On the Google Sheet, we now have an "Instructions" tab as a quick guide for more novice investors.
Please visit our new website at YieldHunting.com. It has all of our public articles and retirement articles.
Lastly, we now have 85 reviews on our service with nearly all being five-star. If you haven't left a review, we would very much appreciate you doing so. Click the link below which should allow you to write feedback.
We are going to start to separate out the newsletter and manage three real time portfolios: Core, Mini Core, and Flexible. Look for more direction on managing these along with more ideas centered around swapping and deep value. The general objective is to be buy and hold while also taking better advantage of opportunities in specific sectors- avoiding losses in others.
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A Look At How Behaviors Affect Investing
Wealth, this idea of your relationship with money, is really rooted more in a set of behaviors than it is in a particular destination.”
The past six months could be a case study in the behaviors of retail investors and the mistakes many can make. Over the summer 2018, we had a rising market which lifted nearly all boats- benefiting shareholders significantly. That changed swiftly as the fourth quarter began. As it progressed, we saw nearly ALL asset classes fall, and fall significantly, scaring investors in the magnitude.
By December, investors had clearly gone from agitated to downright angry and scared. This is not uncommon. But perhaps investors can be 'taught' to not respond so rashly. We have long been posting pieces to stay calm during significant negative market events. This is both part financial literacy and part behavioral coaching.
The cost of a financial advisor, in my opinion, is more so in the stoppage of certain behavioral reactions rather than the security selection or perhaps even financial planning. The fact is that financial literacy can only be partially mitigated. Even if you read everything that the publications you subscribe to on a daily basis- Seeking Alpha, Wall Street Journal, Barron's, etc- if your true profession is outside of the financial field, you are unlikely to have enough time to fully learn and understand it. That is not to say you couldn't. Anyone can. It is more the timing involved and the inclination or desire.
Financial advisors spend a lot of time trying to educate their clients. But the studies show that the time spent on financial literacy only showed a small positive effect on financial habits. Extraneous factors had results that were similar, and more often greater to, financial education. To put another way, someone who is financially intelligent but cannot contain emotions and is highly impulsive may exhibit as bad, or worse, habits compared to the financially illiterate showing that knowledge on its own is not enough.
Additionally, people who are considered smart in certain fields - doctors, lawyers, software engineers, to name a few- often believe that if they can excel in those fields, they can excel in any field. This is often a dangerous cocktail of arrogance and financial illiteracy.
Overcoming behavioral issues is something that can take years to tackle. In its most simplest form, simply being able to buy when others are selling is one of the most fundamental behavioral traits that must be mastered. And yet, most retail investors have trouble following this most basic rule. Why?
Investment assets are hard earned money that the investor has spent years accumulating. It would effect nearly everyone to see it take a 20%-30% hit in less than 3 months, like we saw in the fourth quarter of 2018.
What Investors Do Wrong Most
Chasing Investment Returns: Most investors screen funds, stocks, etc based on the aspect that is most satisfying to them, returns. But returns in and of themselves tell us virtually nothing about the prospect of future returns. We also see herd mentality with the shiny object being the next hot stock or sector, or even fund. The greater fool theory is the one where people pile in and push up prices until the whole house of cards collapses.
Selecting Investments That Are Far Out Of Their Wheel-House: The growth of the investment universe in the last two decades is nothing short of astounding. Add in the amount of financial information that is available to us on a second by second basis and it is very hard to not let the herd effect your thinking. Thus, we tend to get swayed by those shiny objects and go with our emotions over logic. This is why we've used the JP Morgan quote several times over the last year: "Nothing so undermines your judgement as the sight of your neighbor getting rich.”
Selling During Times Of Market Stress: This is probably the premier "emotions-based reaction" investors make. At the first sign of trouble, they pull the trigger and sell everything and anything. Investors that invariably sell when the markets get volatile are just the types of investors who are likely taking too much risk and/or not conforming to points one and two above. This is why we espouse a portfolio whereby you can take enough risk to reach your goals, but the least amount to achieve them so as to not make this mistake. LDI investing can create a better sense of security letting you ride the volatility but avoid selling low.
What are somethings you can do to avoid these common mistakes?
Learn, learn, learn.... You don't need to be in the financial industry to be an expert. If you make it one of your hobbies to read and learn about the financial industry, over time, you will get it. Spending a few hours a week on learning, asking questions, and research can make you a better investor than the vast majority of retail investors out there (and even a lot of financial advisors). Just beware: sometimes being well informed by reading the WSJ or watching CNBC all day can give the illusion of knowledge.
Get Help! And this doesn't need to be from a financial advisor either. This service is meant to give DIY investors a little nudge in the right direction to fill some gaps in knowledge. And we are in a unique and niche space of closed-end funds combined with financial planning. As we noted above, a little guidance and a little emotional support during difficult times can be well worth the costs in many cases.
Keep it simple! There is no need to venture into the overly complex and risk scaring yourself. Some of the portfolios I see from Morgan Stanley, Presidential Brokerage, UBS, and others are just downright crazy. They typically provide little or no value and in the end, just provide the illusion of doing something unique and specialized to justify the fees.
We believe the future of the asset management space is quickly heading towards holistic investing. We recently penned a piece on LDI (or liability-driven investing) where you match your spending to income production in the portfolio to prevent the investor from ever having to sell a share of anything. We believe this will be the future of wealth management for many in the lower mass affluent space ($1M-$5M in total liquid assets).
Traditional financial planning was such that you took your pile of assets, you invested it into an asset allocation, and then you withdrew 4-5% each year adjusted for inflation (4% Rule). The markets did the rest for you as equities boomed for most of the last three decades and even high quality, low duration bonds netted you 6%. In that environment, it is very easy for your plan to work.
We think we are moving towards a holistic, total-wealth approach where other tools that have normally been shunned are needed. Tools like annuities, whole life insurance policies, and other more esoteric securities like closed-end funds are popular anew. This is a change from the old paradigm of dividend paying stocks and some bond funds. Most investors are not schooled in many of these areas and this is why we think the holistic planning age is upon us now.
We want to reiterate how we plan and execute on those plans for members and clients alike. That is, map out your next few years of spending and aligning the portfolio for your true level of risk.
Below is an illustration for a real managed portfolio. This is just an illustration and should not be used as investment advice or copied without assessing your own risk tolerances and objectives.
The client is a family member, 69 years old. They spend approximately 5.7% per month of portfolio value which is aggressive. Health issues are prevalent and the client believes life expectancy to be slightly below average.
I think this will be a good walk-through of both building a portfolio like this from scratch and the specific building blocks.
One of the most repeated feedback items is on the amount of trading. We often hear something to the tune of "too much trading" or "too much getting in and out of positions." We looked at this account's trading activity which has both a Core Income Portfolio and a Flexible Income Portfolio component, in addition to preferreds and open-end mutual funds. In the last six months, we have conducted just 5 trades related to the Core (less than one per month) and 8 trades related to the Flex portfolio (since starting in November). We also made a few initial buys into preferreds (that will be held for a long time period) as well as the open-end funds. We foresee trading in 2019 to be less than 20 times in aggregate (that is round trips, or buys and sells).
Once established, you could simply let the Core ride and not make the small tweaks and rotational trades that we do each month. Most of those trades make small tilts in the portfolio moving more towards the funds that are cheaper and we think are showing better NAV trends. A member could ignore those and simply hold the Core- perhaps making one or two of the major changes each quarter or even year.
For the new members (especially in the last month) establishing positions today may be much more difficult. Looking at the Google Sheets today shows more 'red' than 'green' meaning more 'sells' than 'buys'. We would be extremely patient in starting out today and move in slowly.
If you are very conservative and not needing the higher income production right away, then I would recommend waiting for the buy flags to flip on the Core before purchasing. If income production is paramount, creating at least footer positions in the 'hold' rated may be prudent along with immediately acquiring the 'buy' rated positions.
We have done some performance attribution on 2018 and will be releasing that shortly when completed. Basically, we outperformed the S&P 500 by nearly 250 bps while our annualized volatility on price was more than 40% below that of the index. On NAV, the risk metrics were even more impressive. The NAV volatility of the Core was almost 80% below that of the S&P 500 in the last year. At the same time we outperformed (again, over the last year).
When we had the discussion of safety on the chat, this is to what we are referring. Now, some of that is a bit illusory as it tends to occur during periods of a rising market- but volatility and downside risk can increase correlations during jumpy periods (like the fourth quarter).
Now, let's get back to our example.
The portfolio totaled $1.184M as of February 24th. The total portfolio produces $67K in income or about $5K per month. This is very close to the annual withdrawal rate.
A side note: This withdrawal rate is far too high, especially for a risk averse or conservative investor. However, the investor has a fully paid off home worth approximately $900K plus a likely short life expectancy.
The 'safe bucket' yields 2.9% and generates $3,322. More importantly, most of it is in pure cash, cash plus, or a Bulletshare ETF that matures at the end of next year. This will supplement the income production generated by the portfolio that is sent out on a monthly basis. Sometime probably in the second half of next year, we will be pooling or selling some shares of a security we believe to be the most expensive in order to purchase the BulletShares Corporate Bond 2020 ETF. The base percentage for the safe bucket is 10% or about 22 months of income need.
The Core Portfolio is about 24% of the total liquid assets ("TLA"). This is well below our stated MAXIMUM (read not recommended) rate of 35% in leveraged products. More on this in a moment. The $284K across 12 positions (the accounts are almost all qualified monies so munis didn't make sense for them) produce nearly $2K per month in income.
The Core piece had been over 32% just a few weeks ago but we toggled it back some (buy and holders can set it and forget it). The high withdrawal rate means we need to be careful with volatility and given this portfolio is only 20% equity, the largest source of volatility will be from the Core. Being cognizant of the income production yield (5.66%) and the withdrawal rate, we took down the Core allocation as much as we could without dropping much below the 5.7%. Much of that reduction went into the open-end bond funds of PIMCO Income (PONAX)and Performance Trust (PTIAX). Once we see valuations become cheap again, we will rotate back from the open-ends to some closed-ends and improve the yield.