Jason Zweig at the Wall Street Journal published a disturbing article that deserves more attention. The basic story is this. A number of banks sold a complex financial product to retail investors who have subsequently lost quite a bit of money. Here is the basic pitch that was apparently made to individual investors in 2012. You are going to buy an investment product that is currently invested in bonds and is producing 8% in income per year. The performance of this product is tied to the stock price of Apple, however. In exchange for the high income, you take on the risk of a decline in Apple’s stock price. These products were sold when Apple stock was soaring, so a fair number of people apparently saw this as a favorable bet. With the stock down more than 30% from its peak, many of these investors have lost a considerable amount of money. Read Zweig’s piece for more details. These products have a number of variations and he discusses one specific structure. Here is another. The title of Zweig’s article, How Apple Bit Bondholders, Too, gives the impression that bonds were responsible for these losses. This is not the case, but the title serves to illustrate the subtlety of the problem. Continue reading
Folio Investing’s Successful ETF-Based Alternative to Legacy Target-Date Funds Offers Superior Diversification, Risk Targeting and Flexibility; Firm Seeks Distribution Partner to Broaden Availability
Folio Investing announced today that, over the five years since they were brought to market in December 2007, its Target Date Folios have significantly outperformed traditional target-date funds. The Folios have provided both higher returns and lower volatility than the competing funds during this tumultuous period. Continue reading
Guest post by Contributing Editor, Robert P. Seawright, Chief Investment and Information Officer for Madison Avenue Securities.
When I was a kid I had a paper route. One of my customers was a barber who made book on the side. Shocking, I know. The giveaway was the group of guys always hanging around but not getting their hair cut and the three telephones on the wall that rang a lot. Even as a kid I could tell that something was up. Continue reading
Effective Actions in an Uncertain World: Part Five of Our Special Five Part Series
There are a number of factors that we need to predict in order to come up with saving and investing strategies for retirement. The values that we assign to these factors will have a huge impact on whether or not we will be able to meet our goals. First, there is the expected return that investors will make on their retirement savings. Second, there is the common estimate that people will need about 85% of their pre-retirement income to support them once they stop working. Finally, there is the potential impact of behavior on savings rates, investing, and spending. Continue reading
Generating Income: Part Four of Our Special Five Part Series
During their working years, investors focus on saving and investing with a goal of building wealth. As they enter retirement, either by ceasing paid employment entirely or by scaling back paid employment, investors shift their focus to using their portfolios to provide a reliable long-term stream of income. This transition from building wealth to income generation is the subject of a great deal of research in retirement planning. Once investors are at or near retirement, the most significant financial challenge is using their accumulated savings to provide substantial income for their retirement years. Continue reading
Realities of Investing: Part Three of Our Special Five Part Series
In the various calculations that project retirement portfolio accumulations through time (such as the two discussed in the previous article), there are assumptions about how investors will allocate their savings and how those investments will perform. In the case of the Fidelity study, no specific asset allocation is provided that would achieve the assumed risk-free 5.5% annual return. In the Ibbotson study, the authors assume that investors hold a combination of a stock index fund and a bond index fund that progressively allocates less to stocks and more to bonds as investors get older. The Ibbotson study also assumes that the stock index (the S&P 500) will have an average annual return of 10.96% per year and that the bond index will have an average return of 4.6% per year. The Ibbotson study ignores expenses associated with investing. Continue reading
About four and a half years ago, Folio Investing launched an equity (e.g. stock) portfolio that focused on reducing the impact of market volatility. So-called defensive stocks are those which tend to be fairly insensitive to the mood of the market as a whole. Conventional wisdom suggests that demand for band-aids, electricity and paper does not go up when the market is exuberant, but neither does it collapse when the market swoons. The conventional wisdom also suggests that these stocks will tend to under-perform the broader market during rallies and, over the long-term, that a portfolio of these stocks will deliver modest returns. Our research suggested, however, that it was possible to create a portfolio of defensive stocks that would provide returns to keep up with rallies in the broader market, while still substantially reducing the impact of market volatility. Folio Investing launched the Defensive Strategy Folio that incorporated this research on February 28, 2008. Continue reading
In Part I of this article, I explained why I have issues with the traditional idea that individuals should provide for their required level of retirement income (beyond what is provided by Social Security and any pensions) entirely with assets with zero risk of loss of principal (e.g. Treasury bonds). In Part II, I discuss the alternative approaches.
There are two investments that have zero loss of principal: traditional Treasury bonds and Treasury Inflation-Protected Securities (TIPS), which are Treasury bonds with embedded protection against inflation.
I agree with the notion that people need to save and invest so as to be able to provide a very reliable and consistent income stream in retirement. Zvi Bodie has presented a compelling argument that investments in stocks do not become less risky as you hold them for longer periods, so that investors cannot rely on stocks as part of their required income stream. I have performed detailed analysis of Bodie’s argument and I agree with his argument: the magnitude of loss that you can face with an equity-heavy portfolio increases the longer you hold the portfolio. As I noted in Part I, William Bernstein has recently advocated for a portfolio in which all of your required income is provided by Treasuries and annuities, largely consistent with Bodie. Continue reading
Utility companies are expected to provide fairly stable performance, without too much downside risk. Utilities are also typically expected to provide lower average returns than the broader market. In the last decade, however, utilities have out-performed the broader stock market as investors have become increasingly risk-averse and worried about the prospects for sectors that depend largely on robust economic growth in order to meet their earnings targets. Continue reading
Last week, I posted an article discussing how diversification is one of the most misunderstood concepts in investing. In today’s post I continue with the second half of this two-part series titled, “The Power of Effective Diversification.”
In Part I of this article, I discussed the difference between naive diversification (holding lots of stuff in a portfolio) and real diversification (combining assets in a portfolio to create risk offsets). I also showed how a well-diversified portfolio can maintain the ability to participate in market rallies while still mitigating risk. In Part II, we will explore what an effectively diversified portfolio looks like today. Continue reading