(June 25, 2009) Following a bear market of an intensity not seen since the 1930s, investors wonder if everything they knew about investing should be tossed aside. While the current economic crisis and uncertainty has us all rethinking strategy, no matter your conclusions don't make these financial errors:Â
1. Holding Too Much Cash
Don't invest long term money in short term assets. Why pay for immediate liquidity and zero volatility if you don't need it? Sure, keep enough cash to carry yourself for three to six months. But now, in the Government's effort to push people out of their cash holdings, it's lowered yields on cash and the like to such ridiculously low levels that the cost of hiding in it has rarely been greater.Â
Consider: The average money market fund now yields just 0.18 percent. That means you're getting just 1/18 of the average yield on the stocks in the Dow. But, stocks are too risky you say? Because of the yield curve's current steepness, coupled with the general sentiment that if it has no Government guarantee it's not to be trusted, you get a return nearly 20 times better with even a conservative bond fund like Fidelity's U.S. Bond Index Fund, now yielding 3.56 percent.Â
Hate to pay taxes? You'll make nearly 12 times more with Fidelity's Short-Intermediate Municipal Income Fund, yielding 2.15 percent. Bottom line: Don't let the current financial crisis blind you to the high costs of hiding long term money in cash.
2. Failing To Diversify
Failing to diversify could be your most expensive mistake. Few dispute the risk of an excessively concentrated position; after all, a 45 percent decline in something that's 10 percent of your nest egg is more devastating than losing everything on four 1 percent positions. Still, some don't diversify. For example, you may hold too much of your employer's stock, thinking this is different because you work(ed) there and know the situation better. However, when you see the CEOs of major financial institutions such as AIG, Citigroup, and similar so clueless, be humble about your ability to assess the company's health from your cubicle.Â
Taxes are also a convenient excuse, until you consider that paying taxes on 20 percent of your profits is always less than losing 20 percent of your entire investment. A 20 percent move in a stock in less than an hour is not unusual.
Some make the mistake unwittingly. Planning on renovating your kitchen to make your home more saleable? That's like adding more shares to your largest stock position, as normally your home is your most valuable asset. A turndown in the neighborhood, a fire, all sorts of things could put the kibosh on your largest position, making you wish you were more diversified.
But, don't be over diversified:Â Holding 12 mutual funds, which in turn hold perhaps 500 positions each, is wasteful and expensive. If you can't focus, turn to a cheaper indexed product.
3. Overlooking Tax Exempt Fixed Income
Never forget the old saw, it's not what you make, it's what you make after taxes. Yet, when investors seek shelter from volatile investment markets, or want to set aside something for that upcoming big ticket item, or simply need to accumulate cash to pay future bills, they reflexively turn to Treasuries, CDs, or taxable money market accounts. However, there are few who wouldn't come out ahead using tax free fixed income.
Do the math. Divide the tax exempt yield by one minus your marginal tax rate, in other words how much you would pay in taxes if you earned one more dollar. For many, that's 35 percent Federal taxes, and 5 to10 percent more in state taxes. That makes the aforementioned Fidelity Short-Intermediate Municipal Income Fund's tax equivalent yield 3.3 percent, assuming you are just paying Federal taxes.Â
Or, consider a tax exempt fund focusing on your state's debt. Fidelity's NJ Municipal Income Fund yields 3.59 percent. Assuming you're going to pay 5 percent net in NJ taxes plus 35 percent Federal taxes, divide that fund's yield by 0.6 and you get a tax equivalent yield of just under 6 percent. You just aren't going to get that with taxable high quality investments. Nor is there anything about the massive government deficits being generated that suggests tax rates have anywhere to go but up.
4. Chasing Investment Results
When a company or sector is doing well, it's human nature to want in. The problem is success and stock market returns are cyclical. By the time the average investor has heard about a hot investment its price has usually been bid up to reflect the good news, making future gains no sure thing.
Examples are legion: The internet and the digital evolution are unparalleled advances. So, why did those investing in the Nasdaq nine years ago lose two thirds? You just can't pay 100 times earnings and expect to make a profit.Â
The story is much the same with this decade's real estate craze or last year's energy investments frenzy. Investors who chased these investments have little to show for it, not because homes and oil aren't valuable assets, but because chasing the hype caused them to pay too much.
While many will avoid chasing individual stocks, they may still chase mutual fund returns. But a hot mutual fund is simply a collection of hot stocks. If you really want to buy low and reduce risk, find the fund with the cool stocks.Â
The bottom line is to be extremely cautious when the media and fellow investors start boasting about particular investments. It's late in the game. Invest instead in companies and sectors that make sense over the long haul but are out of favor now. Current examples might include financial companies and drug companies.Â
5. Trading Too Much
One of the pioneers of index investing, John Bogle, has pointed out that the average mutual fund underperforms the market, as measured by the S&P, while the average fund investor underperforms his fund's actual returns. For example, during the period of 1984 to 2002, the S&P 500 returned on average 12.2 percent annually, mutual funds scored a 9.3 percent annual return, while mutual fund investors earned a measly 2.6 percent annually. Why?
There's a whole host of reasons, but one thing that sets an index apart from the funds and individuals is that the index is virtually a static portfolio. The index never reads the paper that morning and dumps a stock or chases one. It does not worry about how the portfolio looks to a spouse or a client. It does not try to time stocks or the market.
Consequently, to improve your returns do what the indexes do, which is trading rarely. Stay the course, and don't try to outsmart the markets; it's very difficult to do.
6. Analyzing Investments Without Considering The Price
You don't order the best wine without checking its price, do you? You don't bet on the best football team without checking the point spread, right? Of course not. So, you can't just invest in the company with the reputed best technology, greatest service, smartest management, or hottest marketing campaign without checking out its price.
If a particular investment seems like a sure thing, is attracting all the buzz, seems to be the market's favorite, or hawks the latest must have thing, that's a red flag. It may well be overpriced and an investment that you should avoid, at least until the price drops.
As Warren Buffett says, you pay a very dear price for a cheery outlook. Continued good news won't boost the investment's value as much as a misstep may hurt it. So, it may well be a poorly skewed risk/reward situation.
Conversely, a company or economic sector under pressure may offer attractive odds. Continued tough sledding may have little affect, as low expectations are already priced in, while the least bit of good news may have a disproportionate salutary effect.
In any event, commit not to part with your hard earned investment dollars without considering the price you'd be paying.
7. Focusing Too Much On What You Paid For An Investment
It's human nature to compare your investment's value to what you paid for it. That's fine in judging the wisdom or luck of that purchase. What isn't fine is using that to decide whether you should continue to hold.
For some, if you've made a profit, it's time to sell, while for others if you're down, say 20 percent, it means you should sell. The fact is, neither the stock nor a potential buyer knows nor cares what you paid. The stock's going in one direction, despite the fact that some bought lower, some higher. Analyze without regard to what you paid; don't look back when trying to look forward.Â
8. Chasing Yield
An above normal yield may signal an undervalued investment. But, if the dividend is unsustainable because the company's unable to generate sufficient cash, its investors have big problems. The only thing worse than a non dividend paying company is a high dividend payer that eliminates its payout.
Recent history shows the perils of blind allegiance to big dividends. Consider iShares Dow Jones Select Dividend Index (DVY), an exchange traded fund whose mandate is to invest in the 100 stocks with the highest dividend yields. Even though it screens out some very distressed stocks, it has still woefully underperformed, returning negative 14.18 percent annually for the last three years, which is not only painful but a full 5.64 percent per year less than the S&P 500. Year to date, DVY has dropped 14 percent, a whopping 14.2 percent worse than the S&P. True, nearly 40 percent of its stocks were financials, but it does not detract from the message that willy nilly piling into high yielders is a mistake.
Bottom line:Â A high yield does not trump proper diversification and a thorough review of the cash generating ability of the company making the payouts.
9. Failing To Use Tax-Sheltered Accounts
Many investors get so hung up on the tax details of IRA type accounts that they fail to appreciate their real usefulness: As lock tight piggy banks. The number one problem keeping the average family from their investment goals is not the investments selected, but the fact that they are not saving enough. Even when they do save they often withdraw their savings prematurely. However, if the assets are in an IRA, 401K, or similar account, that ability to dip into the cookie jar is either unavailable or comes with sufficiently onerous terms, like extra taxes and penalties, that the impulse is quelled.
Tax sheltered accounts are complicated. The fact is, because no one has a crystal ball as to the exact type of tax regime we'll live in, in the future, or even be sure what tax jurisdiction you'll be subject to, the endless debates as to what offers the best tax advantages can never be concluded. Instead, accept the tax uncertainty and embrace these accounts for what they are: Enforced discipline to save and then not touch the savings.
Best Regards,
David G. Dietze,
JD, CFA, CFPT
President and Chief Investment Strategist
Point View Financial Services, Inc.
Summit, NJ
1. Holding Too Much Cash
Don't invest long term money in short term assets. Why pay for immediate liquidity and zero volatility if you don't need it? Sure, keep enough cash to carry yourself for three to six months. But now, in the Government's effort to push people out of their cash holdings, it's lowered yields on cash and the like to such ridiculously low levels that the cost of hiding in it has rarely been greater.Â
Consider: The average money market fund now yields just 0.18 percent. That means you're getting just 1/18 of the average yield on the stocks in the Dow. But, stocks are too risky you say? Because of the yield curve's current steepness, coupled with the general sentiment that if it has no Government guarantee it's not to be trusted, you get a return nearly 20 times better with even a conservative bond fund like Fidelity's U.S. Bond Index Fund, now yielding 3.56 percent.Â
Hate to pay taxes? You'll make nearly 12 times more with Fidelity's Short-Intermediate Municipal Income Fund, yielding 2.15 percent. Bottom line: Don't let the current financial crisis blind you to the high costs of hiding long term money in cash.
2. Failing To Diversify
Failing to diversify could be your most expensive mistake. Few dispute the risk of an excessively concentrated position; after all, a 45 percent decline in something that's 10 percent of your nest egg is more devastating than losing everything on four 1 percent positions. Still, some don't diversify. For example, you may hold too much of your employer's stock, thinking this is different because you work(ed) there and know the situation better. However, when you see the CEOs of major financial institutions such as AIG, Citigroup, and similar so clueless, be humble about your ability to assess the company's health from your cubicle.Â
Taxes are also a convenient excuse, until you consider that paying taxes on 20 percent of your profits is always less than losing 20 percent of your entire investment. A 20 percent move in a stock in less than an hour is not unusual.
Some make the mistake unwittingly. Planning on renovating your kitchen to make your home more saleable? That's like adding more shares to your largest stock position, as normally your home is your most valuable asset. A turndown in the neighborhood, a fire, all sorts of things could put the kibosh on your largest position, making you wish you were more diversified.
But, don't be over diversified:Â Holding 12 mutual funds, which in turn hold perhaps 500 positions each, is wasteful and expensive. If you can't focus, turn to a cheaper indexed product.
3. Overlooking Tax Exempt Fixed Income
Never forget the old saw, it's not what you make, it's what you make after taxes. Yet, when investors seek shelter from volatile investment markets, or want to set aside something for that upcoming big ticket item, or simply need to accumulate cash to pay future bills, they reflexively turn to Treasuries, CDs, or taxable money market accounts. However, there are few who wouldn't come out ahead using tax free fixed income.
Do the math. Divide the tax exempt yield by one minus your marginal tax rate, in other words how much you would pay in taxes if you earned one more dollar. For many, that's 35 percent Federal taxes, and 5 to10 percent more in state taxes. That makes the aforementioned Fidelity Short-Intermediate Municipal Income Fund's tax equivalent yield 3.3 percent, assuming you are just paying Federal taxes.Â
Or, consider a tax exempt fund focusing on your state's debt. Fidelity's NJ Municipal Income Fund yields 3.59 percent. Assuming you're going to pay 5 percent net in NJ taxes plus 35 percent Federal taxes, divide that fund's yield by 0.6 and you get a tax equivalent yield of just under 6 percent. You just aren't going to get that with taxable high quality investments. Nor is there anything about the massive government deficits being generated that suggests tax rates have anywhere to go but up.
4. Chasing Investment Results
When a company or sector is doing well, it's human nature to want in. The problem is success and stock market returns are cyclical. By the time the average investor has heard about a hot investment its price has usually been bid up to reflect the good news, making future gains no sure thing.
Examples are legion: The internet and the digital evolution are unparalleled advances. So, why did those investing in the Nasdaq nine years ago lose two thirds? You just can't pay 100 times earnings and expect to make a profit.Â
The story is much the same with this decade's real estate craze or last year's energy investments frenzy. Investors who chased these investments have little to show for it, not because homes and oil aren't valuable assets, but because chasing the hype caused them to pay too much.
While many will avoid chasing individual stocks, they may still chase mutual fund returns. But a hot mutual fund is simply a collection of hot stocks. If you really want to buy low and reduce risk, find the fund with the cool stocks.Â
The bottom line is to be extremely cautious when the media and fellow investors start boasting about particular investments. It's late in the game. Invest instead in companies and sectors that make sense over the long haul but are out of favor now. Current examples might include financial companies and drug companies.Â
5. Trading Too Much
One of the pioneers of index investing, John Bogle, has pointed out that the average mutual fund underperforms the market, as measured by the S&P, while the average fund investor underperforms his fund's actual returns. For example, during the period of 1984 to 2002, the S&P 500 returned on average 12.2 percent annually, mutual funds scored a 9.3 percent annual return, while mutual fund investors earned a measly 2.6 percent annually. Why?
There's a whole host of reasons, but one thing that sets an index apart from the funds and individuals is that the index is virtually a static portfolio. The index never reads the paper that morning and dumps a stock or chases one. It does not worry about how the portfolio looks to a spouse or a client. It does not try to time stocks or the market.
Consequently, to improve your returns do what the indexes do, which is trading rarely. Stay the course, and don't try to outsmart the markets; it's very difficult to do.
6. Analyzing Investments Without Considering The Price
You don't order the best wine without checking its price, do you? You don't bet on the best football team without checking the point spread, right? Of course not. So, you can't just invest in the company with the reputed best technology, greatest service, smartest management, or hottest marketing campaign without checking out its price.
If a particular investment seems like a sure thing, is attracting all the buzz, seems to be the market's favorite, or hawks the latest must have thing, that's a red flag. It may well be overpriced and an investment that you should avoid, at least until the price drops.
As Warren Buffett says, you pay a very dear price for a cheery outlook. Continued good news won't boost the investment's value as much as a misstep may hurt it. So, it may well be a poorly skewed risk/reward situation.
Conversely, a company or economic sector under pressure may offer attractive odds. Continued tough sledding may have little affect, as low expectations are already priced in, while the least bit of good news may have a disproportionate salutary effect.
In any event, commit not to part with your hard earned investment dollars without considering the price you'd be paying.
7. Focusing Too Much On What You Paid For An Investment
It's human nature to compare your investment's value to what you paid for it. That's fine in judging the wisdom or luck of that purchase. What isn't fine is using that to decide whether you should continue to hold.
For some, if you've made a profit, it's time to sell, while for others if you're down, say 20 percent, it means you should sell. The fact is, neither the stock nor a potential buyer knows nor cares what you paid. The stock's going in one direction, despite the fact that some bought lower, some higher. Analyze without regard to what you paid; don't look back when trying to look forward.Â
8. Chasing Yield
An above normal yield may signal an undervalued investment. But, if the dividend is unsustainable because the company's unable to generate sufficient cash, its investors have big problems. The only thing worse than a non dividend paying company is a high dividend payer that eliminates its payout.
Recent history shows the perils of blind allegiance to big dividends. Consider iShares Dow Jones Select Dividend Index (DVY), an exchange traded fund whose mandate is to invest in the 100 stocks with the highest dividend yields. Even though it screens out some very distressed stocks, it has still woefully underperformed, returning negative 14.18 percent annually for the last three years, which is not only painful but a full 5.64 percent per year less than the S&P 500. Year to date, DVY has dropped 14 percent, a whopping 14.2 percent worse than the S&P. True, nearly 40 percent of its stocks were financials, but it does not detract from the message that willy nilly piling into high yielders is a mistake.
Bottom line:Â A high yield does not trump proper diversification and a thorough review of the cash generating ability of the company making the payouts.
9. Failing To Use Tax-Sheltered Accounts
Many investors get so hung up on the tax details of IRA type accounts that they fail to appreciate their real usefulness: As lock tight piggy banks. The number one problem keeping the average family from their investment goals is not the investments selected, but the fact that they are not saving enough. Even when they do save they often withdraw their savings prematurely. However, if the assets are in an IRA, 401K, or similar account, that ability to dip into the cookie jar is either unavailable or comes with sufficiently onerous terms, like extra taxes and penalties, that the impulse is quelled.
Tax sheltered accounts are complicated. The fact is, because no one has a crystal ball as to the exact type of tax regime we'll live in, in the future, or even be sure what tax jurisdiction you'll be subject to, the endless debates as to what offers the best tax advantages can never be concluded. Instead, accept the tax uncertainty and embrace these accounts for what they are: Enforced discipline to save and then not touch the savings.
Best Regards,
David G. Dietze,
JD, CFA, CFPT
President and Chief Investment Strategist
Point View Financial Services, Inc.
Summit, NJ
