Even the very rich and powerful can get bad advice

August 18, 2016

Dear Friends,

My recent MarketWatch article, “7 Warren Buffet investment tips that could hurt regular investors,” elicited an interesting comment from one of our readers, to which I share my reply. I’d love to hear your thoughts.

Roger writes, “I totally agree with you. His (Warren Buffet’s) belief that investing 90% in the S&P 500 and 10% in a short-term bond fund equate to a complete and well-diversified portfolio doesn’t pass a common sense test. Without getting into politics, I recently learned that the only investment Hillary Clinton appears to own is the Vanguard S&P 500, so she must be following his poor advice. She would be much better off if she used one of your model portfolios and used the S&P 500 index only as a core holding, or small piece of the pie. At least add some small cap value, etc. Anyway, Keep up the good work Paul, investors are listening.”

Thanks, Roger. Wouldn’t it be great if I could do something to help Hillary Clinton? And, as I am trying to help all investors – regardless of religion, national origin, race, color, sex or financial status – I suspect Donald Trump could use the same help too. Of course my advice is considered of little value to most people because it’s free. Yes, there are those who believe, “You get what you pay for.” That’s how many investors justify paying for load funds that almost always have high expenses. I’m sure these investors truly believe that paying more will make them more money.

According to one cnn.com article, Trump has 49% of his liquid investments in hedge funds. The article notes that some of the hedge funds he owns have not done well lately. In fact, Trump is not the only one holding the hedge fund bag recently. Here is what the article notes about recent hedge fund performance: “Hedge funds just aren’t crushing it on returns any more. A barometer of hedge fund performance, called the HFRI Fund Weighted Composite Index, has generated an annualized gain of just 1.7% over the past five years. Compared to that, the S&P 500’s average annualized return for the same period was 11%.”

Hedge funds aren’t for many people. In fact, most of them require a net worth of at least $1.5 million. They are generally more risky and not appropriate for most investors. There is a wonderful quote from Mark Twain that expresses my feeling about such investments: “There are two times in a man’s life when he should not speculate: when he can’t afford it, and when he can.”

But when we have over-saved, I guess it’s okay to take higher risk; but investors in that position rarely need the added risk. For full disclosure, my old firm started a hedge fund in 1995. Since its inception the fund has grown 1390% compared to 546% for the S&P 500, 498% for the Russell 2000 and 163% for the EAFE Index. All of these returns are based on reinvestment of dividends and capital gains, as well as net of all management fees.

In a few weeks I will be addressing a group of employees who work for any of the 100 non-profits on Bainbridge Island, where I live. The presentation is entitled, “How to Retire on a Nonprofit Employee’s Salary.”  It isn’t easy for people who work for lower wages than they might receive in profit-driven companies. The lower income puts financial pressure on all parts of their life. I don’t know how to help them save a lot more money than they are saving now, but I do know how to help them invest more efficiently so their money will work harder. They may not become multi-millionaires but I think I can show them how to get a better return on their mutual fund investments than either Hillary or Donald.

Questions & Answers

Below please find five Q&A’s from the “Ask Me Anything” that I do monthly at Scutify.com. Click here to read all the Q&As from the August session. The next Q&A session will be September 21 at 1 p.m. EST. You can leave your questions anytime, or tune-in for the Live Chat by clicking here.

To your success,

Q: What newsletters have been shown over the last couple of decades to give above-average market returns? I understand that the most important lesson from the Hulbert Financial Digest is that index funds seem to be the way to go for the majority of investors. However, in addition to the newsletters you mentioned that focus on index funds and have had good returns, I’d appreciate knowing about others.

A: There are newsletters that did well based on buying dividend-based blue chip stocks, utilities,value companies and buy backs. Check out The Investment Reporter, The Prudent Speculator (value and leverage), The Turnaround Letter, and Investment Quality Trends. In almost every case there were times (over the last 15 years) that these letter performed well, and times they struggled.

Q: What are your thoughts on selling options (calls and puts) for income? I don’t know much about them yet, but I have been hearing many people do it for consistent income. Can this be a small part of someone’s portfolio? What is the best way to approach this/learn about it? Any trusted sources?

A: I think the best source to understand alternative investments is Larry Swedroe. I suggest you read his book on alternative investments, The Only Guide to Alternative Investments You’ll Ever Need: The Good, the Flawed, the Bad, and the Ugly. If you’re looking for a sense of what Larry says about covered calls, read this article. The good news is Larry considers covered calls flawed, but not bad or ugly.

Q: What do you think of AMD?

A: Sorry, I don’t evaluate individual securities, only asset classes and the funds and ETFs to access those asset classes. Why don’t I recommend individual stocks? The expected rate of return for any individual company is the same as the average of all the stocks in the same asset class. Of course, investors who own individual stocks expect them to do better than the market. Why? Because they own them. I found out early in my investing career (about 50 years ago), that my ownership of a stock had nothing to do with the success or failure of the company. Investing in all of the stocks in an asset class guarantees me the return of that asset class and there are lots of asset classes that have a history of making 12% or more long term.

Q: Do you think we should be extra cautious at this time and just wait for the next bear market since it is long overdue? I know prediction is futile, but I’m just trying to use common sense. We have been in a raging bull market for the last seven years. I want to continue putting a lot of money in equities for long-term growth, since I am young, but…

A: Yours is the “$64,000 question” in the investment process. Here’s what Wikipedia says about the beginnings of the $64,000 question: During the 1940s, “That’s the $64 question” became a common catchphrase for a particularly difficult question or problem. In 1955, the TV show, ‘The $64,000 Question’ became one of the most popular shows on TV. If you inflation adjust $64,000 from 1955 to 2015, it becomes “The $550,000 Question!”

When you invest on a buy-and-hold basis, you have to know yourself well enough to know if you really can continue to buy-and-hold no matter what happens. Your desire to hold back while the market is “too high” is natural. If you do that and you are right, then you can put your hard earned money to work at lower prices. Obviously, if you are right it could pay huge returns over your lifetime. If you are wrong, 2 things are likely to happen. One, you will forget about it over the long term. And two, you will have to work a little longer to meet your goals. That shouldn’t be a problem because you love your work and another year or two until retirement is no problem… now!

The decision you are struggling with is the choice between buy-and-hold and market timing. You have no idea which is best, but I believe very few investors will do well with timing as it is so counterintuitive and tends to be difficult for investors to deal with emotionally.

I have faced exactly the same challenge and solved it in a way that many of my old clients found greater peace of mind, particularly those close to, or in retirement. I have half of my investments managed with buy-and-hold and the other half with market timing. The buy and hold portion is 50/50 (equities and fixed income) and the timing is 70/30. It turns out the returns and standard deviation is about the same for both strategies.

Could you do something similar? Maybe you can cut by half your monthly commitment to adding new 401k investments to equities. Put that money aside until the market has made the correction you expect, and then make the investment. If you are right, you were rewarded. If you are wrong you have to decide if that was just a fluke and next time you will be right.

Q: What are your thoughts on historically low interest rates and the 30 year bond bull market? What precautions should we take? Won’t holding bonds in the coming years hurt our returns since prices will likely drop when rates increase?

A: As I advocate a buy-and-hold approach to both stocks and bonds, my recommendations for bonds (bond funds and ETFs) are short to intermediate term. Please take a look at the Fine Tuning Your Asset Allocation Table.

The column on the far left is 100% U.S. Government Intermediate Bonds. This 46-year period had long periods of rising interest rates, as well as a long period of falling interest rates. What I would like you to focus on are the calendar year losses of the 100% bond asset class. Also I think it’s helpful to look at the worst 36 and 60 month periods. While you are there, I think it’s worthwhile to review the similar periods of loss with the all-equity portfolio. As you can see, the risk in equities is many times that of bonds.


How to use time to potentially double your retirement income in five years

Today’s column is a slight update to a piece I wrote many years ago that was one of the most popular columns I have written for MarketWatch.






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Paul Merriman  | http://www.paulmerriman.com

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