Do Faster Horses Make More Money?

I knew I had to ask him about the mysteries of life
He spit between his boots and he replied
"It's faster horses, younger women, 
Older whiskey, and more money"

Country music fans probably remember Tom T. Hall’s 1975 song, “Faster Horses”. In the song, Hall talks to an old cowboy “about the mysteries of life”, to which the cowboy replied, “It’s faster horses, younger women, older whiskey, and more money.”

Faster horses seemed to provide a safer inspiration for this week’s missive than the old cowboy’s second answer. The third answer also seemed interesting, but I’m more of a consumer than a connoisseur of the fire water. (While researching this article, I stumbled upon the World’s Best Whiskies 2016, if you’re looking for Christmas gift ideas.) “More money”, well, that’s why we’re here so let’s get back to horses.

Whether it is equines, trains, telegraphs, cars, airplanes, internets, or whatever comes next, going faster seems to be an innate desire of humanity. We have gotten to a point where gratification is almost instantaneous with just about everything. But has the resulting pace from the ongoing quest for “faster horses” improved the human condition, at least as far as helping us get “more money”?

It wasn’t very long ago that if you owned some stock, you probably kept the certificate in a safe deposit box. If you were curious about what is was worth, you would look in the back pages of the newspaper where all the previous day’s closing prices were listed. When it came time to buy or sell, you would call the order into your broker and then you had a week to deliver the shares or payment, usually by the US Mail.

When I was a kid, I worked for my father during the summer at his Gulf service station. At lunch, each day, he would visit his stockbroker’s office to pull up quotes on stocks he owned or was following. Other clients of the broker and office staff would discuss the markets and current events while hanging out around the quote terminal, known as a Quotron.

In the corner, the broker kept an old ticker tape machine as part of the décor. I think they held on to the relic probably because it just looked cool, but it also offered an opportunity to appreciate the benefits of “progress”. Instead of waiting around the ticker for a trade to come across, it was now possible to type in a symbol and immediately see its price. It also replaced reams of paper with the soft green glow of an early computer screen.

By the time I was working in the industry in the early 90’s, investors could call toll free phone numbers to get quotes from a broker or through automated telephone systems. Some companies even offered software for purchase that allowed clients to get their own quotes and to make trades through their computers. It was also around this time that 24-hour business channels on cable starting to appear and that brokerage firms began to require that you hold your shares or cash at the firm where you trade.

To get current events and market information, we have gone from tuning into the evening news or reading the business section of the morning paper to having instant updates delivered to us anywhere we can get a cell or WIFI signal. With the touch of the screen, we can buy or sell an entire portfolio in an instant. But are we getting “more money” with all this speed?

The evidence suggests not. Take the turbulent market period from 2008 – 2012, for example. Equity funds in the US experienced net outflows of about $535.7 billion during this period. When you think about how gloomy the news was in that period, it really isn’t that surprising that many investors went to the sidelines.

Dimensional Funds, which are found in all our Accountable Portfolios, had $34.4 billion of net inflows throughout that same period.[i] Why might that be? Well for starters, all their funds are held by institutions or customers of Registered Investment Advisers like ATX Portfolio Advisors.

When a client at a typical investment company or brokerage firm panicked after watching the talking heads declare the coming of the four horsemen in 2008, frequently all they needed was an iPhone to go to cash. Dimensional’s investors, on the other hand, had to call into their adviser to talk about what they were feeling. That certainly was a slower process than logging in and clicking “sell all”, but that momentary pause, often, allowed reason to prevail. The result was that Dimensional’s fund managers weren’t forced to sell stocks at fire sale prices just to meet liquidation demands. In fact, they were able to pick up some bargains.

Only 15% of US equity and fixed income funds that were around in the year 2000 had beaten their stated benchmarks through 2015, while 82% of Dimensional’s funds beat theirs over that same period.[ii] That suggests that deliberately going a little slower may be one reason that Dimensional’s funds have been more successful than so many of their peers, and given their investors “more money” as a reward.

If you are wondering why you don’t have more, it may be a good time to get in touch.

[i] Dimensional estimated net flow data provided by Morningstar based on Dimensional’s US-domiciled equity mutual funds. Industry net new cash flow data provided by Investment Company Institute© based on the approximately 4,600 US-domiciled equity (domestic and international) mutual funds reported on an aggregate level to the Investment Company Institute©. This includes information on Dimensional’s US-domiciled funds during this period. For illustrative purposes only.

[ii] Data from the CRSP Survivor-Bias-Free US Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago. Sample includes funds available at the beginning of the 15-year period ending December 31, 2015. Dimensional funds exclude VA funds and those distributed exclusively through Loring Ward. Industry funds exclude index funds, sector funds, and funds with a narrow investment focus, such as real estate and gold, money market funds, municipal bond funds, asset backed security funds, and non-US bond funds. Success rates are determined by the percentage of funds that survived and outperformed a benchmark over the 15-year period, net of fees and expenses. Dimensional funds are compared to prospectus benchmarks. Industry funds are compared to the diversified benchmark index with which they were most highly correlated over the sample period.

Tax Moves and Predictions About 2017

In case you missed it earlier this week, yours truly was quoted in a Jeff Brown article on CNBC.com about making charitable donations from your IRA. This tactic allows someone over the age of 70 1/2 to satisfy their Required Minimum Distribution but avoid paying taxes on it by directing the distribution directly to a charity. This isn't a question that comes up every day, but it can be very useful in the right circumstances.

A question that I have heard almost every day since November 8 is, “What do you think Trump means for the stock market?” Stock futures gyrated wildly the night of the election, first plunging as much as 10% before rallying back, and continuing to go up since. If we have learned anything from this election, it's that making predictions is easier than getting them right.

I have written about predictions before, but today's Update isn’t about trying to outguess the future. What we can do, however, is to look at some of the proposals being put forth by the new administration and the Congressional majority GOP to try and be better prepared for whatever comes next.

With the Republicans now controlling the executive and legislative branches, 2017 could be a year of significant tax reform. There are differences in what is being proposed by the President-Elect and Republicans in Congress, but by examining the commonalities we may be able to identify some steps we can take in 2016 or to put off until next year to take full advantage.

Both plans want to simplify the tax brackets by dropping the number of tiers from 7 to 3. As illustrated in Exhibit 1, the highest rate would drop to 33% on income over $225,000 for married folks (or $112,500 for individuals). That compares to the current 33% on income over $231,450 ($190,150), 35% on $413,350+ (413,350), and 39.6% on $466,950+($415,050). If you are in the 35% or 39.6% tiers and can defer some income into 2017, that may save you some money immediately.

Exhibit 1. From Michael Kitces at Nerd’s Eye View

Preferential treatment of capital gains and dividends will continue under both plans with some minor differences, as you can see in Exhibit 2. Both will repeal the 3.8% Medicare surtax on net investment income over $250,000 AGI for married couples ($200,000 individuals). If you are currently subject to this tax, it may be worth delaying taxable events into 2017.

Exhibit 2. From Michael Kitces at Nerd’s Eye View

Some deductions would be eliminated by both plans but one of the results of these changes in each case is the elimination of the Alternative Minimum Tax (AMT). If you utilize municipal bonds in your portfolio, this could make higher yielding bonds currently subject to the AMT more attractive.

It is no guarantee that all, or any, of these reforms will take place, as President-Elect Trump has shown that he can disagree with his own party as much as the opposition. However, I do predict that about half of the country will be unhappy no matter what.

Another prediction is that you will see many predictions about market returns in the coming weeks. The following Issue Brief from Dimensional shows that rather than relying on forecasts that attempt to outguess market prices, investors can instead rely on the power of the market as an effective information processing machine to help structure their investment portfolios.

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December 2016 Issue Brief

Prediction Season

The close of each calendar year brings with it the holidays as well as a chance to look forward to the year ahead.

In the coming weeks, investors are likely to be bombarded with predictions about what the future, and specifically the next year, may hold for their portfolios. These outlooks are typically accompanied by recommended investment strategies and actions that are aimed at trying to avoid the next crisis or missing out on the next “great” opportunity. When faced with recommendations of this sort, it would be wise to remember that investors are better served by sticking with a long-term plan rather than changing course in reaction to predictions and short-term calls.

PREDICTIONS AND PORTFOLIOS

One doesn’t typically see a forecast that says: “Capital markets are expected to continue to function normally,” or “It’s unclear how unknown future events will impact prices.” Predictions about future price movements come in all shapes and sizes, but most of them tempt the investor into playing a game of outguessing the market. Examples of predictions like this might include: “We don’t like energy stocks in 2017,” or “We expect the interest rate environment to remain challenging in the coming year.” Bold predictions may pique interest, but their usefulness in application to an investment plan is less clear. Steve Forbes, the publisher of Forbes Magazine, once remarked, “You make more money selling advice than following it. It’s one of the things we count on in the magazine business—along with the short memory of our readers.”(1) Definitive recommendations attempting to identify value not currently reflected in market prices may provide investors with a sense of confidence about the future, but how accurate do these predictions have to be in order to be useful?

Consider a simple example where an investor hears a prediction that equities are currently priced “too high,” and now is a better time to hold cash. If we say that the prediction has a 50% chance of being accurate (equities underperform cash over some period of time), does that mean the investor has a 50% chance of being better off? What is crucial to remember is that any market-timing decision is actually two decisions. If the investor decides to change their allocation, selling equities in this case, they have decided to get out of the market, but they also must determine when to get back in. If we assign a 50% probability of the investor getting each decision right, that would give them a one-in-four chance of being better off overall. We can increase the chances of the investor being right to 70% for each decision, and the odds of them being better off are still shy of 50%. Still no better than a coin flip. You can apply this same logic to decisions within asset classes, such as whether to currently be invested in stocks only in your home market vs. those abroad. The lesson here is that the only guarantee for investors making market-timing decisions is that they will incur additional transactions costs due to frequent buying and selling.

The track record of professional money managers attempting to profit from mispricing also suggests that making frequent investment changes based on market calls may be more harmful than helpful. Exhibit 1, which shows S&P’s SPIVA Scorecard from midyear 2016, highlights how managers have fared against a comparative S&P benchmark. The results illustrate that the majority of managers have underperformed over both short and longer horizons.

Exhibit 1.       Percentage of US Equity Funds That Underperformed a Benchmark

Source: SPIVA US Scorecard, “Percentage of US Equity Funds Outperformed by Benchmarks.” Data as of June 30, 2016.

Past performance is no guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. The S&P data is provided by Standard & Poor’s Index Services Group.

Rather than relying on forecasts that attempt to outguess market prices, investors can instead rely on the power of the market as an effective information processing machine to help structure their investment portfolios. Financial markets involve the interaction of millions of willing buyers and sellers. The prices they set provide positive expected returns every day. While realized returns may end up being different than expected returns, any such difference is unknown and unpredictable in advance.

Over a long-term horizon, the case for trusting in markets and for discipline in being able to stay invested is clear. Exhibit 2 shows the growth of a US dollar invested in the equity markets from 1970 through 2015 and highlights a sample of several bearish headlines over the same period. Had one reacted negatively to these headlines, they would have potentially missed out on substantial growth over the coming decades.

Exhibit 2.       Markets Have Rewarded Discipline
Growth of a dollar—MSCI World Index (net dividends), 1970–2015

In US dollars. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. MSCI data © MSCI 2016, all rights reserved

CONCLUSION

As the end of the year approaches, it is natural to reflect on what has gone well this year and what one may want to improve upon next year. Within the context of an investment plan, it is important to remember that investors are likely better served by trusting the plan they have put in place and focusing on what they can control, such as diversifying broadly, minimizing taxes, and reducing costs and turnover. Those who make changes to a long-term investment strategy based on short-term noise and predictions may be disappointed by the outcome. In the end, the only certain prediction about markets is that the future will remain full of uncertainty. History has shown us, however, that through this uncertainty, markets have rewarded long-term investors who are able to stay the course.

(1) Excerpt from presentation at the Anderson School of Management, University of California, Los Angeles, April 15, 2003.

Source: Dimensional Fund Advisors LP.

Diversification does not eliminate the risk of market loss. Investment risks include loss of principal and fluctuating value. There is no guarantee an investing strategy will be successful.

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.

Need Advice? Be Careful Who You Ask

Recently, while surfing channels one evening, I landed on a new political drama. The scene was a familiar, if not cliché, routine where the President was managing a crisis in the Oval Office, surrounded by his closest advisers who were jockeying to have their opinions heard.

There was a military general demanding that attacking the enemy was the only option, even if it wasn’t entirely clear what enemy was deserving of retribution. An intelligence agency representative offered a range of options, but was non-committal. Instead of offering a firm conclusion, most answers were hedged by suggesting the probability of information being correct. A political advisor measured all the angles to try and deduce what choice best furthered their agenda, irrespective of what was right or just.

Seemingly, only the President truly cared about what was ultimately best for the country, even if it meant he may pay a political cost or lose the next election. After adjourning the meeting, he later talked things over with his one true confidant, his wife, while lying in bed. 

We’ve seen the plot in dozens of movies or TV shows. Sometimes, the Commander in Chief is duped by a conniving bureaucrat.  Other times, like Solomon, the President sorts through all the agendas to arrive at an ultimately satisfying decision. But how much different is this from life?

Just the other day, I saw a sign at a local stockbroker’s office that reminded me of the scene in the fictional Oval Office. The sign read, “If you’re not at your last job, why is your 401(k)?” 

What if you could assemble a table of advisers to counsel you and provide a range of opinions to help you make decisions for the good of your financial future? What kind of advisers would you prefer?

Perhaps you would gather traditional stockbrokers or insurance salespeople. The broker/salesperson would probably, like the sign I saw, start with a question such as, “Why wouldn’t you want to rollover your 401(k)?” This isn’t the sign of an adviser looking out for your best interests. It is a tactic to probe for your objections so that they can respond in a well-rehearsed reply designed to overcome your reasonable concerns.

The broker/salesperson will likely provide “solutions” from their area of knowledge (sales training), access (company sales agreements), or incentives (sales goals and commissions). They are licensed by regulatory agencies such as FINRA and/or the state insurance board to sell investments, insurance, or hybrids between the two, such as annuities. The “answers” they provide will almost certainly be a costly one such as an annuity or a proprietary product. The worst kinds of these “advisers” will even go as far as to suggest that you aren’t paying them for their advice, even though the fees you pay for the product can be much more than non-broker sold alternatives.

The accountant, on the other hand, would likely be able to explain the tax consequences of all your options, such as taking a distribution versus rolling over the funds to another retirement account. They would probably try and understand your objectives and offer a suggestion based on tax laws. Some CPA's even specialize in providing personal financial advice. The designation of those CPA's is Personal Financial Specialist (PFS™). Most CPA's don’t sell products other than their advice, which can give you confidence that their answers are factually correct and not biased by compensation conflicts.

The independent adviser would preferably be a Registered Investment Adviser (RIA) with professional designations such as a Certified Financial Planner™(CFP®). They typically are paid for their time or assets they manage, not the solutions they sell. They put their customers' interests ahead of their own by working to understand their clients’ goals, needs, preferences, and personal situations to tailor advice. 

They would seek to understand the features of any retirement account you participate in and would only suggest a rollover if it was clearly in your best interest. Questions such as how much it costs, what are your investment options, are you taking any loans, or do you qualify for any unique situations (such as penalty free withdrawals if you retired at age 55 but before 59.5) would precede any leading question such as the one I observed on the local brokers sign.

Even with RIA's, you should be wary that some may pay brokers to “sell” their service to customers, but most, like ATX Portfolio Advisors, work independently from those channels. We do work closely with other independent professionals, such as CPAs and attorneys, when specific expertise is needed.

As you consider your next important financial decision, it is perfectly normal to have questions and to reach out for advice. Just be careful who you ask.