funds or timing the market.
Antidote: Humility. By humbly accepting “average” returns through low-cost index funds,

Read more »

Money Guide

Fixed vs. Adjustable

MOST FOLKS instinctively opt for a fixed-rate mortgage, where your principal-and-interest payment stays the same every month. But in all likelihood, an adjustable-rate mortgage, or ARM, will be cheaper. ARMs are priced off short-term interest rates, while fixed-rate mortgages are priced off intermediate-term rates—and short-term rates are generally lower than intermediate-term rates. Moreover, when interest rates drop, homeowners with ARMs will likely see their monthly payment fall when their rate next resets. By contrast, for holders of fixed-rate mortgages to benefit from lower rates, they need to go through the hassle and cost of refinancing. Of course, with an ARM, there’s also a risk that the interest rate will increase at the next adjustment date. ARMs often have both periodic and lifetime caps that limit how much the rate can increase. Let’s say an ARM has a two-percentage-point periodic cap, a six-point lifetime cap and a one-year adjustment period. Every year, the rate you’re charged could climb two percentage points, though it can never climb more than six points above your initial rate. Not sure you want to take that much risk? Instead of a pure ARM, many homebuyers take out a 3/1, 5/1, 7/1 or 10/1 hybrid ARM. With these loans, your rate is fixed for the first three, five, seven or 10 years, and then the rate adjusts every year thereafter. At that point, the rate could climb sharply. But there’s also a good chance you might move or refinance within the first five or six years, so you may never feel the bite from the mortgage’s adjustable rate. As you ponder what mortgage to get, give some thought to your job situation. If you have a secure job with a steady paycheck, you might take the risk of an ARM and, fingers crossed, get rewarded with a lower average rate over the course of the mortgage. But if your income fluctuates, you should probably look for predictability in the rest of your financial life, including favoring fixed-rate mortgages. Next: Conforming vs. Not Previous: Mortgages
Read more »

Archive

Private Matters

IN SUMMER 2000, the Art Institute of Chicago fell under the spell of a young hedge fund manager named Conrad Seghers. The allure? Seghers claimed that his funds, called Integral, offered “the highest Sharpe ratios in the industry.” The Sharpe ratio is supposed to measure an investment's risk relative to its returns and is popular in the world of hedge funds. Convinced by this pitch, the Art Institute committed more than $40 million of its endowment to Seghers's funds. A year later, the investments unraveled—and the Art Institute lost 90% of its money. How can you avoid a similar fate? The simple answer: Avoid private investment funds. Still want to try your hand with a private equity, venture capital or hedge fund? I’d recommend an extra dose of due diligence. As a starting point, ask these 10 questions: 1. Who recommended this investment? The Art Institute thought it was employing best practices by hiring an investment consultant to screen prospective hedge funds. What the folks there overlooked was that the consultant had a financial relationship with Integral and received a hefty matchmaking fee. The lesson: If you’re paying experts for advice, be sure there's no one else on the other side also paying them. 2. What’s the fee structure? David Swensen, manager of Yale University’s endowment, cautions that, “Investors in hedge funds face dramatically higher levels of prospective failure due to the materially higher level of fees.” As a result, “generating risk-adjusted excess returns [is] nearly an impossible task.” This is not to say that you should never invest in a private investment fund. Indeed, Swensen invests much of Yale’s assets in private funds. But you should think critically about a fund's ability to overcome its fees and generate healthy performance. 3. What’s behind the fund’s track record? You need to understand how the fund is generating its returns and shouldn’t hesitate to ask questions. If you can’t understand the explanation, don’t invest. Complexity doesn’t necessarily indicate that something is wrong—and, indeed, many perfectly reputable funds pursue highly complex strategies. But if you don’t fully understand the strategy, it means you aren’t in a position to make a determination one way or the other. 4. Does the fund use leverage and, if so, how much? If a fund uses debt, it can amplify your returns, but it also amplifies your risk. A fund’s debt level will give you some indication of how much risk you’re taking—and how badly things could turn out in adverse conditions. 5. Does the fund have a track record through different economic cycles? By the time the Art Institute met Conrad Seghers, he had been in business for just two years. A long track record certainly doesn't guarantee success—but a limited track record makes it harder to know how your investment might perform. 6. What’s in the fine print? In the end, Seghers was convicted of fraud. Still, Integral's investor agreements included disclosures that perhaps the Art Institute should have read more carefully. While probably a stretch, Integral's attorney argued that Seghers "could have bet on the Super Bowl if he wanted." The lesson: Be sure you understand the fund's mandateand that the documents reflect this understanding. Never rely on verbal assurances alone. 7. What do references say? Reputable funds will allow you to speak with both current and former investors. In the case of Seghers's funds, another investor decided it was “hocus pocus” and pulled his money out before the collapse. I suspect he wasn't the only one. If you're looking to make an investment, it's worth making some calls first. 8. Who are the fund's vendors? You should always insist that a fund’s assets be held by a well-known independent custodian and you should insist on a national auditing firm. Pick up the phone and verify these relationships independently. 9. Can you estimate the tax impact? To calculate a fund’s after-tax returns, ask for copies of all past annual K-1 forms. At the same time, ask when K-1s are issued. Private funds have a habit of being late with K-1 forms, causing investors to put their own tax returns on extension. 10. What’s the fund’s liquidity policy? Most funds have lock-up policies that limit your ability to withdraw funds on demand. This might prevent you from withdrawing money for some months. Adam M. Grossman’s previous articles include Don't OverthinkB Is for Bias and Humble Arithmetic. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.
Read more »

Numbers

ALMOST 46% of U.S. households own mutual funds, with 63% investing primarily through their employer’s plan, 27% through a financial planner or broker, and 10% buying funds directly, says the Investment Company Institute.

Home Call to Action

Manifesto

NO. 33: WE HAVE two great financial advantages: time and our income-earning ability. To grow wealthy, we should take a slice of each month’s earnings—and invest it for as much time as possible.

Truths

NO. 73: MOST TAX deductions will cost you dearly. If you’re able to itemize your deductions and you’re in the 22% income tax bracket, $100 of mortgage interest or medical expenses might save you $22 in taxes, leaving you $78 poorer. A crucial exception: If you contribute $100 to a tax-deductible retirement account, you save the $22, but still retain your $100.

Act

DROP UNNECESSARY insurance. If the kids have left home or you have $1 million-plus in savings, you might no longer need life insurance. With a seven-figure portfolio, you could perhaps also drop disability coverage and skip long-term care. Even if you can’t cancel policies, consider raising deductibles and extending elimination periods as your wealth grows.

Think

EFFICIENT FRONTIER. What mix of investments offers the highest expected return for a given level of risk—or the lowest risk for a target return? In theory, these optimal portfolios can be found on the so-called efficient frontier. Their key characteristic: broad diversification, thus reducing volatility by combining investments that don’t always move in sync.

Why We Try

BEATING THE STOCK market over the long term is no mean feat. Only a tiny proportion of investors—professional or otherwise—manage to do it. So why do so many people think they can?
Meir Statman, a finance professor at Santa Clara University, cites eight key reasons. In a new monograph titled Behavioral Finance: The Second Generation, he slots these reasons into two broad categories—five cognitive and emotional errors, followed by three expressive and emotional benefits:
1.

Read more »

Seven Paradoxes

“THE INVESTOR’S CHIEF problem—even his worst enemy—is likely himself.” So wrote Benjamin Graham, the father of modern investment analysis.
With these words, written in 1949, Graham acknowledged the reality that investors are human. Though he had written an 800-page book on techniques to analyze stocks and bonds, Graham understood that investing is as much about human psychology as it is about numerical analysis.
In the decades since Graham’s passing, an entire field has emerged at the intersection of psychology and finance.

Read more »

Just in Time

I USED TO THINK anybody could be taught to manage money sensibly. I no longer believe that.
When I was in my 20s and scraping by on a junior reporter’s salary, I had some sense for the financial stress suffered by everyday Americans. But after a handful of years of diligently saving, I was able to escape those daily worries. Many Americans, alas, never do.
This was hammered home when I recently took the financial well-being questionnaire offered by the Consumer Financial Protection Bureau (CFPB).

Read more »

Our To-Do List

I HAVE NEVER broken a New Year’s resolution—because, until this year, I’ve never made one. But now that I’m retired, with time on my hands, I figure my wife and I ought to challenge ourselves with 10 financial resolutions for 2020:

We’ll continually monitor routine spending with the goal of reducing or eliminating at least half-a-dozen expenses this year. That’s one every two months. Phone companies, internet providers and insurers, be warned: Here we come.

Read more »

Magnitude Matters

WHY DON’T WE spend our time and energy on financial issues that have the greatest impact? We’ll drive to a more distant gas station to save 10 cents a gallon, but fail to do all the maintenance needed to extend the life of our car. What lies behind this sort of behavior? The savings from getting the best price per gallon is concrete and immediate, while maintaining our car is long term and abstract.

Read more »

12 Investment Sins

WANT TO IMPROVE your investment results? The deadly sins below are not only among the most serious financial transgressions, but also they’re among the most common. I firmly believe that, if you eradicate these 12 sins from your financial life, you’ll have a better-performing portfolio.
1. Pride: Thinking you can beat the market by picking individual stocks, selecting actively managed funds or timing the market.
Antidote: Humility. By humbly accepting “average” returns through low-cost index funds,

Read more »

Free Newsletter

Numbers

ALMOST 46% of U.S. households own mutual funds, with 63% investing primarily through their employer’s plan, 27% through a financial planner or broker, and 10% buying funds directly, says the Investment Company Institute.

Manifesto

NO. 33: WE HAVE two great financial advantages: time and our income-earning ability. To grow wealthy, we should take a slice of each month’s earnings—and invest it for as much time as possible.

Home Call to Action

Act

DROP UNNECESSARY insurance. If the kids have left home or you have $1 million-plus in savings, you might no longer need life insurance. With a seven-figure portfolio, you could perhaps also drop disability coverage and skip long-term care. Even if you can’t cancel policies, consider raising deductibles and extending elimination periods as your wealth grows.

Truths

NO. 73: MOST TAX deductions will cost you dearly. If you’re able to itemize your deductions and you’re in the 22% income tax bracket, $100 of mortgage interest or medical expenses might save you $22 in taxes, leaving you $78 poorer. A crucial exception: If you contribute $100 to a tax-deductible retirement account, you save the $22, but still retain your $100.

Think

EFFICIENT FRONTIER. What mix of investments offers the highest expected return for a given level of risk—or the lowest risk for a target return? In theory, these optimal portfolios can be found on the so-called efficient frontier. Their key characteristic: broad diversification, thus reducing volatility by combining investments that don’t always move in sync.

Money Guide

Start Here

Fixed vs. Adjustable

MOST FOLKS instinctively opt for a fixed-rate mortgage, where your principal-and-interest payment stays the same every month. But in all likelihood, an adjustable-rate mortgage, or ARM, will be cheaper. ARMs are priced off short-term interest rates, while fixed-rate mortgages are priced off intermediate-term rates—and short-term rates are generally lower than intermediate-term rates. Moreover, when interest rates drop, homeowners with ARMs will likely see their monthly payment fall when their rate next resets. By contrast, for holders of fixed-rate mortgages to benefit from lower rates, they need to go through the hassle and cost of refinancing. Of course, with an ARM, there’s also a risk that the interest rate will increase at the next adjustment date. ARMs often have both periodic and lifetime caps that limit how much the rate can increase. Let’s say an ARM has a two-percentage-point periodic cap, a six-point lifetime cap and a one-year adjustment period. Every year, the rate you’re charged could climb two percentage points, though it can never climb more than six points above your initial rate. Not sure you want to take that much risk? Instead of a pure ARM, many homebuyers take out a 3/1, 5/1, 7/1 or 10/1 hybrid ARM. With these loans, your rate is fixed for the first three, five, seven or 10 years, and then the rate adjusts every year thereafter. At that point, the rate could climb sharply. But there’s also a good chance you might move or refinance within the first five or six years, so you may never feel the bite from the mortgage’s adjustable rate. As you ponder what mortgage to get, give some thought to your job situation. If you have a secure job with a steady paycheck, you might take the risk of an ARM and, fingers crossed, get rewarded with a lower average rate over the course of the mortgage. But if your income fluctuates, you should probably look for predictability in the rest of your financial life, including favoring fixed-rate mortgages. Next: Conforming vs. Not Previous: Mortgages
Read more »

Archive

Private Matters

IN SUMMER 2000, the Art Institute of Chicago fell under the spell of a young hedge fund manager named Conrad Seghers. The allure? Seghers claimed that his funds, called Integral, offered “the highest Sharpe ratios in the industry.” The Sharpe ratio is supposed to measure an investment's risk relative to its returns and is popular in the world of hedge funds. Convinced by this pitch, the Art Institute committed more than $40 million of its endowment to Seghers's funds. A year later, the investments unraveled—and the Art Institute lost 90% of its money. How can you avoid a similar fate? The simple answer: Avoid private investment funds. Still want to try your hand with a private equity, venture capital or hedge fund? I’d recommend an extra dose of due diligence. As a starting point, ask these 10 questions: 1. Who recommended this investment? The Art Institute thought it was employing best practices by hiring an investment consultant to screen prospective hedge funds. What the folks there overlooked was that the consultant had a financial relationship with Integral and received a hefty matchmaking fee. The lesson: If you’re paying experts for advice, be sure there's no one else on the other side also paying them. 2. What’s the fee structure? David Swensen, manager of Yale University’s endowment, cautions that, “Investors in hedge funds face dramatically higher levels of prospective failure due to the materially higher level of fees.” As a result, “generating risk-adjusted excess returns [is] nearly an impossible task.” This is not to say that you should never invest in a private investment fund. Indeed, Swensen invests much of Yale’s assets in private funds. But you should think critically about a fund's ability to overcome its fees and generate healthy performance. 3. What’s behind the fund’s track record? You need to understand how the fund is generating its returns and shouldn’t hesitate to ask questions. If you can’t understand the explanation, don’t invest. Complexity doesn’t necessarily indicate that something is wrong—and, indeed, many perfectly reputable funds pursue highly complex strategies. But if you don’t fully understand the strategy, it means you aren’t in a position to make a determination one way or the other. 4. Does the fund use leverage and, if so, how much? If a fund uses debt, it can amplify your returns, but it also amplifies your risk. A fund’s debt level will give you some indication of how much risk you’re taking—and how badly things could turn out in adverse conditions. 5. Does the fund have a track record through different economic cycles? By the time the Art Institute met Conrad Seghers, he had been in business for just two years. A long track record certainly doesn't guarantee success—but a limited track record makes it harder to know how your investment might perform. 6. What’s in the fine print? In the end, Seghers was convicted of fraud. Still, Integral's investor agreements included disclosures that perhaps the Art Institute should have read more carefully. While probably a stretch, Integral's attorney argued that Seghers "could have bet on the Super Bowl if he wanted." The lesson: Be sure you understand the fund's mandateand that the documents reflect this understanding. Never rely on verbal assurances alone. 7. What do references say? Reputable funds will allow you to speak with both current and former investors. In the case of Seghers's funds, another investor decided it was “hocus pocus” and pulled his money out before the collapse. I suspect he wasn't the only one. If you're looking to make an investment, it's worth making some calls first. 8. Who are the fund's vendors? You should always insist that a fund’s assets be held by a well-known independent custodian and you should insist on a national auditing firm. Pick up the phone and verify these relationships independently. 9. Can you estimate the tax impact? To calculate a fund’s after-tax returns, ask for copies of all past annual K-1 forms. At the same time, ask when K-1s are issued. Private funds have a habit of being late with K-1 forms, causing investors to put their own tax returns on extension. 10. What’s the fund’s liquidity policy? Most funds have lock-up policies that limit your ability to withdraw funds on demand. This might prevent you from withdrawing money for some months. Adam M. Grossman’s previous articles include Don't OverthinkB Is for Bias and Humble Arithmetic. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.
Read more »