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 Financial Happenings Blog 
Thursday, December 17 2015

A common discussion I have with new clients or existing clients adding funds into an existing portfolio is the issue of market entry risk.  This is the risk that you purchase investments at a peak only to see values fall after entry.  A strategy to moderate this risk that I canvas with clients is to spread out this market entry risk through either investing an immediate amount and then dollar cost averaging the remaining funds over a year or two or simply dollar cost averaging over a set period of time.

Jim Parker in his latest article for Dimensional sets out some thinking around this issue including the dollar cost average method I often use.

December 17, 2015

The Deep End
Vice President

Have you ever seen a child standing tentatively at the edge of a swimming pool? She's torn between her desire to join the gang in the water and her fear of diving in. In committing to the market, investors can be like that.

You can always find a reason for not investing. "Perhaps I should wait till after interest rates rise?" goes one line of the thinking. "Or maybe I should delay till there's more clarity on China? Or hold back until after earnings season?"

Emotions and assumptions usually underlay this indecision. The emotion can be anxiety about "making a mistake" or fear of committing at "the wrong time" and suffering regret. The assumption is that there is a perfect time to invest.

Obviously, the ideal solution would be to enter the market just as it bottoms and exit the market right at the top.

But the reality is that precisely timing your exit and entry is close to impossible. If it were easy, millions would be doing it and getting very rich in the process. Instead, the only ones who tend to consistently make money out of market timing are those who write books about it.

The financial media certainly love market timing stories. For one thing, there is always some event or variable they can peg it to—like a decision on interest rates or upcoming earnings or a chart indicator. For another, the idea of timing the market is a powerful one and tends to get readers' attention.

For example, one high-profile US forecaster in early 2012 predicted a 50-70% equity market decline over the following two-to-three years. It was to be a replay of the 2008-09 crisis, he said, but with an even deeper recession.(1)

That turned out to be a bad call. Global equity markets, as measured by the MSCI World Index, delivered a total positive return in Australian dollars of 93% from the end of 2011 to the end of 2014. (2) In USD, it was 53%.

Others advocate more elaborate timing strategies. For instance, one recent academic paper suggested the stock market delivers better returns relative to Treasury bills in the second, fourth and sixth week after each of the US Federal Reserve's policy-setting meetings in a given year. (3)

The idea here is that the Fed leaks information about its interest rate intentions in such a predictable way that, even without the information, savvy investors can make money by just buying stocks in certain periods.

While these theories can be fascinating, it is arguable how many of us have either the time or inclination to try them out. And even if we did, this does not take account of the costs of all the required trades or the possibility that as soon as we implemented the idea it would be arbitraged away.

So ahead of a central bank meeting, some would-be investors fret about whether they should hold off until they see how the market reacts. Others already invested worry whether they should take their money out.

The truth is that for long-term investors, these issues should be irrelevant. What matters is how their portfolios are structured and how they are tracking relative to their chosen goals. Markets will go up and down, security prices will change on news and it makes little sense to second guess them.

But while no one yet has come up with a consistently successful strategy for timing the market to perfection, there are some things that everyone can do to help ease the anxiety they feel about investing.

One is to realise that it does not have to be a choice between being 100% in the market and 100% outside. Ideally, an investor should stick to their strategic asset allocation—be it 70/30 or 60/40 or 50/50 equity/bonds.

Another is that this strategic allocation can be combined with periodic, disciplined rebalancing, in which the investor shifts assets from well performing asset classes to those less favoured. This is a good way of controlling risk without necessarily trying to time the market.

A third option is that there is nothing wrong with investors taking into account the returns they have already enjoyed and adjusting their asset allocations if they are on course to meet their goals. So, for example, for some investors it might make perfect sense to lock in returns after a good period and put the money into short-term fixed income if that meets their needs.

Yet another option is dollar-cost averaging. This is a method where an individual invests small amounts of an available pool of cash into the market over a period, rather than investing a lump sum in one go.

A useful contribution on this subject comes from Ken French, Professor of Finance at the Tuck School of Business at Dartmouth College. In his role as an academic, Professor French says the optimal decision is to invest it all at once. But while this might give an individual the best investment outcome, he says it might not be the best investment experience. (4)

This is because people tend to feel regret more strongly when it results from things they did do than from things they did not. So, for instance, it feels much more painful to buy stocks now and see the price go down than it is to neglect to buy stocks and the price goes up.

Professor French says that by dollar cost averaging, people can diversify their "acts of commission" (the stuff they did do) as opposed to their "acts of omission" (the stuff they didn't do).

"The nice thing is that even if I put my finance professor hat back on, it's really not that damaging to your long-term portfolio to just spread it out over three or four months," he says. "So if you as an investor find that's much more tolerable for you, you're not really doing much harm."

So, in summary, it's always difficult to choose exactly the right time to get into or out of the market. For instance, it would have been nice to get out in late 2007 and back in around early March 2009.

But most mortals are unable to finesse it to that degree. The good news is that there are other options than just staying out of the market altogether and plunging back in.

These include maintaining a long-term strategic asset allocation in the first place, periodically rebalancing, taking money off the table if retirement goals are on track and dollar-cost averaging if that provides comfort.

(1) “Get Set for a Crash, Forecaster Says”, Globe and Mail, 10 January, 2012.

(2) MSCI World Index (net div, AUD), Returns Program

(3)  “Want to Play the Market? Count the Fed Leak Weeks: Study”, Reuters, 21 November, 2015.

(4) Fama/French Forum, “Dollar Cost Averaging”, 23 June, 2009. 

Posted by: Scott Keefer AT 03:36 am   |  Permalink   |  Email
Thursday, October 24 2013

It has been a number of months since we updated the website with Scott Francis' articles published in the Eureka report.  We have now caught up and welcome you to take a look at these pieces - 17 in total.

 

Posted by: Scott Keefer AT 03:54 pm   |  Permalink   |  Email
Friday, May 10 2013

The Association of Superannuation Funds of Australia (ASFA) has just released new data regarding indicative costs in retirement relating to the period ending 31st of March 2013.  The media release suggests that health and energy costs rose over the March quarter whilst food and leisure goods and services fell.

I believe the information provided by ASFA can be useful in 2 key ways:

- assisting clients to determine what their budget should be when reaching retirement
- providing a gauge of inflation for those preparing for or in retirement

The study includes indicative budgets for 4 groups as follows:

A single person with a modest lifestyle                $22,641
A single person with a comfortable lifestyle         $41,169
A couple with a modest lifestyle                         $32,603
A couple with a comfortable lifestyle                  $56,317

When using the breakdown of budgets provided care should be taken in seeing whether they fit your requirements.

In terms of inflation the latest data suggests there has been only slight changes with the two comfortable lifestyle budgets actually falling slightly.  However the annual change was between 2.16% and 3.17% due to a large jump in costs in the September quarter of 2012.

This inflation data can be really useful for assisting with determining what level of total return will be required to meet the goal of making sure assets last long enough through retirement years.

Using this data you can add a required drawdown rate - say 5% - and add the level of fees you are paying - say 1.25% - to work out what you need your portfolio to be generating in total returns - 9.25% using the example data.

This can then be a really useful starting point to see what style of portfolio you require to reach that total return target.  In particular how much risk needs to be incorporated into a portfolio.  In particular, if you are targetting a 9.25% total return, you should be considering what style of portfolio has provided that return through history with the least amount of volatility (risk).

For anyone contemplating or in retirement taking a look at the ASFA Retirement Standard data could be a really valuable use of time and a great starting point for retirement planning.

Regards,
Scott

Posted by: AT 09:21 am   |  Permalink   |  Email
Tuesday, January 08 2013
Happy New Year!!  I hope that 2013 will be a happy, healthy and succesful year for all readers of this blog.

The start of a new year encourages reflections on what happened in 2012 and what is likely to happen next.

Weston Wellington, from Dimensional Fund Advisors in the US in his latest commentary piece reminds us that much of what was predicted for 2012 didn't happen:

  • The plunge off the so-called fiscal cliff was averted.
  • The euro zone did not fall apart.
  • China’s economy and stock market did not crash.
  • The bond market did not implode.
  • The re-election of President Barack Obama did not derail the US market.
  • Doomsday did not arrive on December 21, as some interpreters of the Mayan calendar suggested it would.
It goes to show that trying to predict the future for investment markets is near impossible.  This proposition is backed up by a myriad of historical and contemporary research showing the great difficulty in being successful with an active approach to management of your investments

So if you are prone to try to make such predictions and consequently make big bets with your investment portfolio, go away,  have a cuppa and then come back to your investment portfolio with the objective of a building a portfolio structured for the long term and not on the latest whim.

Weston's full article can be found below.

Regards,
Scott

January 5, 2013
2012: The Year It Didn’t Happen
Vice President

Judging by the headlines in the financial press, investors spent much of the past year anxiously awaiting one calamity after another that failed to occur. The plunge off the so-called fiscal cliff was averted. The euro zone did not fall apart. China’s economy and stock market did not crash. The bond market did not implode. The re-election of President Barack Obama did not derail the US market. The “flash glitch” in early August did not lead to further trading disruptions. Doomsday did not arrive on December 21, as some interpreters of the Mayan calendar suggested it would.

Instead, the belief that owning a share of the world’s businesses is a sensible idea appears to be alive and well, despite suggestions from some observers that the “cult of equity” is dead. For the year, total return was 16.42% for the MSCI World Index in local currency, and 16.00% for the S&P 500 Index. Among forty-five global stock markets tracked by MSCI, only three posted negative results in local currency (Chile, Israel, and Morocco), and twelve markets had total returns in excess of 25%, with Turkey leading the pack at 55.8%. Although much of the financial news over the past year highlighted Europe’s fragile financial health, most of the region’s equity markets outperformed the US, including Austria, Belgium, Denmark, France, Germany, the Netherlands, Sweden, and Switzerland. For US dollar-based investors, results were further enhanced by a modest decline in the US dollar relative to the euro, the Danish krone, and the Swiss franc.

As is so often the case, earning the rewards offered by the world’s capital markets may have required a combination of discipline and detachment that eluded many investors.

2012 Index and Country Performance

Total return (gross dividends) for 12-month period ending December 31, 2012.

MSCI Index Local Currency USD
WORLD 16.42% 16.54%
WORLD ex USA 16.73 17.02
EAFE 17.89 17.90
EMERGING MARKETS 17.39 18.63
EMERGING + FRONTIER MARKETS 17.15 18.35
TURKEY 55.80 64.87
EGYPT 54.66 47.10
BELGIUM 38.56 40.72
PHILIPPINES 38.16 47.56
THAILAND 30.84 34.94
DENMARK 30.37 31.89
GERMANY 30.07 32.10
INDIA 29.96 25.97
HONG KONG 28.01 28.27
POLAND 27.05 40.97
AUSTRIA 25.07 27.02
SOUTH AFRICA 25.07 19.01
COLOMBIA 23.87 35.89
SINGAPORE 23.54 30.99
NEW ZEALAND 23.28 30.38
CHINA 22.85 23.10
JAPAN 21.78 8.36
FRANCE 20.93 22.82
AUSTRALIA 20.77 22.30
MEXICO 20.09 29.06
PERU 19.73 20.24
THE NETHERLANDS 19.35 21.21
SWITZERLAND 18.91 21.47
SWEDEN 17.11 23.41
USA 16.13 16.13
FINLAND 14.71 16.50
KOREA 12.89 21.48
TAIWAN 12.84 17.66
HUNGARY 11.86 22.79
INDONESIA 11.83 5.22
ITALY 11.72 13.46
NORWAY 11.63 19.70
UNITED KINGDOM 10.24 15.30
MALAYSIA 10.23 14.27
BRAZIL 10.14 0.34
RUSSIA 9.73 14.39
CANADA 7.46 9.90
IRELAND 4.66 6.29
GREECE 4.11 5.73
PORTUGAL 3.36 4.98
SPAIN 3.12 4.73
CZECH REPUBLIC 0.26 3.48
CHILE –0.14 8.34
ISRAEL –6.24 –3.91
MOROCCO –12.63 –11.48


Posted by: Scott Keefer AT 11:55 am   |  Permalink   |  Email
Wednesday, November 21 2012
I have recently written in a blog about a problem I have with unitised "big bucket" super funds in pension phase - the way they force you to sell down growth assets at times that might not be ideal to do so.

Scott Francis in his recent Eureka Report - Feeling the pension pinch - thrashes this issue out in greater detail.

The solution is to build a distinct cash hub from where pension payments can be drawn and interest and income can be paid into, supported by a significant defensive fixed interest component.

An investor should never be forced to sell growth assets to pay pension payments at the wrong time.

Regards,
Scott
Posted by: AT 07:22 am   |  Permalink   |  Email
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