Afraid to Invest? Here’s How To Get Over Fear of Investing

Plunking money into the stock market is a weird psychological trick.  No matter how much evidence is out there, about ‘time in the market’ being valuable, there’s a bit of fear putting a bit in — even for myself who’s well studied the market extensively.

Nobody wants to loose money. Nobody wants to see the value of their investment go down.  How would you feel if you’re portfolio lost 10%?  What if it were 50% as we seen in 08/09?  It would hurt.  And that’s why investors block exists.  No one wants the pain.  No one want’s to feel like they made a bad decision.  But the risk we assume by investing is part of what makes the future returns possible.

So how do you get over the fear block?

Dollar.  Cost.  Average.  That’s the secret.  Invest little chunks of money consistently.  If you’ve got a large sum, say $100,000 (or whatever large is to you), invest $4,000 per week for 25 weeks (about 6 months).  By doing this, you’ll largely avoid the anchoring effect of investing a lump sum.  In other words, you’re not going to look at your portfolio that started off as $100,000 and see if it went up or down.  You’re not going say point to compare to and deal with the ‘pain’ of investing at the wrong time.

You’re going to buy in on some ups, and some downs.  Once you’re in you won’t have a psychological starting point. If you’re not working with a lump sum, just systematically invest a little bit every week, or month.  As with the example above, you’ll lose track of the starting point and it won’t be painful.

Know this, even if you are ‘world’s worst market time’, and invest at market peaks, but are in it for the ‘long haul’, you still would’ve done rather well as explained on A Wealth Of Common Sense (an awesome blog btw).

Also Read this: What If You Invested $1,000 Per Month For The Last 10 Years.

I Don’t Give A Fuck Because I’m A Systematic Investor

With one finger swipe on my Facebook feed I see an attention grabbing headline of either doom and gloom or gold and boom in the market. Sometimes I’ll even get one of each, from the same publisher back to back,  When I turn on the TV I’ve got some loud mouth telling me to buy or sell.  Every day you and I are plastered with this stuff from the latest Guru or some intern who landeda gig as a freelancer.  Who’s right?  Guru or intern, it doesn’t matter.  It’s all bullshit anyways.  No one know what the market is going to do.  The numbers don’t lie, most guru insight is worse than a coin toss.

Despite the evidence I’m shocked at how many people fall for it and make trades based on what ‘they’ or some ‘expert’ says to do.

I truly don’t give a fuck what the talking heads are saying today, or where that article told me to invest my next dollar because I’m systematic investor.  A hunch is

bull shit.  So is a tip.  Those things can’t be measured, or quantified.  I only act on systems — things that can be tested time and time again and shown to be reliable over the years.  This takes the emotion out of it and keeps focused only on what works consistently over the long run.

Factually speaking, the average equity investor does quite poorly.  Horribly.  For the 20 years ending 12/31/2015 the S&P 500 Index averaged 9.85%.  The average equity investor did just 5.19%.  Anyone with a basic understanding of compounding returns know just how horrible that is.  And it’s largely the result of emotion.  Just think back to not even 2 years ago.  2015 was a go no where year for the stock market with 2 drops.  After that year, bearish investor sentiment was over 45%, at one of its highest points ever.  Bullish sentiment was below 25%. The consensus was the that the 7 year bull run had come to an end and things were head down.  Here’s just one headline from December 2015.

 

… In the roughly 20 months since the fear of 2015, the S & P 500 has gone on to return 23%.

Back to systems; they don’t need to complicated.  Simple is better in many aspects of decision making and just the same in investing. Simple, systematic investing takes the emotions out of it.

Here’s the deal, systematic investors and strategies don’t make the headlines.  They don’t make it to your Facebook feed.  They’re boring.  Can you imagine how much attention a systematic investor would get on TV?  Here’s something they would say:

Investors should keep investing right now… because erm, thats what you should do based on the simple rules that have been shown to get the risk adjusted return we’re looking for.

… and cut.  Career as a pundit ended.

 

Here’s a systematic investing strategy:

It will keep you from wasting time reading pointless articles and worry about how your portfolio is doing.

Dollar Cost Average Into A Diverse Portfolio (preferably low cost).

Just take a percentage of your monthly take home pay and contribute it to a diverse portfolio and never look back.  That’s it.  When investing systematically like this you’d be surprised at how quickly you set your emotions aside, as the dollar cost averaging avoids a psychological anchoring to a lump sum investment.

Many will advocate a low cost index portfolio through Betterment or a Vanguard Life Strategy fund, and quite frankly that is statistically likely to outperform most alternatives, but a mutual fund portfolio will work (just make sure the manager has over $1,000,000 personally invested), or a smart beta portfolio.  Either option you go with will have have you substantially outperforming the average equity investor.

 

Want To Avoid Market Bear Markets & Volatility?

 

Trend Follow Using A Simple Moving Average.

My investing life hasn’t been long enough to have me ride through a 50% drawdown as we seen in the the late 2000s, but I know I don’t want to.  For that reason I’m a trend follower.  It’s real simple… just use a simple moving average.  10 month, 12 month, 200 day, no matter which of these time frames you use you’ll get similar results.  If the market is above the is above the simple moving average I am invested.    If it’s below I go to a low risk asset such as cash, Tbills or bonds.  That’s it, 2 rules.  There’s no emotion involved.  No need to read the headlines.  No need to listen to the bullshit.  No need to play guessing games.

A study of trend following in 235 markets, has shown that trend following over the long term results in near market returns (sometimes a little above, sometimes a little below) applied to near.  Net of taxes and trading fee’s, you’ll probably underperform market beta a slight bit, but if it keep you money in the market, and keeps you investing systematically, its a win for your portfolio.

Now do yourself a favor, and stop reading the headlines.  Turn off the TV.  Start investing systematically.  Don’t use fancy verbiage as your system.  Keep it simple, quantifiable, and non emotional.  Your future self will thank you.

 

pitfall of financial advisors

Who’s Who: The Full Mess Of Financial Advisors [Infographic]

Some days it seems like everyone is a ‘financial advisor’.  When I go to the bank, I get suggested a meeting with their financial advisor.  I’ve got some financial advisor who consistently hounds me on the phone for a meeting about how he “can help me”.  And at the bar, there’s a financial advisor too.  Armed with their bachelors degree, and 2 week introduction course from their employer, they all have the latest and greatest financial instrument or portfolio suggestion for me.  I’ve heard some them out for mere comical value, and none of them have anything of value.  The better ones have just the typical diversified portfolio for about 5x the cost of diversified portfolio through a robo-advisor.  Some of the worse ones, have high load fee mutual funds, or some mythical strategy to ‘protect’ your investment.  The reality is, they’ve all got bullshit.  That’s not saying there aren’t great financial advisors out there, but generally most of them are financial salesman, more concerned with their commission check than your portfolio.

So when everyone (most) is an advisor peddaling overpriced and/or crap investments, who’s who?   Morgen Beck Rochard of Origin Wealth Advisors recently created the helpful infographic below on the wide range of possibilities you can get when you hire a “financial advisor”.

What can we tell from all this?  The term “financial advisor” is extremely broad, kind of like saying “dog”.  It tells us nothing about:

  • Their qualifications, certifications, or years of experience.
  • The types of financial instruments that suggest (sell); individual stocks, active funds, passive funds, life insurance products, or annuities.
  • How they are compensated (flat fee, percentage of assets, commissions).
  • Whether they are a fiduciary (legally required to always act in the client’s best interest).

All of the robo-advisors I suggest for everyone who wants a ‘hands-off’, effective portfolio, including my sister, such as Wealthfront, Betterment, WiseBanyan, Schwab Intelligent Portfolios, all find their place near the top of the chart in the “Fee-only Passive Management” category.  They are all Registered Investment Advisors, which are fiduciaries legally required to act in your best interest, and they are  Securities Investor Protection Corp (SIPC) insured, which means that the securities in your account are protected up to $500,000 per individual account type (Note insurance cover mis-management, not portfolio fluctuations).  All of them will give you a well diversified portfolio of low-cost passively managed funds based on your risk tolerance and investment horizon.  Their fee, which is all relative low, around 0.25%, is based on the total value of your account.  The provide limited financial planning using well designed software.  In my opinion Betterment does the best of financial planning with their tax loss harvesting and tax coordinated portfolio’s.

Stay away from everything in the yellow, orange and red boxes.  Here you get complicated universal life insurance, mythical hedge fund strategies, and expensive mutual funds often with managers who will not even invest in their own funds.  By simple avoiding the crappy financial products, you’re already doing better than the average investor.

Up at the very top are the unicorns of financial advisors.  A well qualified human advisor that evaluates your financial position, and life financial picture holistically, and acts as fiduciary sounds great, but it is also out of reach for most of us.  These guys often won’t even say return your call unless you’ve got an account balances over $1,000,000m they also tend to be a bit more expensive.  The Form ADV of Origin Wealth Advisors (firm who published the infographic above), reveals that over 75% of their clients are “high net worth” and the portfolio management fee  is 1.5% annually, unless you have more than $5 million.  That’s clearly not for most people and quite frankly it would be hard for any advisor to add that much ‘alpha’ to a portfolio.

There are lower cost financial planners out there, but they are hard to find, and still have a minimum investment beyond what most can invest.  On the otherhand, anyone with $500 can go to Betterment an awesome portfolio, coordinated with their goals, and with tax strategies implemented, for 0.25%.  A $100,000 portfolio will cost just $250 per year.  Not even 10 years ago, this kind of investing was only available for the upper echelon of investors.

Statistically, all investors would be best served just saving up a bit and opening an account with any of the robo-advisors mentioned here, and then consistently investing into the account.  That means avoiding all the other financial advisors and their largely unmet promises.  At the same, learn all about investing, taxes, market history, and investor psychology so you can be your own financial advisor.  It’s really not that hard, and I believe everyone should… thats part of why I started this site!

 

5-reasons-why-to-invest-with-betterment

5 Reasons Why I Told My Sister To Invest With Betterment

When I had that talk with my sister about “so how much money do you have sitting in the bank? – You need to invest!”, I ultimately pointed her to Betterment.  At the most basic level Betterment aims to get you simple, do nothing, stock market returns – adjusted for your level of risk and time horizon.  With Betterment you buy (according your goals), do nothing except keep investing, and check back in many years to see how much you have (aka buy & hold).  Some of you might be a bit shocked by that I would suggest a buy & hold allocation for my closest relative.  If you know me or have read my blog, its no secret that I’ve invested countless hours into finding quantitative formulas to beat the market.  Formulas to give me a slight edge over the market beta returns of a globally diversified portfolio like what betterment offers.  So why would I, her brother, who has all kinds of awesome quantitative investment ideas and knowledge point her to Betterment – a solution so simple?

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why you should start investing right now

Why You Should Be Investing Every Penny You Can RIGHT NOW!

 Right now I’m  flooding my brokerage accounts with money like an addict filling his veins with chemicals. It’s a bit of an extreme metaphor but I am stuffing all my pennies into investments right now. I know right now is a great time to invest.   The best time I have. The only better time was 20 years ago, unfortunately my time machine is in the shop.

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Stock-Wouldve-Had-A-Great-2016

Stock Would’ve Had A Great 2016!

2015 was a go no where year for US stocks, and most other markets.  Nothing went up, nor down.  Sideways.  Flat.  That was it.  Certainly it was a precursor to an inevitable drop in 2016.  That’s what I thought.  I kept large chunks of cash on the sidelines.  I even bought some ‘SH’, an ETF that shorts the S&P 500, in early 2016.  Just the same, on Jan 2016 the AAII blog, published an article titled ‘Optimism At Lowest Level Since 2005’.  Their Investor Sentiment Survey was reporting that ‘bullish sentiment’ was low, the lowest since April 14th 2005.  Everyone else was feeling the same as I was.  You can see what the levels were on their chart below, and notice the decline in bullish sentiment.

Bullish reading in the AAII Sentiment Survey getting low.

Bullish reading in the AAII Sentiment Survey getting low.

A Year Later, we get to see what happened…

From Jan 15th 2016 to Jan 14th 2017 the S&P 500 had a total return of 20.8%.  Yes, it went up far by more then the 7-9% (whatever people claim as the average market returns these day).  I was wrong.  Everyone was wrong.  What we felt was wrong.

sp500 returns from jan 14 2016 to jan 14 2017

S&P500 total returns from Jan 14 2016 to Jan 14 2017

If you would’ve invested in a simple Betterment portfolio with an 80/20 portfolio, you would’ve had a pretty good year as well!  Their 80/20 portfolio was up 13.8% after their extremely low fee.

Lets take a look back to the second lowest level in 11 years on April 14th 2015.   Things were pretty good the following 12 months as well, with the S&P 500 posting a total return of about 12.9%.

Returns for the next 3 and 12 months when readings are 10% most bullish or least bull (from Meb Fabers Blog)

Returns for the next 3 and 12 months when readings are 10% most bullish or least bull (from Meb Fabers Blog)

The pattern of sentiment (feelings) being wrong doesn’t end there.  Turns out the investor sentiment index is a pretty good contrarian indicator.  Meb Faber posted that the 10% least bullish readings result in an average next 12 month returns of 13.20% and most bullish readings result in an average next 12 month returns of a mere 0.47%.  In otherwords, when investors feel like things are going to go down, they usually go up.  And go up by a more than average amount.

The-Portfolio-Optimization-Techniques-and-Limitations-of-Top-Robo-advisors

The Portfolio Optimization Techniques and Limitations of Top Robo-advisors

A vital part of asset management business is portfolio optimization. The more efficient a portfolio is optimized for a given level of risk, the better your chances of realizing expected returns. Robo advisors also use optimization process to provide you the maximum return you can get for a given level of risk, while at the same time minimizing investment costs for you. Let’s review some of the popular models used in investment finance (geek alert!) and how robo advisors apply them in their own investment process.

  1. Mean Variance Optimization

Harry Markowitz introduced a mathematical formulation for investment diversification in his paper “Portfolio Selection” that was published in 1952. He showed how diversification in a portfolio could lead to better returns for the same amount of risk. In effect, the model solves for an “efficient frontier” which is a set of portfolios, each one offering maximum return for a given level of risk.

Efficient Frontier (Source: ToolsForMoney.com)

Efficient Frontier (Source: ToolsForMoney.com)

Below the curved efficient frontier, portfolios offer a sub-optimal risk adjusted return. That is to say, diversification has not been done efficiently enough to reap the rewards of maximum risk adjusted returns. This trade-off between risk and return is at the heart of the MVO theory, which is designed optimize a portfolio for a single period.

In order to find a portfolio on the efficient frontier that maximizes return for a given level of risk, following inputs are needed.

  1. Forecasts for asset returns for a single period
  2. Forecasts for standard deviations for a single period
  3. Forecasts for correlations between the assets

These forecasts are based on historical data. Once you have these forecasts, next step is to calculate the minimum variance portfolio and maximum return portfolio. Finally between these two portfolios, portfolio that has a minimum risk for each of the 98 portfolios between minimum risk and maximum return portfolios is calculated, which in turn provides the efficient frontier.

MVO Limitations  

Despite the significant utility of the MVO theory, there are some major limitations in this model.

  • It is difficult to forecast asset returns with accuracy using historical data, which tends to be a poor forecasting source. As return estimations have a much larger impact on MVO asset allocations, small changes in return assumptions can lead to inefficient portfolios. Therefore, MVO tends to lead to highly concentrated portfolios that do not offer as much diversification benefits in practice as they seem to provide in theory.
  • The model assumes that asset correlations are static or linear. In reality, asset correlations move dynamically, changing with the market cycles. During the global financial crisis, asset correlations approached almost to 1, so if anything, diversification seemed to have insignificant impacts on the portfolios.
  • Last but not the least, MVO assumes normality in return distributions. Therefore, it does not factor in extreme market moves which tend to make returns distributions either skewed, fat tailed or both. Without optimizing the portfolio for asset that may actually have skewed distributions or fat tailed, MVO could lead to a riskier allocation that is intended.

As a result of these limitations, portfolios optimized using the MVO approach are rather concentrated and fail in achieving maximum diversification.

  1. Black Litterman Model

To counter the limitations of the Mean Variance framework which often results in concentrated portfolios, economists Fisher Black and Robert Litterman at Goldman Sachs developed the Black Litterman model. It’s a step ahead of the MVO framework in that it allows an investor to incorporate his views on expected returns into the market implied asset returns. After all, if an investor seems to specialize in a certain asset class and possesses unique insight into how that particular asset class will perform over a future period, there needs to be a way to forecast returns considering the investor’s own return expectations. Thus, Black Litterman Model tries to overcome high-concentration (normal distribution assumption), input sensitivity, and estimation error maximization problems that are inherent in the MVO theory.

Black Litterman builds on the MVO framework. It starts with neutral, equilibrium asset weights that are implied from the market portfolio assumed to be on the efficient frontier. Investment professionals often tend to have expert views on the performance of certain asset classes in a portfolio, which may deviate from the market portfolio implied weights. An investor can then enter his views into the model, which uses reverse optimization process to calculate CAPM (Capital Asset Pricing Model) equilibrium returns for each of the assets in a market portfolio. An investor has the option to express views regarding one or all of the assets in a portfolio, though because investor views on all the assets in a portfolio are not mandatory, estimation error is minimized to a certain extent.

figure-2-investor-views-reflected-in-optimal-portfolio-weights-under-the-black-litterman-framework

Given the level of confidence as well as the magnitude of the views an investor inputs into the model, a portfolio is created that may have asset weights different from the market portfolio. The degree of investor confidence in the original market portfolio weights also has an impact on the portfolio optimization process using this model, which means if you have a high confidence in the market portfolio implied weights, your optimized portfolio will reflect that. The resulting optimized portfolio is a weighted average of the market equilibrium portfolio and “investor views portfolio” – the stronger these views are, the greater the divergence of the optimal portfolio will be from the market equilibrium portfolio. However, in the absence of any specific views, an optimal portfolio will be the market portfolio.

Black Litterman Limitations

Black Litterman model brought the MVO model one step further and has usage in the practical world. However, it still faces a few limitations, which are discussed next

  1. It is difficult to define the market portfolio. Risky assets trading on public markets are far from a complete representation of the overall market. For instance, REITs do not encompass the private real estate deals, which are a much larger chunk of the overall REITs market. Therefore, asset allocation based on publicly available securities may render a portfolio with less than optimal allocation to certain asset classes.
  2. Normality assumption in the model again leads to the same problems suffered under the MVO model. Asset returns do not always behave normally and the need for a model that uses other than normal return distributions, and factors in asset return skewness and fat tails, still remains.
  3. Gordon Growth Model

Thus far we discussed two models that are central in portfolio optimization process. Gordon growth model, though not a tool for portfolio optimization per say, can help an investor boost individual asset returns by hand picking asset classes, indices, or securities that pay a high fixed payment growing at a constant rate in perpetuity. This could either be dividend paying stocks (typical application of the model), asset classes with a high payout ratio to investors, or indices such as ETFa paying out dividends. The model was first published in 1956 by a professor at the University of Toronto, Myron J. Gordon along with Eli Shapiro.

Figure 3: Gordon Growth Model Equation

The model posits that the value of a stock/security is the net present value of all of its future payouts. For a dividend paying stock, given the value of a company’s dividend in one year, it is possible to find out the intrinsic value (true value based on fundamentals) of a stock today. The model makes the following two assumptions

  • Stock is dividend paying
  • And dividends grow at a constant rate in perpetuity

It does not require inputs on stock return expectations nor requires information on the market conditions. Thus due to its simplistic approach, it’s fairly easy to value a company, provided it pays out a dividend. Though the model finds its applications in an index or an asset class valuation as well, it is mostly used to value dividend paying stocks.

Gordon Growth Limitations

As it turns out, the model’s simple approach to valuation is one of its main drawbacks. The model suffers from the following disadvantages.

  1. It can only be used for stable companies that pay a dividend growing at a constant rate, which is rarely the case as companies go through different business cycles that make growing dividend at a constant rate difficult. Extending it to indices or asset classes, the problem is multiplied as the whole indices or asset classes can suffer from different economic stages.
  2. The growth rate in the formula can’t be bigger than the rate of return used to discount the future payments. Otherwise, it ends up with a negative number in the denominator which will not mean anything.
  3. Despite the simplicity, Gordon Growth model still requires forecasting of inputs. Specifically, growth rate and required rate of return both need to be forecasted as precisely as possible because small changes in these two inputs can have major effects on the value of a company’s equity.
  4. Robo Advisors Optimization process

Finally, it’s time to turn to the primary question – what is the process used by robo advisors to optimize their portfolios? Most robo advisors use one form or the other of an optimization process and the details vary as to the extent of the optimization. In the end, it comes down to each robo advisors individual investment philosophy and views on the market.

Figure 4: Robo Advisors' Investment Philosophy (Source: ETF.com)

Figure 4: Robo Advisors’ Investment Philosophy (Source: ETF.com)

In order to explain how robo advisors go about portfolio optimization, consider Wealthfront and Betterment.

  1. Wealthfront uses Black Litterman model to get implied market weights and combines them with investment views of Burton Malkiel, Wealthfront’s Chief Investment Officer, to create asset allocation for portfolios. In order to optimize the portfolio, the company also puts constraints such as minimum and maximum asset weights. Thus, Black Litterman model serves their optimization well as it takes the mean-variance approach and allows the company to input its own views as reflected by Malkiel to arrive at an optimal portfolio.
  2. Betterment also uses the Black Litterman model. However, they do not insert investor views into the optimization process and rather try to stick to the market equilibrium portfolio weights, specifically on the equities side of the portfolio. It also does not constraint portfolio weights. The resulting optimal portfolio resembles the global market portfolio to a certain extent. The one thing that Betterment does unique, however, is its Fama French style tilt towards small cap and value asset classes.

Although robo advisors are known for their minimal human intervention in the investing process, their product offerings are in fact affected by the views and market insights of their respective investment committees or experts. In the end of the day, it is the mind behind the robo that is making investing calls, and you need to familiarize with him sooner rather later.

who-manages-your-money-better-human-vs-robo

Who Manages Your Money Better – Human or Robo?

A relationship is central to human experiences, and trust is a defining aspect of this experience. Investment management is built on a similar idea of maintaining a trustful relationship with your advisor/planner. In the years past, however, there has been one too many such instances where a breach of trust was done by an investment professional. Planning for your future is an emotional endeavor, and you do not want to be misguided about any detail while doing so.

There needs to be clarity regarding investment outcomes and full faith in an investment professional providing guidance related to financial matters. You have the right to know that the other person does not have any other motive but to help YOU meet your investment goals. With a human advisor, a conflict of interest is sometimes unavoidable. A human advisor has to look after his paycheck too, after all. But that is not so likely when you go with a robo-advisor. In terms of the chain of commands for a robo, your investment goals are set as the foundation for every transaction and trade. What’s more is all this is done at a much lower cost than a traditional advisor. With a robo-advisor, you will pay much lower fees to have an advisor work for you around the clock with transparency that is beyond what a human advisor can match.

Financial Advisors Have Their Pocket At Heart

Advisor’s compensation is a major reason why a human advisor’s interests can deviate from yours. Almost all advisors charge a fee for the assets they manage, and this fee can be anywhere between 1% – 3% of the account value. So their primary interest is in increasing the level of funds they are managing for their clients. The more funds they receive, the better their fees will be. A robo –advisor works without human intervention (for the most part) as it employs a software for financial planning, asset allocation options, and investment solutions. Due to the reduced overhead charges, online investment platforms are able to drive their costs much lower – ranging from 0.15% – 0.75% in most cases.

To illustrate how robo-advisors are more cost effective, consider a portfolio worth $50,000. It will generate dollar savings worth $1,200 over a course of 10 years. Comparing a traditional advisor charging management fees of 1% (the lower end of the fee range) and a robo advisor charging 0.50% (towards the higher end of fee range for a robo-advisor), then annual difference will be of $250. If this amount is reinvested into your portfolio at an annual 8% rate with quarterly compounding, the savings will add up to $1,200 over a decade. The analysis is quite conservative though, because typical human advisors charge much more than 1% in fees and most robo-advisors charge less than 40 percentage points in fees. Thus the potential for higher savings over time is much bigger with a robo-advisor.

  Traditional Advisor Robo Advisor Annual savings (with robo) Addition to net return over 10 years(in $)
Fees per year 1% 0.50%  0.50%
Annual Fees (in $) $500 $250  $250.00      $1,200.00

  No Shady Advisor Need.  Transparency Is Clear — And Cheap

Last but not the least, transparency that comes with using a robo-advisor enables you to be in the driving seat. A robo-advisor provides you frequent updates on how your investments are performing and make suggestions to improve the results based on your level of risk tolerance. It is you who call the shots as to how the portfolio needs to be invested. One has easy access to all the reports that show where your money is invested and how much you are paying in fees and other expense ratios – all just a few clicks away! On the contrary, traditional advisory services are not optimized from the perspective of the investor. They do report on investment performance, but the reporting is far less frequent.

Advisory business has not been meant to educate the investors to help them make the decisions; rather, it is about getting investors to invest with them and let them make the decisions for you. Nobody knows your financial goals better than you do; so keep your focus on the investment goals, use a web-based advisor, and enjoy smooth sailing from there on out.

an intro to stocks and bonds

New to Investing? An Intro To Stocks & Bonds

When it comes to your hard earned, most valuable asset – money – it pays to get acquainted with the tools and ways to increase it in value over time aka investing. Most people who do not have a financial background often decide to put their money in a savings account, earn interest on it, and sleep peacefully. But here lies the problem: it’s not the 1980’s anymore where average interest rate on a 5 year CD was well over 7% (source: bankrate.com). With all-time low interest rates, by putting money in a savings account, you will either see the value of your savings account stay the same – or worse deplete with time. This is the hard reality of a post financial crisis world. But there is hope. Everyone can gain the financial know-how to start investing their money prudently and that is the aim of this article today – to introduce you to the world of stocks and bonds.

Stocks Explained

A stock is a security that represents your piece of ownership in a corporation and represents your portion of claim on its assets and earnings. There are two main types of stocks.

  • Common shares – this is what most people purchase when investing in stocks. A common stock grants an investor voting rights and a claim on dividend payments.
  • Preferred shares – although do not grant voting rights in a corporation, preferred shares have a higher claim on a company’s assets and earnings than common shares and allow its investors to receive dividend payments. In a bankruptcy/liquidation event, preferred shareholders are given priority over common shareholders. Thus, common shares are riskier than preferred shares as they are subjugated in rights to preferred shares, but they also offer more reward (more on the risk-reward trade-off in subsequent posts, so stay tuned).

Bonds Explained

A bond is a fixed income security that guarantees principal repayment at the end of the term of the bond and make semiannual interest payments. By investing in a bond, an investor lends money to an entity at a specified interest rate — much like a loan.  The entity could be a government, a corporation, or a municipality. There are many variants of bonds that offer much higher returns, but at the cost of higher risk. A bond is a great income generating security and should be considered a part of every investor’s portfolio.

Which one to invest in?

So how can you decide where to park your investments: bonds or stocks? It depends how much risk you are willing to take on. Bonds are less risky than stocks as generally speaking, bonds do not have a lot of inherent volatility.  Once you invest in a bond, you know you will get your payment in full at the end of the term of the bond with periodic interest payments.  So with a bond, you already know from the start what return you can expect from your investment.  Stocks, on the other hand, are a different story.  They provide higher returns than a bond but at the expense of assuming higher risk.  Everyday news is full of reporting on how Dow Jones, S&P500, and Nasdaq performed in a given day.  You know why?  Because stock market moves multiple times in a minute, let alone an hour!  This is not a bad thing by any means.  It reflects the efficiency of a stock market as every piece of new information regarding public company stocks is absorbed and reflected in their respective stock prices.  So when you buy/sell your stocks, the price you pay/get is what the market participants think is the fair value for that stock.  Given the volatility that is inherent in stocks, they offer a higher return than bonds to compensate the investor for taking on more risk.

To get you thinking about stocks and bonds and which one is more appropriate for your portfolio (or both), consider the graph below. It shows the value of $1 invested since 1926 up to 2014. As can be seen, by investing in only stocks, the realized return is multiple folds higher versus investing in only bonds versus not investing at all i.e. staying all cash.

Value of a $1 invested in Jan 1926.  $1 invested in equities would now be worth over $5,000 with an annual compounded return of about 10%.  Based on US equities & bonds (illustrative purposes only)

Stocks are volatile, but they provide a higher risk adjusted return over the long haul than bonds.  This is the ‘risk/reward’ thing you hear about.  Generally the more risk you take, the more return you get in the long term.  Now with a little more knowledge lets answer the original question above; “which one to invest in”.  The answer is both — stocks and bonds.  When you have a long term investment horizon, you should invest more in stocks.  If your investment horizon is shorter you should invest more in bonds.  For example if you are 25 years old and are investing for retirement at 60 you would consider allocation most to stocks.  Perhaps 100% stocks if you don’t mind the risk — your return will likely be higher.  If you are risk adverse you might consider allocating some to bonds like 40% and then 60% to stocks.  On the other hand if you are in retirement, depending on your portfolio for income, you should hold a significant portfolio in bonds which are less volatile.  

No matter what age you are, the sooner you start investing, the better-off you will be down the road.  Having a proper allocation to stocks and bonds is key to maintaining a portfolio that works for you!

If you’ve found this site you’ve probably already heard of a robo-advisor and are looking to get started investing. Robo-advisors have changed the investment landscape. In just the few years since their initial launch they’ve brought smart, low cost, highly transparent investing to everyone. No more fee gouging, or shady financial advice. savings-on-fees-saved-by-robo-advisor-asset-allocation-portfolio The difference between a 1% annual fee, and 0.25% annual fee results in a total savings of over $100,000 over 30 years on a $100,000 investment, assuming a 6% return. So what is a robo-advisor? A robo-advisor is a web based financial service which invests you in a low cost portfolio based on your investment time frame and risk tolerance. Robo-advisors keep their business online which keeps costs low, makes your account easily accessible, and investing super simple. A key here is low costs. Traditional financial advisors often charge fees in excess of 1% and then further invest you in high cost mutual funds that charge another 1% of so in fees – often giving a kickback to financial advisors or their firm. While a percent here and there might not sound like such a big deal, it adds up to a lot over the course of an investment. This chart below by Wealthfront, an excellent robo-advisor, shows how lowering fees from 1% to .25%, a .75% savings, can add up to over $100,000 in 30 years. Many traditional advisors charge a lot more than 1%. Robo-advisors keep the fees low which ultimately brings higher total returns to you. Robo-advisors keep their fees low by investing you in a diverse portfolio of index funds. Their portfolios are created to keep you diversified and not exposed to a single market. Their algorithms allocate you according to your risk tolerance and investment timeframe. Shorter time frames and lower risk tolerances will have you allocated more into bonds, as they are a less volatile asset. Longer duration investors with a higher appetite for risk will be allocated more into stocks that generally have higher returns in the long run, although short term volatility is higher. Either way robo-advisors keep you fully diversified across the globe. The stock and bond holdings used by top robo-advisors such as Betterment or Wealthfront are comprised of low cost index funds often issued by reputable low cost brokerages such as Vanguard or Ishares. This ensures that the index of each asset class is tracked in the lowest cost manner possible. Many Robo-advisors have no minimum With the low fees come no minimums. The top robo-advisors have no account minimum. This is awesome for people just getting started investing with limited funds. Many traditional financial advisors aren’t interested in a few thousand dollars as they have no room to profit. Online brokerages, such as E-trade and Scottrade have an account minimum of $1,000 or so, but charge a trade fee every time you want to buy or sell a fund. The trade fee, while often only $7-10, sounds small but will quickly eat into your returns. With a Robo-advisor investments are ‘hands off’. There is no need to stay up to date on the latest stock market news, attempt to trade stocks and lose sleep while wondering if you made the ‘right’ investment. Robo-advisors are for the ‘set it and forget about it’ investor. The longer you forget about your investment and let the laws of the time value of money work to your advantage, the higher your returns will likely be. To make it simple, robo-advisors can set an automatic deposit so funds are consistently deposited into your account without your need to take a look at it. As I said early on, robo-advisors bring transparency to financial services. Every action they take on your behalf is fully transparent, as is the reasoning behind it. There’s no shadiness, or self-interested action from the robo-advisors. Only action that will benefit you. Robo-advisors offer a low cost investment, that has YOUR benefit at the core. They keep fees low, and make things simple, so you don’t have to worry about investing. I recommend all my friends start investing with a robo-advisor.

What Is A Robo-Advisor?

If you’ve found this site you’ve probably already heard of a robo-advisor and are looking to get started investing.  Robo-advisors have changed the investment landscape.  In just the few years since their initial launch they’ve brought smart, low cost, highly transparent investing to everyone.  No more fee gouging, or shady financial advice.

savings-on-fees-saved-by-robo-advisor-asset-allocation-portfolio

The difference between a 1% annual fee, and 0.25% annual fee results in a total savings of over $100,000 over 30 years on a $100,000 investment, assuming a 6% return.

So what is a robo-advisor?  A robo-advisor is a web based financial service which invests you in a low cost portfolio based on your investment time frame and risk tolerance.  Robo-advisors keep their business online which keeps costs low, makes your account easily accessible, and investing super simple.  A key here is low costs.  Traditional financial advisors often charge fees in excess of 1% and then further invest you in high cost mutual funds that charge another 1% of so in fees – often giving a kickback to financial advisors or their firm.  While a percent here and there might not sound like such a big deal, it adds up to a lot over the course of an investment.  This chart below by Wealthfront, an excellent robo-advisor, shows how lowering fees from 1% to .25%, a .75% savings, can add up to over $100,000 in 30 years.  Many traditional advisors charge a lot more than 1%.  Robo-advisors keep the fees low which ultimately brings higher total returns to you.

Robo-advisors keep their fees low by investing you in a diverse portfolio of index funds.  Their portfolios are created to keep you diversified and not exposed to a single market.  Their algorithms allocate you according to your risk tolerance and investment timeframe.  Shorter time frames and lower risk tolerances will have you allocated more into bonds, as they are a less volatile asset.  Longer duration investors with a higher appetite for risk will be allocated more into stocks that generally have higher returns in the long run, although short term volatility is higher.  Either way robo-advisors keep you fully diversified across the globe.

The stock and bond holdings used by top robo-advisors such as Betterment or Wealthfront are comprised of low cost index funds often issued by reputable low cost brokerages such as Vanguard or Ishares.  This ensures that the index of each asset class is tracked in the lowest cost manner possible.

Many Robo-advisors have no minimum

With the low fees come no minimums.  The top robo-advisors have no account minimum.  This is awesome for people just getting started investing with limited funds.  Many traditional financial advisors aren’t interested in a few thousand dollars as they have no room to profit.  Online brokerages, such as E-trade and Scottrade have an account minimum of $1,000 or so, but charge a trade fee every time you want to buy or sell a fund.  The trade fee, while often only $7-10, sounds small but will quickly eat into your returns.

With a Robo-advisor investments are ‘hands off’.  There is no need to stay up to date on the latest stock market news, attempt to trade stocks and lose sleep while wondering if you made the ‘right’ investment.  Robo-advisors are for the ‘set it and forget about it’ investor.  The longer you forget about your investment and let the laws of the time value of money work to your advantage, the higher your returns will likely be.  To make it simple, robo-advisors can set an automatic deposit so funds are consistently deposited into your account without your need to take a look at it.

As I said early on, robo-advisors bring transparency to financial services.  Every action they take on your behalf is fully transparent, as is the reasoning behind it.  There’s no shadiness, or self-interested action from the robo-advisors.  Only action that will benefit you.

Robo-advisors offer a low cost investment, that has YOUR benefit at the core.  They keep fees low, and make things simple, so you don’t have to worry about investing.  I recommend all my friends start investing with a robo-advisor.