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In a June 1999 interview with Businessweek, Warren Buffett is quoted as saying, “Success in investing doesn’t correlate with IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people in trouble investing.”
Michael Mauboussin, director of research at BlueMountain Capital Management (and prior to that, head of global financial strategies at Credit Suisse and chief investment strategist at Legg Mason Capital Management), seems to agree with Buffett. In his book, “More Than You Know,” Mauboussin wrote: “Investment philosophy is really about temperament, not raw intelligence. In fact, a proper temperament will beat high IQ all day long.”
Temperament is critical to successful investing because markets persistently test investor discipline with periods, often long ones, of volatile and/or poor performance. In my more than 20 years of > SEE MORE
Is that you? Are you fortunate enough to be in the tiny minority of people who don’t have a financial care in the world?
If not, I’ll bet you know that person who, to the best of your knowledge, lacks nothing. You probably even have a picture of them in your mind right now.
They’re financially independent. They have all the material possessions they could want, take all the vacations they want, dine wherever they want. They live where they want, in the house that they want, with all the upgrades they want. And they certainly drive the car they want.
All earthly goals … CHECK!
In that case, there’s no need for financial planning, right?
Well, let’s put that question to the test with a simple exercise I believe will deliver meaningful insight, whether you have everything—or not.
Imagine that you wake up tomorrow morning and everything about your life is the same as it was today—your professional calling, your relationships, your interests—except for one thing: Other than the clothes on your back, you have no possessions whatsoever.
How do you feel?
In his book, “The Only Guide You’ll Ever Need for the Right Financial Plan,” Larry Swedroe has a detailed discussion on how investors can choose the right asset allocation for them, with the focus being on determining one’s ability (capacity), willingness (tolerance) and need (the rate of return required to achieve a goal) to take risk.
To help with issues surrounding the willingness to take risk, risk tolerance questionnaires have become a very popular. Unfortunately, as Joachim Klement showed in his article, “Investor Risk Profiling: An Overview,” published in the June 2018 CFA Institute Research Foundation brief “Risk Profiling and Tolerance: Insights for the Private Wealth Manager,” the “current standard process of risk profiling through questionnaires is found to be highly unreliable and typically explains less than 15% of the variation in risky assets between investors. The cause is primarily the design of the questionnaires, which focus on socioeconomic variables and hypothetical scenarios to elicit the investor’s behavior.”
He went on to explain that there are three problems questionnaires typically fail to address: Our genetic predisposition affects our willingness to take on financial risks, the people we interact with shape our views, and the circumstances we experience in our lifetimes—in particular, > SEE MORE
The evidence is clear that investors are waking up to the fact that, while the past performance of actively managed mutual funds has no value as a predictor of future performance, expense ratios do—lower-cost funds persistently outperform higher-cost ones in the same asset class.
That has led many to choose passive strategies, such as indexing, when implementing investment plans because passive funds tend to have lower expense ratios. Within the broad category of passive investment strategies, index funds and ETFs tend to have the lowest expenses.
Based on my experience, most investors tend to believe that all passively managed funds in the same asset class are virtual substitutes for one another (meaning > SEE MORE
News of an escalating trade war between the United States and China dominated headlines late last week as both countries formally imposed substantial tariffs on one another. In response to the Trump administration’s 25 percent tariff on $34 billion worth of Chinese goods (largely industrial and technology products), the Chinese government levied tariffs of equal size on certain U.S. goods (largely agricultural products). The U.S. government is expected to launch a second round of tariffs on China, worth another $16 billion, in the next few weeks. Then on Wednesday, the White House announced it is preparing yet another wave of tariffs targeting China, this time a 10 percent levy on consumer and other goods worth $200 billion, to go into effect sometime after August 30.
This most recent trade conflict follows tariffs of up to 25 percent that the Trump administration imposed in June on steel and aluminum imports from Canada, Mexico and the European Union, who then countered with levies on U.S. exports ranging from maple syrup to Harley-Davidson motorcycles.
The Trump administration’s apparent goal in introducing its various tariff programs is to 1) secure what it sees as a better trade balance, and/or 2) procure more advantageous trade terms by using U.S. tariffs as a tactic for compelling other countries to eventually lower their own tariffs on incoming U.S. products. The administration’s end game, however, is not yet clear, and economists are still trying to sort out the impact the latest round of tariffs ultimately will have.
It is important to point out that, trade terms aside, a negative trade balance isn’t necessarily the same thing as being on the losing side of a trade relationship. Consider the following analogy: You buy (import) produce from, but don’t sell (export) produce to, your local grocer. This opens a negative trade balance with the store. Nevertheless, you probably don’t see yourself as somehow coming out short in a deal where the store gets your cash and you get dinner.
As events unfold, it’s also not clear what impact the Trump administration’s tariff policy will have on the economy. For instance, we don’t know whether even higher tariffs on even more goods imported from even more countries will be levied (or not), or how long reciprocating tariffs could be in effect. In addition, tariffs that in theory should represent only a minor drag on the economy may have an outsized influence, depending on how consumers perceive and respond to them. What we do know is that tariffs raise prices, effectively amounting to a tax on consumers. That is why, in the end, no one “wins” trade wars, making them a detrimental prospect for all involved. We are well aware that such events, however unpredictable, can and will happen. That’s why we build long-term, evidence-based financial plans to anticipate and incorporate market risks.
Before considering any drastic action with your portfolio, it may be helpful to recall that the stock market is forward-looking, so it already has incorporated its best guesses for how the current tariff situation will (and a lengthy trade war would) play out. This information already is reflected in prices. Furthermore, we simply do not know how the game will end. If the Trump administration’s strategy to confront U.S. trade partners works, and all tariffs come down, it would be a huge win for the world, not just domestically. If the strategy precipitates an all-out trade war, it likely would lead to lower economic growth around the world, with the consolation prize being that the U.S. would likely be affected the least.
In a trade war, relatively speaking, the U.S. tends to weather the storm better because trade is a much smaller percentage of U.S. gross national product than it is for most countries. This likely explains much of U.S. stocks’ outperformance year-to-date. In the event of a trade war, small-cap stocks tend to do better than large-cap stocks because, in general, they are exposed to less global trade. Again, this likely helps to explain small-cap stocks’ outperformance year-to-date. Moreover, the dollar tends to strengthen as investors flee to safety and liquidity.
Conversely, international stocks tend to do worse in a trade war, and emerging market stocks tend to do the worst of all because their economies often are more reliant on global trade and their currencies take a hit from investors’ flight to safety. This can be a double whammy for foreign economies, as much of their debt tends to be in dollars (which are appreciating relative to other currencies, making debt financing more expensive). That is exactly what has happened as the risk of a trade war has increased.
If the market anticipates that the odds of a full-blown trade war are rising, investors likely will see more of this type of action. When the odds of a bad outcome seem to decrease, likely the reverse will occur. Indeed, an increasing risk of trade conflict likely explains equities’ relative performance (that is, why U.S. stocks, particularly U.S. small-cap stocks, are outperforming).
Finally, a trade war could forestall the Federal Reserve from further interest rate hikes this year should it become concerned about economic growth. On the other hand, it could lead to spikes in inflation, as not only would the cost of many imports rise, but also the competition for domestic producers would lessen, allowing them to raise prices. We will continue to keep an eye on potential consequences the Trump administration’s tariff policy may have.
In virtually all cases, economic or geopolitical news is not value-relevant information, unless you have a copy of tomorrow’s newspaper. The prudent course of action remains to adhere to your comprehensive financial plan, ignoring speculation in the financial media. The only time you should alter your plan is when your assumptions about your ability, willingness or need to take risk have changed.
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This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them. The opinions expressed by the author are their own and may not accurately reflect those of Beacon Hill Private Wealth LLC. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
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The opinions expressed by featured authors are their own and may not accurately reflect those of Beacon Hill Private Wealth or the BAM Alliance. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2018, The BAM ALLIANCE®
Founder and Private Wealth Advisor
Beacon Hill Private Wealth