Service Before Selfie, More Idiotic Advice, and a Wish

Service Before Selfie

Today is Veterans’ Day, a day for honoring those Americans that have served in our armed forces. Since the US military draft ended in 1973, our military has drawn exclusively from volunteers. The result has been that the percentage of Americans that have served has fallen from over 70% of the “Greatest Generation” of the World War II era to around 13% of “Millennials” and “Gen Y”.

Today’s veterans chose to serve for a variety of reasons, ranging from sense of patriotic duty, to gain life and/or vocational experience, pay for education, or just to have gainful employment. I know my personal choice was driven as much by the economic benefits of the GI Bill as any perceived obligation to God and Country.

So today is not only a day to thank a Vet, but also an opportunity to reflect on what it means to serve and whether we are all doing our part. Go ahead and post your heartfelt appreciation on Facebook, but in today’s narcissistic self-absorbed world, also remember that what we need is more service before selfie.

More Idiotic Advice

Speaking of narcissists, you might have caught my Update a couple of weeks ago where I pointed out the absurdity of following “Self-Made Millionaire” Grant Cardone’s idiotic advice to not invest in a retirement account. Cardone doubled down on his lunacy this week, advising people to avoid home ownership.

He began an Entrepreneur.com article with the statement, "Unless you have 20 million bucks in the bank, in cash, you have no business buying a house." This guidance flies in the face of the evidence that home ownership is a “significant source of household wealth”, per a 2013 paper from Harvard University’s Joint Center for Housing Studies.

Additionally, a 2014 Federal Reserve Bulletin found that homeowners, on average, are worth 36 times more than renters. Mr. Cardone provides occasional useful advice, such as "invest in yourself", peppered with dangerous ideas that have little or no foundation. I appreciate that he has had success as a businessman, but the fact that he has found a platform in popular media that is helping him sell awful advice through books and speaking engagements puts him in a position to do real harm.

I haven’t read Cardone’s books, nor have I attended his “Sales Training University”, but I am comfortable advising anyone considering the purchase of either to put that money to better use in an IRA or on a down payment for a house.

A Wish

Finally, if the past couple of weeks has taught us anything, it’s that the only certainty in life is uncertainty. Whether it was the Chicago Cubs coming back from a 3-1 game deficit on the road to win the World Series, Donald Trump’s defeat of Hillary Clinton, or the Dow Jones Industrial Average hitting new highs the day after election night when indications were that a correction was imminent, you just never know.

Trying to speculate on short term results seldom leads to long term success. On the other hand, having a plan both for the expected and unexpected is the best way to avoid a potentially damaging knee jerk reaction. Remember, a goal without a plan is just a wish. 

My wish is for all of the Accountable Update's readers to have a plan. If you don't have one or haven't reviewed it in the past 12 months, we should talk.

A Sports Lesson For Investors

If you are a baseball fan, it doesn’t get much better than the treat we were all served this week by the Chicago Cubs and Cleveland Indians. In addition to a fantastic series capped off by an epic extra innings Game 7, those of us that don’t consider ourselves fans of either team got to watch the tortured anticipation that Cubs and Tribe fans suffered through on each pitch of the final game.

Seemingly, each time the cameras panned the crowd in the later innings, you would see people with their hands covering their eyes, hats pulled over faces, and hands clasped as if in a church filled with the faithful. It ultimately worked out for the previously hapless (at least since 1908) Cubs, but as I tend to do, I saw a lesson for investors in the faces of those beleaguered fans.

I like to draw analogies from my own experiences and interests, such as last year when I wrote about treating investing the same way we do spectator sports. In that update, I shared studies that demonstrated that fans experience physiological changes, such as testosterone boosts to their bodies, when watching their favorite teams.

But after watching so much pain, strain, and torment of so many in the stadium, and no doubt in bars and living rooms across the county, maybe there is something else at work too. Why do fans keep watching even when their team is facing elimination, down 3 games to 1? Why even bother turning on the TV when your team is facing an overwhelming favorite, such as the 1980 US Olympic Hockey game vs the USSR. What about when the market has had a run of bad days, such as the last week or so? Why bother tuning in to a business channel? Is it because misery loves company?

In my opinion, it's the opposite of why you might think. For in spite of our worst instincts, it ultimately is optimism that keeps us from turning away.

No matter how reasonable our brain tries to be, at heart most of us are optimists. We expect the worst but hope for the best. It is in that mindset that we can we can also learn to be better investors. All too often we look for reasons to not be optimistic, even though history has repeatedly rewarded those that stay the course. Embrace the glass that is half full, but know that there will be terrifying moments where it appears certain that it may run empty or even fall of table. Cover your eyes if you have to, but stay in your seat.

And if today doesn’t end in our favor, there is always next year.  In the meantime, enjoy this Issue Brief on The Power of Markets.

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The Power of Markets

In 1958, economist Leonard Read published an essay entitled “I, Pencil: My Family Tree as Told to Leonard E. Read.”

The essay, narrated from the point of view of a pencil, describes the “complex combination of miracles” necessary to create and bring to market the commonplace writing tool that has been used for generations. The narrator argues that no single individual possesses enough ability or know-how to create a pencil on their own. Rather, the mundane pencil—and the ability to purchase it for a “trifling” sum—is the result of an extraordinary process driven by the knowledge of market participants and the power of market prices.

THE IMPORTANCE OF PRICE

Upon observing a pencil, it is tempting to think a single individual could easily make one. After all, it is made up of common items such as wood, paint, graphite, metal, and a rubber eraser. By delving deeper into how these seemingly ordinary components are produced, however, we begin to understand the extraordinary backstory of their synthesis. Take the wood as an example: To produce wood requires a saw, to make the saw requires steel, to make steel requires iron. That iron must be mined, smelted, and shaped. A truck, train, or boat is needed to transport the wood from the forest to a factory where numerous machines convert it into lumber. The lumber is then transported to another factory where more machines assemble the pencil. Each of the components mentioned above and each step in the process have similarly complex backstories. All require materials that are sourced from far-flung locations, and countless processes are involved in refining them. While the multitude of inputs and processes necessary to create a pencil is impressive, even more impressive are the coordinated actions required by millions of people around the world to bring everything together. There is the direct involvement of farmers, loggers, miners, factory workers, and the providers of capital. There is also the indirect involvement of millions of others—the makers of rails, railroad cars, ships, and so on. Market prices are the unifying force that enables these millions of people to coordinate their actions efficiently.

Workers with specific knowledge about their costs, constraints, and efforts use market prices to leverage the knowledge of others to decide how to direct their own resources and make a living. Consider the farmer, the logger, and the price of a tree. The farmer will have a deep understanding of the costs, constraints, and efforts required to grow trees. To increase profit, the farmer will seek out the highest price when selling trees to a logger. After purchasing the trees, the logger will convert them to wood and sell that wood to a factory. The logger understands the costs, constraints, and efforts required to do this, so to increase profit, the logger seeks to pay the lowest price possible when buying trees from the farmer. When the farmer and the logger agree to transact, the agreed upon price reflects their combined knowledge of the costs and constraints of both growing and harvesting trees. That knowledge allows them to decide how to efficiently allocate their resources in seeking a profit. Ultimately, it is price that enables this coordination. On a much larger scale, price formation is facilitated by competition between the many farmers that sell trees to loggers and between the many loggers that buy trees from farmers. This market price of trees is observable and can be used by others in the production chain (e.g., the lumber factory mentioned above) to inform how much they can expect to pay for wood and to plan how to allocate their resources accordingly.

THE POWER OF FINANCIAL MARKETS

There is a corollary that can be drawn between this narrative about the market for goods and the financial markets. Generally, markets do a remarkable job of allocating resources, and financial markets allocate a specific resource: financial capital. Financial markets are also made up of millions of participants, and these participants voluntarily agree to buy and sell securities all over the world based upon their own needs and desires. Each day, millions of trades take place, and the vast collective knowledge of all of these participants is pooled together to set security prices. Exhibit 1 shows the staggering magnitude of participation in the world equity markets on an average day in 2015.

Any individual trying to outguess the market is competing against the extraordinary collective wisdom of all of these buyers and sellers. Viewed through the lens of Read’s allegory, attempting to outguess the market is like trying to create a pencil from scratch rather than going to the store and reaping the fruits of others’ willingly supplied labor. In the end, trying to outguess the market is incredibly difficult and expensive, and over the long run, the result will almost assuredly be inferior when compared to a market-based approach. Professor Kenneth French has been quoted as saying, “The market is smarter than we are and no matter how smart we get, the market will always be smarter than we are.” One doesn’t have to look far for data that supports this. Exhibit 2 shows that only 17% of US equity mutual funds have survived and outperformed their benchmarks over the past 15 years.

CONCLUSION

The beauty of Leonard Read’s story is that it provides a glimpse of the incredibly complex tapestry of markets and how prices are formed, what types of information they contain, and how they are used. The story makes it clear that no single individual possesses enough ability or know-how to create a pencil on their own but rather that the pencil’s miraculous production is the result of the collective input and effort of countless motivated human beings. In the end, the power of markets benefits all of us. The market allows us to exchange the time we require to earn money for a few milliseconds of each person’s time involved in making a pencil. For an investor, we believe the lesson here is that instead of fighting the market, one should pursue an investment strategy that efficiently and effectively harnesses the extraordinary collective power of market prices. That is, an investment strategy that uses market prices and the information they contain in its design and day-to-day management. In doing so, an investor has access to the rewards that financial markets make available to providers of capital.

Leonard Read’s essay can be found here: http://econlib.org/library/Essays/rdPncl1.html.

Source: Dimensional Fund Advisors LP.

There is no guarantee investment strategies will be successful.

US-domiciled mutual fund data is from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago. Certain types of equity funds were excluded from the performance study. Index funds, sector funds, and funds with a narrow investment focus, such as real estate and gold, were excluded.

Funds are identified using Lipper fund classification codes. Correlation coefficients are computed for each fund with respect to diversified benchmark indices using all return data available between January 1, 2001, and December 31, 2015. The index most highly correlated with a fund is assigned as its benchmark. Winner funds are those whose cumulative return over the period exceeded that of their respective benchmark. Loser funds are funds that did not survive the period or whose cumulative return did not exceed their respective benchmark.

All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

Ken French is a member of the Board of Directors for and provides consulting services to Dimensional Fund Advisors LP.

5 Year End Ideas That Aren't Idiotic

Remember when the class Dunce was relegated to the corner? If the internet has made the world a village, it has also given rise to many of the idiots that once were confined to a corner or at least a local coffee shop. No place was this more evident than an interview this week with entrepreneur Grant Cardone on CNBC.

In the article, Cardone was quoted as saying, "I would never, ever invest money in a 401(k). Why would I go to work, have my employer give me another $6,000 a year, and then take that money and send it off to Wall Street, where I can't even touch it for 30 years? I wouldn't do that."

Hey Grant, since no one answered your question in the article, I thought I would help you out. The reason you would invest in a retirement account and take advantage of an employer match, if offered, is so you won't be one of the 55% of Americans that a 2016 study by Fidelity Investments showed do not have enough money to afford 80% of expenses in retirement. 

Sure, everybody could take your advice to “focus on earning”, but what about the fact that 71% of small businesses fail by their 10th year? No doubt you have enjoyed successful business ventures, but winning the lottery doesn’t qualify you to suggest that buying Powerball tickets is a good idea.

It's at least partially due to ignorant or stupid statements such as these that lead to 1 out of 4 employees leaving employer 401(k) matching money on the table each year, an average of $1,336, according to Financial Engines. 

If you are interested in some ideas that arguably aren't quite as dumb as Grant's, consider the following before year end:

Review Your Portfolio - Year end is a great time to review your investments to see if you are on track. During the review, you should confirm that your investment mix is still appropriate for your goals. If the mix has drifted too far off target, now is an ideal time to re-balance or make a clean break for 2017. If you have any investment losses in your taxable accounts, you should consider selling some losers to generate a tax write off or to offset other capital gains.

An often overlooked tactic when addressing imbalances is to contribute shares of appreciated stock to your favorite charity or a donor advised fund (DAF). This approach may allow you to simultaneously lighten your exposure, avoid capital gains, and get a tax deduction. 

Pay Yourself First - Are you getting the most from your retirement accounts? If your employer offers a matching contribution, you are passing up free money if you aren't contributing up to the matching amount. If you are getting a year-end bonus or raise, use this opportunity to increase the amount you are saving in your retirement accounts. If you are 50 years old or more, there are probably "Catch Up Contributions" available to allow you to save even more. You not only will be increasing your savings, but you may save some tax money, too.

Remember that retirement contributions are perishable. Once you pass the deadline, you’ll never be able to take advantage of this year’s contributions again.

Check Your Beneficiaries - This is a simple administrative task, but is a crucial step in insuring your estate plan will work as you intend. If you want your state or the IRS to get more of your inheritance, not naming beneficiaries is a great way to increase their share.

A more common problem is not updating beneficiaries after deaths, divorces, births, etc. These designations are considered contractual and supersede your will. 10 minutes a year on this task can save a lot more than money. Don't believe me? Check out this Accountable Update from last year.

Don't Forget Your Required Distributions - For most folks, if you are 70.5 before year-end, you are required to distribute some money from your retirement accounts. The penalty for not taking the Required Minimum Distribution (RMD) can be 50% of the amount not taken, so it is very prudent to always confirm that you have satisfied the requirement. The only year you get a grace period is the year you turn 70.5, and then for only 3 months. Mistakes can often be made when inheriting an IRA or when accounts have been transferred from one company to another, so be especially mindful if this applies to you.

Use Your Flexible Spending Account (FSA) - If you set aside money in an FSA and have more than $500 left at year end, you need to use it or lose it. Here is a list of eligible expenses.

If all of this is a little much, give me a call if you would like some help.