Tag Archives: stocks

Timeless Financial Tips #5: Trust the Evidence

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Evidence-Based Investing – Your Best Chance to Hit Your Long-Term Investment Goals

By Steve Lowrie, CFA

Special to Financial Independence Hub

If I could, I would grant amazing investment returns to every investor across every market. Unfortunately, that’s just not how it works. In real life, we must aim toward our financial ideals, knowing we won’t hit the bullseye every time.

That’s why I recommend evidence-based investing: or investing according to our best understanding of how markets have actually delivered available returns over time, versus how we wish they would. Our “best understanding” may still be imperfect, but it sure beats ignoring reality entirely.

Luck-Based Investing and Random Returns

Many investors try to pick and choose when and how to invest based on what they or others are predicting will happen next. All evidence suggests their success or failure will be driven far more by luck than skill. Worse, going down this path, there is a very high probability they’ll end up with worse results versus a properly structured “buy and hold” approach.

Some deliberately embrace this approach, hoping to “beat” the market. Others come to it accidentally, by reacting to financial behavioural biases such as panic-selling or spree-buying. Either way, these sorts of investment portfolios typically devolve into a disheartening assortment of holdings over time, offering little sense of where you stand in relation to your own goals or overall market performance. The odds stack steeply against your achieving any carefully planned outcome: provided you had one to begin with.

Evidence-Based Investing and Portfolio Planning

In contrast, evidence-based investors adhere to decades and volumes of time-tested, peer-reviewed analysis by academics and practitioners alike. In aggregate, we seek to answer an essential investment challenge:

How can an investor increase the probability they’ll capture the highest expected market returns, given the levels of investment risk they’re willing to accept?

The answers point to a two-step strategy:

1. Build It. Prepare your personal portfolio:

  • Allocate your investments between broad asset classes.
  • Widely diversify your bonds and equities to reduce the unnecessary risks inherent to individual bond or stock picks.
  • Tilt your overall portfolio toward factors with higher expected returns, according to your personal financial goals and risk tolerances.

2. Keep It. Sit tight with your carefully constructed portfolio for the long term, to ensure you capture the expected long-term growth from your various market allocations. So, stay invested through thick and thin and set aside enough cash reserves to cover upcoming spending needs.

At the risk of repeating ourselves (which is, after all, the theme of this “Play It Again, Steve” financial tips blog series), evidence-based investing translates into building and maintaining a portfolio that looks something like this:

three key portfolio construction decisions

Keeping It: The Hardest Thing

It’s one thing to build an ideal portfolio. It’s another to keep it in balance as intended. In fact, thanks to our behavioural biases, I would argue it’s the hardest part.

For example, what will you do after the stock market has been surging, and your 60%/40% stock/bond allocations end up being closer to 70%/ 30%.? You’ll probably want to let your overweight allocation to high-flying stocks ride, hoping to score even more. That’s because recency and other behavioural biases trick us into believing the party will never end. However, the more prudent, evidence-based move is to sell some of your equity allocations (selling high) and use the proceeds to buy more humdrum fixed income (buying low), until you’re back to your original 60%/40% mix. Continue Reading…

A Failure to understand Rebalancing

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By Michael J. Wiener

Special to the Financial Independence Hub

Recently, the Stingy Investor pointed to an article whose title caught my eye: The Academic Failure to Understand Rebalancing, written by mathematician and economist Michael Edesess.  He claims that academics get portfolio rebalancing all wrong, and that there’s more money to be made by not rebalancing.  Fortunately, his arguments are clear enough that it’s easy to see where his reasoning goes wrong.

 

Edesess’ argument

Edesess makes his case against portfolio rebalancing based on a simple hypothetical investment: either your money doubles or gets cut in half based on a coin flip.  If you let a dollar ride through 20 iterations of this investment, it could get cut in half as many as 20 times, or it could double as many as 20 times.  If you get exactly 10 heads and 10 tails, the doublings and halvings cancel and you’ll be left with just your original dollar.

The optimum way to use this investment based on the mathematics behind rebalancing and the Kelly criterion is to wager 50 cents and hold back the other 50 cents.  So, after a single coin flip, you’ll either gain 50 cents or lose 25 cents.  After 20 flips of wagering half your money each time, if you get 10 heads and 10 tails, you’ll be left with $3.25.  This is a big improvement over just getting back your original dollar when you bet the whole amount on each flip in this 10 heads and 10 tails scenario.  This is the advantage rebalancing gives you.

However, Edesess digs further.  If you wager everything each flip and get 11 good flips and 9 bad flips, you’ll have $4, and with the reverse outcome you’ll have 25 cents.  Either you gain $3 or lose only 75 cents.  At 12 good flips vs. 12 bad flips, the difference grows further to gaining $15 or losing 94 cents.  We see that the upside is substantially larger than the downside.

Let’s refer to one set of 20 flips starting with one dollar as a “game.”  We could think of playing this game multiple times, each time starting by wagering a single dollar.  Edesess calculates that “if you were to play the game 1,001 times, you would end up with $87,000 with the 100% buy-and-hold strategy,”  “but only $11,000 with the rebalancing strategy.”

The problem with this reasoning

Edesess’ calculations are correct.  If you play this game thousands of times, you’re virtually certain to come out far ahead by letting your money ride instead of risking only half on each flip.  However, this is only true if you start each game with a fresh dollar. Continue Reading…

Inverted Yield Curves & Recession: How smart are Markets?

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Image Outcome/Creative Commons

By Noah Solomon

Special to Financial Independence Hub

Today’s Special: An Inverted Yield Curve with a Side Order of (Possible) Recession

In our discussions with clients over the past several months, the two frequent topics of conversation have been:

  1. The inversion of the U.S. Treasury curve, and
  2. The possibility of a recession occurring within the next few quarters.

In the following missive, I use a data-based, historical approach to explore the possible investment implications of these concerns.

How Smart is the Yield Curve?

The U.S. Treasury market has an impressive track record in terms of forecasting recessions. Going back to the late 1980s, every time the yield on 10-year U.S. Treasury bonds has remained below that of its two-year counterpart for at least six months, a recession has followed. Such was the case with the recession of the early 1990s, of the early 2000s, and of the global financial crisis.

When it comes to investing (as with many things), timing is critical. Given that yield curves do occasionally invert and that recessions do happen from time to time, it follows that every recession has been preceded by an inverted curve, and vice-versa. What makes the historical prescience of inverted yield curves so impressive is that the recessions which followed them did so within a relatively short period.

United States – Months from Yield Curve Inversion to Onset of Recession: 1989-Present

The table above covers the past three U.S. recessions, excluding the Covid-induced contraction of 2020, which I have omitted since it had nothing to do with macroeconomic factors, monetary policy, etc. As the table demonstrates, the time lag between yield curve inversions and economic contractions has ranged between 12 and 18 months, with an average of 15 months.

However, the yield curve’s impeccable record of predicting recessions has not been matched by its market timing abilities. As summarized in the following table, the S&P 500 Index has produced mixed results following past inversions in the Treasury curve.

S&P 500 Performance Following Yield Curve Inversions: 1989-Present

When the Treasury curve inverted at the beginning of 1989, stocks proceeded to perform well, returning 24.1% over the following two years. Conversely, when the curve became inverted in March 2000, the S&P 500 fared poorly, losing 21.5% over the same timeframe. The index suffered a similarly undesirable fate following the Treasury curve inversion in September 2006, when stocks suffered a two-year decline of 9.1%.

How Smart is the Stock Market?

In the past, the economy and equity markets have not been correlated. Stock prices are forward looking. Historically, equities have started to decline prior to peaks in economic growth and have tended to rebound in advance of economic recoveries.

The trillion-dollar question is not whether the market is smart, but whether it is smart enough. Do prices bake in a sufficient amount of bad news ahead of time so that they avoid further losses following the onset of recessions? Or do they lack sufficient pessimism to avoid this fate? Frustratingly, the answer depends on the recession!

S&P 500 Performance Following Start of Recessions: 1990-Present

Stocks managed to skate through the recession of the early 1990s unscathed. Following the peak of the economy in mid-1990, the S&P 500 Index went on to produce a total return of 27.2% over the next two years. Unfortunately, investors were not so lucky during the recession of the early 2000s, with stocks losing 24.6% in the two years after the recession began. Similarly, the recession of 2008 was no walk in the park for markets, with the S&P 500 falling 20.3% after the economy began contracting at the end of 2007. Continue Reading…

Surviving a “Bear Scare” in or just before Retirement

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Image Leonard Dahmen/Pexels

Billy Kaderli, RetireEarlyLifestyle.com

Special to Financial Independence Hub

It’s everyone’s nightmare: watching retirement assets vanish in a bear market, especially in or just before retirement.

Many of you will remember the severe market downturn of 2000-2002, the Dot Com Bubble, when the Standard & Poor’s 500 Index fell 37%.

We’d be lying to say that this declining market didn’t affect us. Our finances dropped about the same as most others on a percentage basis. As retirees, with no regular paycheck coming in on Friday, this event could have spelled disaster for our future plans of maintaining our financial independence.

Then there was the 2007-2009 “Great Recession,” where the market fell by almost 50% lasting 17 months, testing our courage.

The 2020 Covid scare shook the market’s foundation, earning the title of the “shortest bear market” in the S&P 500 history, lasting only 33 days.

And now here we are again in 2023, where the market is in the grip of a bear. How much longer will this last? How low will we go?

What should we do? How do we cope?

First, we’ve learned from past bear markets the importance of some cash flow. Having aged a bit and now receiving Social Security we have adjusted our portfolio to a more balanced one adding DVY, iShares Select Dividend ETF as a dividend-producing asset as well as increasing our cash holdings.

Then, there are regular chats about our finances and the state they are in, in hopes of averting a possible worst-case meltdown. We have discussed the fiscal facts and tried to extrapolate them out into the future.

One obvious problem: No one can predict the future.

Friend asks “Billy, why are you investing now? You know the market is crashing, right?” Same friend 10 years later: “Hey Billy I heard you retired early. How did you do that?”

Using history as a guide

Researching bear markets, we take heart from the knowledge that past downturns always ended.

Retiring is definitely easier when markets are rising as compared to when they are falling. But how do you know if you are in a rising or falling market? That depends on your starting point and there has been no 20-year rolling negative returns.

Another question to ask – is this is a good time to buy equities? For every buyer there is a seller and they both think they are right. Maybe the cure for cancer will be announced tomorrow or the global economy will collapse. We just don’t know.

That’s the point. Continue Reading…

How 12 Business Leaders invest to Grow their Income

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From getting over the fear of starting to looking into REITs, here are 12 answers to the question, “Can you share your most recommended tips for how you can invest your money to grow your wealth and increase your income, specifically for financial independence through investing?” 

  • Get Started Right Now 
  • Maximize Tax-advantaged Investments
  • Avoid Trying to Time the Market
  • Remember Diversification is More Important Than You Think
  • Put Your Tax Refunds to work
  • Create a High-Yield Savings Account
  • Think of the Market as a Game
  • Prioritize Risk Management Over Chasing High Returns
  • Be Patient and Plan
  • Raise Your Savings Rate by 5% Each Year
  • Repay High-interest Debt
  • Try REIT Index Funds 

Get Started Right Now 

Investing is one of those things that seems like an insurmountable barrier to entry for many people. How can I invest when I don’t have thousands of dollars just kicking around is a common attitude I’ve come across, and in my opinion, it is one of the biggest mistakes toward actually growing your wealth and becoming financially independent. 

The thing is that you actually have to get started: even if it’s a few dollars at a time invested in penny stocks, you’ve got to make a start. Even if the amounts are negligible, you’re gaining invaluable experience in financial markets and financial literacy that will pay massive dividends down the line. — Dragos Badea, CEO, Yarooms

Maximize Tax-advantaged Investments

Both IRAs and 401(k)s have tax advantages [and the equivalent RRSPs and group RRSPs in Canada: editor]. You can choose to deduct your contributions from your taxes or contribute after taxes and avoid taxes when you withdraw during retirement. 

IRAs and 401(k)s are easy to set up. A 401(k) is offered through employers, so if your workplace offers one and matches a percentage of your contributions, take advantage of that matching benefit.

Anyone can start an IRA. You can open an account online today with Fidelity or another firm. Many people assume it’s hard to set up, but it’s not. You can do it in half an hour. 

With both options, you can set up automatic withdrawals from your paycheck. That option helps you succeed in saving because you don’t have to think about it. — Michelle Robbins, Licensed Insurance Agent, Clearsurance.com

Avoid trying to Time the Market

Almost 80% of active fund managers fall behind the major index funds. 

So if these financial professionals can’t beat the market, what chance do ordinary people like you and me have? 

This is why my best investing tip is consistently putting money into an index fund like the S&P 500 without trying to time the market. 

By putting a portion of your salary into an index fund every month for decades, your investments compound, allowing you to build unimaginable amounts of wealth. 

For example, if you put just $300 a month into an index fund growing 8% annually, you’ll have over one million dollars after 40 years. — Scott Lieberman, Owner, Touchdown Money

Remember Diversification is more Important than you Think

Portfolio diversification is a powerful tool that can help protect your investments against large losses due to market downturns. By selecting assets with low correlation, you are essentially increasing the safety of your portfolio while pursuing rewards. This strategy has become indispensable for individual investors and financial advisors alike: after all, who wouldn’t want some extra security for their hard-earned money?

If you split them between two different companies, such as Invest A and B — one providing package deliveries and another offering video conferencing services — you’ll have far less reason for worry in times of economic hardship or other disruptive events! Look at how gas shortages can fuel success with Investment B: when stock prices dip on account of limited resources, people switch to digital communication tools from home, which ultimately benefits Investment B’s performance. — Derek Sall, Founder and Financial Expert, Life and My Finances

Put your Tax Refunds to work

Using your tax refunds to invest is a wise investing tactic to consider that you may have never thought about: for many, the short-term sacrifice is worth the long-term benefits, especially as you settle into life after work. 

This is a great way to supplement your current income or even a retirement account, or jump-start a new investment account. Tax refunds can also be used for other pivotal financial reasons, including paying off debt, funding an IRA, building a health savings account, and creating an emergency stash. — Dakota McDaniels, Chief Product Officer, Pluto

Open a High-Yield Savings Account

While savings accounts aren’t exciting ways to grow your wealth, online banks are currently paying 3-4% interest. While 3-4% might not seem like much, it only takes a few minutes to set up an account, meaning you can earn interest risk-free while also keeping your money easily accessible. — Larissa Pickens, Co-Founder, Worksion

Think of the Market as a Game

For investing, I always tell people to think of the stock market as a big game of poker.

Invest in real estate: “I like to think of real estate as the gift that keeps on giving. With rental properties, you’re not just earning income from tenants, but also building equity over time.”

Start your own business: “Entrepreneurship is not for the faint of heart, but neither is settling for a mediocre 9-5 job. Starting your own business is like taking a leap of faith and trusting that you’ve got what it takes to make it happen. Just remember to pack a parachute.”

Invest in yourself: “Investing in yourself is like planting a money tree, except instead of watering it with H2O, you’re watering it with knowledge and experience. So, go ahead and take that online course, attend that industry conference, or volunteer for that new project. Your future self will thank you.” — Russ Turner, Director, GallantCEO 

Prioritize Risk Management over Chasing High Returns

Although even small returns can accumulate into significant wealth through compounding, a single failed investment can cause a substantial loss. 

To mitigate risk, I employ the dollar-cost averaging (DCA) strategy when investing in the S&P 500. The S&P 500 is already a diversified index, reducing the risk associated with individual stock investing. Furthermore, the DCA strategy further minimizes risk by investing fixed amounts of money at regular intervals, regardless of the market’s ups and downs.  Continue Reading…