Why Take the Risk…

I had the pleasure of attending one of Dimensional Funds annual advisor conferences in Chicago this past week, although with our weather lately it begs the question why Chicago?! Perhaps I should have held out for a different venue! Chicago weather has lots of folks wondering these days the sanity of living here. The risk of living in this great city is in some ways analogous to investing in the stock market…why take the risk? For much of the year, Chicago’s weather is treacherous. And when it isn’t it is rainy, overcast, cold, windy and basically not very pleasant. You could say that the weather is flat for most of the time, but when it is nice, people’s attitude changes, smiles come to their faces, and they are reminded why they stay here. We get rewarded for our patience in the coming months of June through October.

At the conference I sat through a session featuring Dr. Eugene Fama, the father of modern finance and co-founder of the Dimensional family of funds. Professor Fama has a way of grounding investors in the stock market. Through his research we are reminded of the risks associated with equity investments and the randomness of returns. The simple graph attached illustrates the stock market returns over and above the riskless return investors get from 3 month Treasury bills going back to the great depression. Now there’s a sobering reminder of risk! Yes, you can get rewarded from investing in the stock market, but be prepared for a bumpy ride. Nothing is guaranteed in the stock market except the volatility. It goes up and down, but it doesn’t have to do anything for you during your short tenure as an investor. Now add to this Wall Street’s penchant to keep your money moving by bombarding you with endless advertisements and the subsequent fees that follow your money movements and your chance of improving your rewards from stock investing drop exponentially. That is to say the market may do well, but the average investor’s returns are never much greater than the return of just taking the Treasury bill rate because they chase the next hot stock or mutual fund long past the returns they bring. There are managers out there that beat the market occasionally, but finding them is virtually impossible regardless of the ‘facts’ the brokers may tell you as they make their case for the sale.

I lost a very dear friend a few months ago, a fellow I grew up in the business with for the past 30 years. Walt was a smart guy, a CFA (Certified Financial Analyst) and wrote a market commentary letter for the various firms he worked for over the years. Walt’s job, as he saw it, was to educate investors and give sage advice as to where the markets were heading. He was very good at his job and made a lot of money for himself and the firm. While Walt and I disagreed on many things as we debated the market over the years, I always respected his opinion and tried to trade on his advice from time-to-time. Plus, we both worked in the retail environment and we did agree that we always had to remember to make the sale, markets be damned. On my path to find a better way to navigate the markets ups and downs, I left the retail the environment which has led me to open my firm, Smart Choice Financial Planning. I loved to read Walt’s letters and I have them all from the past 25 years. I pulled one from 17 years ago talking about what may happen should the Fed start to raise interest rates and have attached it for your review. Stocks don’t like it when the Fed begins to raise rates as this gives investors another reason to bail out on a rally and accept the riskless rate offered by Treasuries. The prime rate was 6.25% back in 1994 and Walt expressed concern that should they go much higher the stock market may stall. Fast forward to 2011 when the Fed again is poised to begin raising rates, but this time from a Prime Rate of 3.25%. What does this portend for stocks? While I know from experience that it definitely brings volatility, there seems to be some room on the interest rate front before equity dividend yields drop below Treasury rates. The risk today, of course, is that investors are worn out from recent market crashes and may sell first and ask questions later when the Fed starts to tighten. This is why the first attachment illustrates such extreme market moves. Of course, you will be reminded by watching CNBC and from taking calls from your brokers to sell as that money needs to get in motion to hit those monthly sales quotas. What value can be added from moving the money? Sadly nothing for the investor. Every right move will be offset by wrong timing and you are back to Treasury bill rates again.

So given the debate and the prognostications Walt and I engaged in over the years, the markets grew from 3674 on the Dow in April 1994 to 12,518 as of this writing. Is the stock market overvalued today…probably. Are interest rates too low by historical standards, yes. Can you expect things to get back to the boom-boom years of the 80’s and 90’s soon…the odds don’t favor that. Markets, like the weather in Chicago, tend to stay flat for longs periods of time. The patient investor will be there when the sun shines again and will be rewarded.

Take note of the things you can control, namely, allocations and cost. Adjust your allocations yearly as your life requires. Smart Choice offers you the chance to invest in the very best market based funds available with the Dimensional family at a cost you will not find anywhere in the country. This is how you can add value to your portfolio with the dollars you choose to put at risk.

Rest in peace Walt, I miss you buddy. Send me a sign on what’s coming next…please!