Year-end investor review

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We made it, another year is in the books and everyone has an opinion on where the market is going. My line of work involves me adamantly advising people not to try to predict markets, but even I have an opinion about what might happen in the future. Thankfully, there’s a difference between having an opinion and making a poor investing decision.

So where are we now? We’re coming off of a historically great period of market returns, especially in the category of U.S. large growth companies (the S&P 500, which happens to be the category we almost exclusively hear about in the news). Since U.S. large growth companies have faired well, so have investors, because the vast majority of investors have the majority of their investments in large U.S. growth companies. That’s great news right now. But it’s also a problem.

Large growth companies are historically one of the poorest performing asset categories in the free market. This holds in performance data going back one hundred years, but it also makes sense a priori. Large growth companies are inherently less risky than small and value companies, they stay in business longer, they seldom go bankrupt (it happens, just not as often), and their prices don’t fluctuate as significantly. Small companies are often younger, less established, and more susceptible to tough markets. Value companies are often distressed and sometimes never recover. These small and value companies default more often and their prices are more volatile, they’re riskier.

You’ve heard the principle, risk equals return. That applies here. It makes sense that as entire asset classes, small companies and value companies outperform large growth companies by a significant margin over time because their additional risk brings additional return. The fact that large growth companies have performed so well over these last ten years is great, but it also means that at some point we’ll see these returns balance out. Now, I would never pretend to know which asset classes will perform better or worse next year, that’s a fool’s errand which we refer to as ‘market timing.’ But I do know that most years will favor a diversified portfolio that leans toward small and value asset classes instead of a heavy weighting towards large growth companies. Next year the most likely circumstance is that you’ll be happy to have left your large growth company portfolio to get into a more diversified situation, which, incidentally, is true at the end of every year.

So the obvious question is how to diversify with a lean towards small and value companies. I’ve covered this before, but total market index funds won’t help you here, because of cap weighting total market funds are invested almost entirely in large growth companies. Index funds have become very popular over the last 20 years and, while they’re certainly an improvement over active funds, they’re inherently flawed. To get into an ideal portfolio takes an advisor committed to the academics of investing utilizing structured funds (a solution to the index fund problem).

Take the opportunity to review your portfolio as we head into the new year. The returns may look great, but that doesn’t mean you’re in a great portfolio.

This is the problem with debt consolidation

 

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It’s not a math problem. The numbers on debt consolidation actually sometimes make sense. Credit cards (for instance) offer high interest rates because they’re unsecured, personal lines of credit. The most popular consolidation loans are home equity loans which offer much lower interest rates because they’re secured against your home. If you stop paying a credit card, the debt goes to collections and the credit card company receives pennies on the dollars that you owe them, their risk is high and you pay for it. If you stop paying a home equity loan, the bank has a stake in your house and they can sell it to get their money back (foreclosure), their risk is much lower and you pay less for it. So that all makes sense, isn’t it an obviously beneficial move to slide the debt from unsecured credit cards with high interest rates into a secured home equity line with a low interest rate?

Like I said, the math may sometimes make sense on paper (may, although there are some serious issues with home equity loans which offset the juicy interest rates), but the math was never the issue. We need to consider the root of the problem. If the root of the problem is that you’ve got high interest rates on credit card debt then a consolidation loan solves the problem; done, easy. Unfortunately, that’s not the root problem. The root of the problem is that you’ve got a broken relationship with money and things. You buy things because you want them and you worry about where the money will come from later. You use credit cards because, points (obviously), and they make you feel like lots of little purchases are no big deal. Your financial life lacks intention, there’s a disconnect between your purpose/values, and your money/spending. A consolidation loan is appealing for the momentary relief it could provide, your monthly debt payments might be cut in half, but it’s only a bandaid. Without a more fundamental change to your relationship with money and your spending habits, the consolidation loan will actually only end up causing more debt and more pain in the future.

Home equity loans (again, the most common type of consolidation loan) are usually interest-only loans, which means if you make the minimum (interest-only) payment each month, the debt could continue on into eternity. The lower interest rate is not helpful if the debt isn’t going down. People often end up paying far more interest on a low-rate equity loan than they would have by aggressively paying off a credit card.

A debt consolidation loan will wipe out your credit card balances leaving lots more room to spend. Without a change in the deeper issue (your relationship to money), you’ll just end up with the old credit card debt in the consolidation loan and new credit card debt on the credit cards. It’s a wicked spiral.

So don’t play the debt games. Credit cards aren’t necessarily the enemy, but using them without having the cash to back your purchases, that’s a problem, a problem that the best consolidation program in the world can’t solve.

Robinhood is dangerous

robinhood-for-webFirst of all, I don’t mean Robinhood the vigilante, the hero. Sure, was a criminal, but at least he was fighting against the bad guys. In an unjust agrarian society, his actions could be seen as defensible, but I digress.
I mean Robinhood the investment app. A few notes on its danger:

  • The Robinhood app is gorgeous. It’s so pretty it’s hard not to look at it. The graphs and charts are perfect, the animations and gestures are seamless, the design is minimal, it’s about as well designed as apps come. The old mantra ‘beauty is only skin deep’ applies here. The beauty draws you in but also masks some sordid parts.
    The beauty of Robinhood masks the fact that it’s essentially a place to gamble. Sure, you could call it sophisticated gambling, at least you’re not sitting in the smoky haze with eyes glazed over at a shiny slot machine, but it’s still gambling. The little news tidbits aren’t going to help you beat the market, nor will the pretty charts. The truth is that even professionals don’t beat the market. The beauty and ease just make it more tempting.
    Robinhood will you trade options, which is an even riskier way to invest, and even more likely to lose you more money. An option is just a leveraged bet on the market, like putting your money on 13 at the roulette table. It’s a terrible idea.
  • Robinhood offers free trades, perhaps its most alluring selling point. Purchasing stocks always involves fees, brokerage fees, trade commissions, transaction fees, etc. Brokers who conduct trades charge fees, usually per transaction. Robinhood is one of the few places where consumers can purchase shares without transaction fees. So it’s beautiful and free? Who says no to that?
    It’s not entirely free. There are regulatory fees on every trade which Robinhood does pass on to customers. These fees are typically fractions of pennies, and Robinhood rounds them up to the nearest penny, pocketing the round-up of course.
    Robinhood also generates substantial income from a practice called ‘payment for order flow,’ a controversial industry practice interestingly invented by Bernie Madoff. It basically means Robinhood sells the right to execute customer trades to third-party market makers who pay a small fee. Those small fees add up, and Robinhood relies on their high-frequency traders to make it work. Regulators don’t love it, in fact, other brokers and market makers have faced lawsuits over the issue. Robinhood’s dependence on this income could spell its downfall in the coming years.
  • Robinhood only allows you to buy entire shares, which are often pricey. At the time of this writeup Apple is trading at around $200/share, SPY (a very popular ETF that tracks with the S&P 500 index) is trading at about $300/share, Tesla is at $220, you get the idea. Not all shares are that expensive, but it’s tough to deposit a small amount and get trading, you need more money to buy full shares.
    It’s not like Robinhood couldn’t offer partial shares, other platforms do it. Robinhood doesn’t because this is another one of the ways they make money. Offering full shares exclusively means that you will usually have some leftover change in your account, and Robinhood earns interest on those leftover funds. It also encourages you to invest larger chunks of money, which means you’re likely to lose more money.

I’m not saying you’ll die young or retire destitute if you invest some money in Robinhood. But just be aware of what you’re doing. You’re gambling. For the most part, it’s best to stay away.

How does your retirement plan look?

Many of us, especially those who are younger, probably haven’t thought much about our retirement plans. I wouldn’t have put any thought into it either if I wasn’t an investment advisor. But I’ve run into some troubling stats about the relationship between Americans and retirement, so I think it’s worth talking about.

First, by retirement, I mostly mean age, like somewhere in your 60s. I don’t mean quitting all obligations and sitting around by a lake somewhere. Retirement definitely could include that (I’m counting on it!), but most of us probably won’t be content to only sit around. We’ll probably be doing some kind of work when we’re retired. What you definitely don’t want when you’re in your 60s is to be working full time out of necessity at a job you’d rather not be working at (which is unfortunately normal among retirement age Americans). I think about retirement as a time when people have options. I’ll personally want to keep working or doing something productive, but it could be work that doesn’t pay, or pays very little; I’ll be doing it because I want to, not because I have to. And let’s be honest, at some point we just won’t have the strength to keep working full time, so we need a plan to pay the bills.

Here’s a problem, 1 in 3 Americans has nothing saved for retirement. 4 out of 5 Americans have less than one year’s worth of income saved in retirement accounts. That obviously isn’t great. Consumer debt is on the rise. Student loans put young people in a large hole right out of college, the most fruitful investing years. Credit card debt is up. Car loans are accepted as the normal way to buy a car. The average American starts behind finically and borrows their way further down. Partly because of this debt crisis and partly because of our consumer culture, Americans only save about 3% of their income today, barely enough to keep up with inflation let alone fund their futures.

Compounding all of this is our increasing dependence on savings for retirement. Generation Y (Millennials) and Generation Z will to need to lean on investment accounts more than any generation before for a few reasons:

1) Pensions are all but gone. They’re a conduit for too much risk to employers who have shifted to 401(k) offerings. This trend isn’t actually bad, the market will do a better job growing money, and many employees offer generous 401k matching programs. But in order for it to work employees need to be intentional about utilizing 401(k)s, and to understand how the money is invested within the 401(k)s. That’s where we tend to fall short. Employees miss out on $1,336 in employer matches each year. We also let the money we do have in 401(k)s languish in actively trading mutual funds, surrendering large sums to fees and sub-market performance.

2) We don’t know exactly what Social Security will look like in the future, on its current trajectory it will have to be cut by about 23% by 2033. There will likely still be some sort of social security benefits down the road but it’s not something reliable enough to stake retirement on.

So right now, regardless of your age, do you have any idea what your retirement is going to look like? One meeting with an advisor to take a quick look at your situation could save you worlds of financial hurt down the road. Maybe you’re actually in great shape, or maybe there are just a few small things you can change which would have a dramatic impact on your financial future, or maybe you need someone to tell you your lifestyle needs trimming. It’s something you can, and probably should know.

How To Fix Your Finances

If you’re super stressed about your money situation, which, according to CNBC is pretty common, you’ve got two options:

Option 1: tighten your budget and stick to it at all costs. This option is not a lot of fun, but it’s still very important. The basic principle of personal finances is to live within your means. This means that if you don’t have money for something, you don’t purchase it, instead, you save some money over time until you can afford it. It’s common sense, but it’s not commonly practiced. SNL is an authority on the topic: Don’t Buy Stuff You Cannot Afford. Though this definitely isn’t the fun option, it might be the more important option. Sticking to a good budget and living within your means teaches you to think differently about money. If you’re a subscriber to the ‘I want it and my credit card isn’t maxed out yet’ line of thinking, this budget thing won’t be easy, but it will change your life.

Option 2: make more money. This is much more fun. Instead of holding back, you’re increasing. You can be creative, start a side-hustle, work towards a promotion. The options aren’t exactly endless, but they’re pretty broad. Do something that is exciting, something that you love, or something with a loved one! The only rule is that your idea has to make some money (and also stay within the bounds of federal law).

Here’s the twist, you don’t have to pick just one option. Ideally, you’ll work on both simultaneously. If you only tightened the budget, you would confine yourself to a workable, but boring financial existence. If you only earned more money, you would spend it as soon as you earn it since you would never have learned the discipline and benefits of saving. Neither option, by itself, is likely to get you where you’re hoping to go. But together, these two strategies can create a real and lasting fix to your finances.