John Gardner

Investment Myths & Misconceptions

April 7, 2019 by John Gardner Leave a Comment

The Dirty Dozen investment lies to ignore.

Bonds mature. Stock trades come and go. All options expire. What is timeless in investing are certain principles essential to success. The rules required are non-negotiable if you want long-term investment success. My intent isn’t to scare you, but to encourage all investors, both future and present, to embrace a rules-based approach to investing. We are all either trained or un-trained in our chosen endeavors, including investing. Be disciplined, do the homework, stick to the rules, and, ignore the “lies.” We must separate investment myths and misconceptions from truth. Below, I have listed the “Dirty Dozen”—twelve common fictitious beliefs you may have heard.

1) Investing is easy and a quick way to make money.

You may have heard this myth. And, given the bull market that we are now in, which just turned 10 years old, you may have had thought so yourself. I had a client once decide to go on her own, saying, “Buying stocks is easy! It’s like gambling. It’s fun.” She said that verbatim. Make no mistake, that myth could not be further from the truth. Investing is not easy, and it’s no way to make quick money. Know anyone who quit their job in 1999 to become a “day trader”? I’ve said for 35 years, “Serious money should be managed seriously.” A recent study by the American Enterprise Institute showed that as of last year, over 80% of professional equity fund managers failed to “beat the market” over the last five years.

2) Stocks Are Riskier Than Bonds.

It is understandable that this investment myth is widely believed since the stock market is so volatile. However, over the long term, the U.S. stock market has been remarkably consistent. Since 1926, the rolling 30-year average annual return of the S&P 500 index has averaged 10%. While most bonds have little risk, so can a diversified portfolio of high-quality stocks.

3) Gold Is the Best Investment.

Not true. While gold provides protection against inflation, there is little evidence to suggest it is a better long-term investment than other investments, especially stocks. From 1996 to 2015, gold generated an average annual return of 5.2%, well below the average annual historical return of the S&P 500. From 1970 to 2015, gold averaged a 7.9% annual return, still below the stock market’s historical average return (10%). Like any other asset, gold is only worth what investors are willing to pay for it. Some believed Beanie Babies and Bitcoin were the best investments, too.

4) International Investment Risk Is Too High.

To the contrary, the fact is NOT investing internationally is high-risk. International stocks in combination with U.S. stocks can actually lower risk in an equity portfolio, compared with an all-U.S. portfolio. That’s because historically, the performance of U.S. and international stocks has been somewhat uncorrelated, which reduces risk. Historically, a globally-balanced (hypothetical) portfolio of 70% U.S./30% international equities has produced better risk-adjusted returns and lower volatility than an all-U.S. portfolio.

5) Avoid Market Fluctuations by Investing in Index Funds.

Index funds mirror the market, so this belief cannot be true. Last market crash resulted in the S&P 500, the most popular index fund, falling about 58% (from October of 2007 to March of 2009). The truth is, index funds should lose more in a down market. Since they are not managed, they just passively go along for the ride as bear markets continue to drop month-after-month and year-after-year.

6) I’m Too young to plan for retirement.

It’s never too soon to save or plan for retirement. It can only be too late. Ask a young person, say around 20, if they want to be a multi-millionaire when they retire? Then tell ‘em that after saving $100/week for 40 years they will have over $2,531,000 (assuming a 10% annual rate of return on the investments) when they are 60. Investing small amounts adds up over time. What if only half of that was saved? The real lesson here is the power of compounding.

7) All Investment Advisors Are the Same.

Not all doctors, CPA’s or car mechanics are the same. We all know no two are alike. This myth simply is not true. Experience, education, certifications and designations are just a few factors among investment advisors that can help you identify key differences among investment advisors. The fact is there are many professional attributes that differentiate one advisor from another. Perhaps most beneficial is an advisor who does things in ways best aligned with what you want, in ways you want them done.

8) Timing the market right is required to make money.

One of my Top 10 Investment Tenets is that the key to long-term investing success is time; “It is the amount of time inthe market, not timingthe market, that matters.” There is evidence from investor behavior studies that analyzes “investor vs. investment” returns. The average investor’s returns are less than the investment’s return they owned. How’s that? The investors got out. For the twenty years ending 12/31/2015, the S&P 500 Index averaged 9.85% a year. The average investor in the index only earned 5.19% (according to a January 2019 Dalbar study). Must stay in to win.

9) Good companies are always good stocks.

I call it the “Good company, bad stock” scenario. Just because a company has a recognizable brand or a popular product doesn’t mean the company’s stock will be a good investment. Even the very best company can be a bad stock investment at times. The market reacts to different valuation metrics other than brand popularity. Investors should value stocks based on earnings and revenue growth, company debt levels, and many other fundamental and technical analysis criteria. Chevron Corp, headquartered here in the East Bay, has been long considered a good company; a caring corporate citizen and a worldwide leader in the oil exploration and production industry. However, over the last 10 years its’ stock has substantially underperformed the general stock market. Chevron stock gained a total 85%, while the S&P 500 index is up over 250% over that time.

10) You Can’t Beat the Market.

Yes, you can. As I write this, I am reminded that today is the public birthday of Microsoft Corp. The company’s IPO was March 13, 1986. One thousand dollars invested in the stock then is nearly $1,400,00 today. The same investment in the S&P 500 index (the “market”) is now about $11,000. Just that a portfolio of well selected stocks will beat the market. Warren Buffet has proven that.

11) Stocks that have gone up must come down.

Sure, stocks and the stock market experience declines. Whether more frequent “corrections,” or more infrequent and severe bear market down turns, stocks go down at times. However, the laws of physics do not apply to the stock market, and there is no gravitational force to pull stocks back to even. For example, over 20 years ago, Warren Buffett’s Berkshire Hathaway stock price rose from about $7,400 to over $17,000 per share in just a five-year period. Far from coming back down, the stock has continued its ascent, now over $306,500 (as of 3/15/2019). Dozens or more innovative, well managed, leading companies in growing industries have continually increased in value over many decades.

12) Investing on your own requires being intellectually gifted.

My wife Maya reminds me often that “Common sense isn’t that common.” It is perhaps just knowing yourself and having some common sense that is needed to be a successful investor. You do not need to be a member of Mensa to invest wisely. Isaac Newton was one of the smartest people to ever live. But there’s a big difference between being a smart physicist and smart investor. As many do, Newton learned that the hard way. He got caught up in the first “bubble” in stock market history. From the book on his story, Back in the spring of 1720, Sir Isaac Newton owned shares in the South Sea Company, the hottest stock in England. Sensing that the market was getting out of hand, the great physicist muttered that he ‘could calculate the motions of the heavenly bodies, but not the madness of the people.’ Newton dumped his South Sea shares, pocketing a 100% profit totaling £7,000. But just months later, swept up in the wild enthusiasm of the market, Newton jumped back in at a much higher price, and lost £20,000. That’s more than $4 million today.

“What’s obvious is obviously wrong” is an old investment adage. It implies that knowing just a little will only have you following the crowd like a lemming. Successful investing takes hard work and effort. I hope this article helps increase your investment knowledge and success.

Mutual Funds or ETFs?

March 12, 2019 by John Gardner Leave a Comment

Some decisions in life are simpler than others. Choosing between “paper or plastic” at the supermarket (before California banned single-use plastic bags about a year and a half ago) was a much easier decision than whether to buy or lease a car, or when to start receiving your social security benefits.

In the investment world, however, few decisions are easy. An investment decision being contemplated more and more nowadays is mutual funds or ETFs, which is the right investment choice? The difficulty with the decision between the two investment vehicles is compounded by a general lack of knowledge and understanding, and information that is typically biased by the two sides promoting their respective product. Another factor adding to the difficulty of the decision is the relative youthfulness of ETFs compared to the aged mutual fund industry. There were only about 100 ETFs in existence in 2002. By the end of 2016, there were over 1,700 U.S. issued ETFs, representing $3.4 trillion. Conversely, there are a lot more mutual funds, they have been around a much longer time, and there is nearly six times more money in them than ETFs. The first mutual fund was created in 1924. At the end of 2017, there were nearly 9,400 mutual funds issued in the U.S. In total, the money held in U.S. mutual funds amounted to almost $19 trillion at the end of 2017.

In my effort to help make this investment choice a little simpler, I suggest you consider the two from the perspective of taxes and cost. A third significant consideration when deciding between the two investment products is the flexibility of buying and selling (trading) them. Which is the right choice? A look at mutual funds vs. ETFs from these three perspectives will lend an answer:

#1) Cost

ETFs often have lower fees and expenses. ETF expense ratios are typically lower than mutual fund fees. In 2016, the average expense ratio of index ETFs was just 0.23% compared with a 0.82% average expense ratio of actively managed mutual funds and a 0.27% expense ratio for index equity mutual funds, according to Investment Company Institute. Today the cost difference between the two is even greater as ETFs, on average, cost even less. Many mutual funds include a variety of fees in their expense ratio, including fees to cover marketing and distribution costs. Then there is the “transaction cost”—the cost to get in and/or out of them (buy and sell cost). Today, there are many hundreds of ETFs with NO cost to buy or sell. That is not the case even for “no load” mutual funds.

That impressive out-performance by the dark line (ETF portfolio) is due to very low cost and great tax efficiency. The graphs below depict that. The mutual fund portfolio cost is nearly 9x more than the ETF mix.

The red is a sufficiently diversified mutual fund portfolio allocation. The blue portfolio is the same allocation for a portfolio of ETFs. Even with the same investment asset classes held for same time period and gaining the same annual return on investment, the compounding cost savings in the ETF portfolio will result in a greater overall investment return than the costlier mutual funds. In addition to the lower costs, ETF investments are also much more tax efficient.

#2) Tax Efficiency

ETFs are more tax efficient than mutual funds. ETFs and mutual funds have the same tax consequences when it comes to capital gains taxes and taxes on dividend income. However, investors can control their capital gains from ETFs. You cannot with mutual funds. Like a stock, investors can defer tax on gains from an ETF until they sell it. This is much more tax efficient than mutual fund investments that trigger a capital gain tax liability every year that the fund company sells holdings in the fund at a profit. This is essentially every year. So, the mutual fund owner is paying capital gain taxes even if he/she doesn’t sell anything. That just takes away from the overall return on the investment.

#3) Flexibility

ETFs offer more trading flexibility. ETFs trade like stocks, as they are “listed” on major U.S. stock exchanges. Tick-by-tick, ETFs’ share prices change second-by-second every trading day. At any time in a market trading session, an investor can buy or sell ETF shares. This is significant. Mutual funds, instead, can only be purchased or sold at the end of a trading day—after the market closes and their price is determined (based on Net Asset Value—the value of fund assets minus liabilities divided by the number of shares. Imagine the difference in selling an ETF early in the morning of a big down day versus selling a near identical mutual that same day and forced to receive the end of day price for it. This could easily result in 3 or 4%, or greater difference. Then, think of the other side of this coin. A mutual fund investor on the buy side, again forced to get the end of day price, misses out on any gain in a big up market day. The ETF buyer, able to buy early during the trading session, gets the day’s gains.

I hope this helps you make the right choice between mutual funds and ETFs. Back to the buy or lease, or when start Social Security questions—I consult other professionals for those answers.

Global Markets & Economy

February 9, 2019 by John Gardner Leave a Comment

In part one of my 2019 OUTLOOK, published in last month’s ALIVE Magazine, I offered my forecast for our domestic stock market and economy in 2019. Here, part two completes ERPE’s 2019 OUTLOOK with my expectations for the global markets and economy in the year ahead.

Global Markets

My Global Market Outlook for 2019 is thematically one of increased uncertainty. Uncertainty breeds volatility. Also, I believe, volatility brings opportunity. In 2018, volatility was the world investment market’s dominant driver of investor fear. Price swings were dramatic, especially in the 4th quarter as the year’s global stock market gains were erased in weeks. The role of increasing uncertainty and risk factors for investors pose challenges and opportunities in the year ahead. Although global GDP growth is expected to slow in 2019, economic fundamentals should continue to support earnings growth in equity markets, though most notably in the U.S.

U.S. equities are likely to outperform those in Europe and emerging markets in 2019, as investors face increased volatility amid rising interest rates and trade uncertainty.

U.S. equity return drivers are well supported by several factors, including increases in intended capital expenditures due to U.S. tax reforms, low unemployment, and share buybacks.

Political and economic uncertainty is causing risk aversion among global investors, who are demanding higher risk premia from non-U.S. markets. This risk / reward ratio will potentially lower demand for foreign stocks, which I expect to lead to attractive valuations in global companies. Security analysis will prove critical to investment returns resulting in an advantage to single stock selection over prepackaged funds. Any U.S. dollar weakness, downside surprises on U.S. economic growth, signs of Federal Reserve dovishness or a greater impact from China’s looser fiscal and monetary policy stance, could provide a catalyst for emerging markets and other global stock markets to strengthen.

Europe

European equities continue to be hamstrung by regional politics. Leaders in countries such as Germany, France and the UK are preoccupied with their own political survival. Brexit and the immediate financial risks presented by countries such as Italy fuel FUD (Fear Uncertainty & Doubt). This has weakened the energy needed to implement much-needed structural reforms aimed at protecting the eurozone from the next crisis. If Brexit negotiations result in a deal and populists fail to dominate May’s European Parliamentary elections, European markets could make progress in the second half of 2019. European growth remains reasonable and the European Central Bank is set to wind down quantitative easing and may even raise rates towards the end of 2019. Looking ahead to 2019 in the euro-zone financial markets, I expect it to overcome that headwind of the economic and political uncertainty and once again improve relative performance. I believe there is a case for global investors to be overweight in stocks in 2019 while remaining alert to increased tail risks. In such an environment, I recommend maintaining a global strategy as part of an overall investment portfolio allocation. Stay focused on stocks and regions with defensive characteristics, own companies likely to benefit from US economic tailwinds.

Japan

Japanese equities stand out as attractive, looking ahead in 2019. Japanese growth should see a boost from reconstruction efforts following a year of natural disasters in 2018, along with construction work ramping up for the 2020 Olympics. The Summer Games will be held in Tokyo. The tight labor market should provide a boost to consumption as wages start to rise. This should also bode well for capital expenditure as companies try to improve labor productivity. A key Japan event will be the consumption tax hike that is scheduled for October 2019. I expect Japanese bond yields to gradually edge up from a very low base, as inflation continues to slowly move higher. As was the case in 2018, the consumer will have a major impact on Japan in 2019.

Emerging Markets

Emerging markets (EM) relative equity valuations traded at all-time lows in 2018, with a discount to developed markets of roughly 70%, against a backdrop of trade conflict, idiosyncratic issues in countries such as Turkey and Argentina, fear of contagion and concerns about Chinese banks. Trade tariffs concerns took their toll, too. While the Fed continues to tighten monetary policy and the U.S. dollar remains strong, emerging markets are likely to struggle in aggregate. Earnings-per-share estimates continue to trend downwards for 2019 and will need to stabilize before strength in EM returns. Specific EM opportunities, namely China, could emerge later in 2019, if the risks already priced in to markets do not materialize. China has responded to the trade war with the U.S. by loosening monetary policy to stimulate demand, while Chinese banks are trading close to the low levels not seen since the global financial crisis of 2008. Chinese equity valuations in general are very low. However, Chinese retail sales rose 9% year-on-year in September, and fixed capital investment (think investments in factories and infrastructure) has gone from roughly 44% of GDP to 48% in just five years. As I said in my 2018 OUTLOOK, China, in my opinion, remains positive. Trade and tariffs will tell.

The winds of change are already blowing strongly on the global economic landscape. I expected global growth to slow this year, and that is being manifested now. Global markets are still vulnerable to fears that a downturn is near, even as the real risk of a U.S. recession is low in 2019. A general slowdown in the pace of world economic growth will not necessarily be the end of global economic expansion.

The takeaway is with increased uncertainty in 2019 there will be an increase in volatility, as already seen in the first days of the new year. With that will come investment opportunity.

Invest wisely.

Winds of Change

January 9, 2019 by John Gardner Leave a Comment

2019 Outlook: Winds of Change

Tailwinds of tax cuts and strong earnings shifted to headwinds of trade tariffs, global economic slowdown and tighter monetary policy in 2018. What does it mean for 2019?

U.S. Stock Market

Gauging the investment and economic climate is always challenging—at least it has been for me over the last 35 years. But, ’tis the season! It is with every new year that economists, research analysts, market experts and my type, portfolio managers, offer their outlook and forecast for the year ahead.

Even as this year’s theme is Winds of Change, the truth is, the weather is easier to forecast than the stock market. While I wouldn’t trade my job to be a weather man, the weather’s wind predictions might have a higher success rate than foretelling the changing winds moving the stock market. With that, back to my job.

This is my outlook for the U.S. stock market in 2019, along with a view of the U.S. economy. My 2019 outlook for the global markets and economy will appear in ALIVE next month.

What I know…

In March, the bull market we have enjoyed turns ten. It is the longest bull market in history. It is instructive to remember what Sir John Templeton said about bull markets. “Bull markets are born out of pessimism, grow on skepticism, mature on optimism and die on euphoria,” he said. Euphoria is an emotion that leads to greed and excess. That makes for the most helpless animal of the Wall Street bunch; pigs. According to the Chinese calendar, 2019 is the Year of the Pig. Coincidence? Essentially, bull markets don’t end of old age; they end with piggishness. Let’s remember, “Bulls can make money and bears can make money, but pigs get slaughtered.” That old Wall Street sage sounds grim, but it’s true. So, let’s not be the pig.

We know that investor sentiment, a key psychological indicator of the stock market, is far from euphoric. In fact, the “Bull/Bear Barometer” has flashed decreasing bullish and increasing bearish sentiment since early October. This development is good; it’s bullish, from a contrarian perspective. Simply put, in contrarian thinking, bad is good and good is bad. Therefore, it is bullish that market sentiment has recently turned bearish. What caused the market sentiment swing that began in early October? The tailwinds of tax cuts and strong earnings shifted to headwinds of trade tariffs, global economic slowdown and tighter monetary policy. We also know stocks’ historically strong post-midterm-election performance trend is a tailwind, but mounting trade uncertainty and the political landscape have created offsetting headwinds. Discipline around diversification and rebalancing will be important in 2019. Recession risk is rising, and we know stocks historically have posted their weakest performance during the six months leading up to recessions. Over the last 50 years, U.S. equities have never peaked more than 13 months before an economic recession, so if we learn in the near term that the market topped with its October highs, the next recession is no sooner than late 2019.

What I think…

Earnings will be key. I expect earnings growth to decelerate sharply in 2019. Year-over-year comparisons will be more challenging relative to the tax-cut-related boost 2018 earnings received. Last year’s fourth quarter volatility was in large part driven by a growing conviction that 2018 would be “peak” earnings for companies. Also, I see the continued strength in the U.S. dollar and the impact of trade tariffs imposing additional headwinds for earnings, even though stock valuations have become more reasonable as prices have dropped. The winds of change affecting the market will further influence investor sentiment, which is likely to move the stock market in 2019, as volatility persists. As I write this 2019 OUTLOOK, the major U.S. stock indexes are struggling to recapture key support levels. After slicing through their respective 200-day moving averages, the major market indexes have attempted—and twice failed—to climb back above those meaningful levels. Having clearly fallen enough to be in “correction” mode, the looming question is: will the U.S. stock market fall further into the throes of a bear market? I don’t think so. With the notion that bull markets do not simply die of old age, as a strategist I think it is too early to become overly defensive given that 2020 seems the recession danger zone. Ultimately, stock prices are all about earnings. Adopting the consensus view, I expect earnings growth to drop significantly from last year’s growth rate. With a forecast of 9% earnings growth for the S&P 500 in 2019, I have a price target of 3000 for the major index—not bad from the current level of 2600 in mid-December, but for proper perspective, only a 2% price gain from 2940 in early October. Do the potential returns justify the risks? It’s the most fundamental investment question. I think they do. Again, as said above, discipline around diversification and rebalancing will be important in 2019 to contend successfully with the winds of change.

The U.S. Economy

As some think 2018 was a peak earnings year, some also think the U.S. economy is now as good as it gets for the cycle. Real GDP growth in the middle quarters of 2018 logged north of 3%, roughly double the estimate of the U.S. economy’s long-term potential at the year’s start. Earnings growth for the S&P 500 index has been 25% or higher in every quarter this year (through Q3) – a remarkable rate seen usually when coming out of recessions. And, the unemployment rate stands near a 50-year low. U.S. fundamentals are unequivocally strong right now.

Interest Rates: 1 & 4, or 1 & no more? The inference is, will the Fed raise their key federal funds rate one more time in late December, as they have signaled, and hike four more times in 2019, or will they raise one and be done (with no rate increases in ’19)? That’s the great debate over the Fed’s target interest rate. Certainly “ZIRP” (zero interest rate policy) is a thing of the past as the Fed has raised rates eight times since December of 2015. Many believed through most of 2018 that the Federal Reserve was on a mission to get interest rates to normal levels. ZIRP was far from normal and so is today’s still low rate level. Interest rates in the United States averaged 5.70% from 1971 until 2006, reaching an all-time high of 20% in March of 1980 and a record low of 0.25% in December of 2008. As I write this is mid-December, I see the Fed’s playbook as “1 + 1 = done”. They will hike rates late December 2018 and at the June 2019 scheduled FOMC meeting. The wild card? Chairman Jerome Powell & Co. at the Fed decide NOT to raise in December…

Inflation: Labor costs are the biggest component of inflation in the U.S. With unemployment near 50-year lows, labor costs can only go up. Expect this in 2019, and inflation pressures to ensue. As I said this time last year, the jobs market is just too strong for another year of below average inflation measured by the CPI (Consumer Price Index). Historically, inflation has averaged about 3.2%. As of late 2018, the “core” rate — all prices except food and energy — picked up to a 2.2% yearly rate. This rate will likely edge up to near 3% by the end of 2019 as the economic expansion generates small inflationary pressures, the healthy jobs market being the catalyst. Speaking of health, U.S. health care inflation rate was at 2.03% (2018), compared to 1.68% last year (2017). This is lower than the long-term average of 5.32%. Expect inflation approaching 3% in 2019.

Look for Part 2 of my 2019 Outlook: Global Markets and Economy, in February’s ALIVE Magazine.

HAPPY & HEALTHY NEW YEAR! 8Z

Part 2 of the Investment Planning Process: Steps 4—6

December 9, 2018 by John Gardner Leave a Comment

My father, one of the best stock investors I have ever known, used to frequently remind me of what he called the “7 P’s.” This is how it went: “Proper Prior Planning Prevents P_ _ _ Poor Performance.” You can probably guess the 5th P. He found a way to hit me with that every chance he had. It applied to school, sports, work, and all elsewhere performance mattered. It matters a lot with respect to investing. So, over the last 34 years as a professional investment advisor, I have developed a simple and effective process to a successful investment plan.

Charles Kettering, a legendary American inventor said, “I expect to spend the rest of my life in the future. That is my reason for planning.” As I noted inpart one, investment planning is a process. In part one, last month’s column, I elaborated on the first three steps of the six-step process: Learn About You (or know yourself if you’rea DIY’r), Set Investment Goals, and, Review Existing Assets. The remaining threesteps of the investment planning process are: Understanding Investment Selection and Allocation, Prudent Investment Decisions Making,and, last but not least, the ongoing step called Portfolio Monitoring.

Step 4:Understanding Investment Selection &Allocation

When considering investments, it is critical to thoroughly understand both the risks and rewards, and how to strategically use them to achieve your goals. Again, the process. The investment planning processoften involves an understanding of strategic investment concepts. Even a conservative investor seeking safety and income from high quality bonds is well advised to adopt effective bond portfolio management techniques. A laddered portfolio, for example, will minimize interest rate risk and maximize returns. There is a learning curve. Investment planning requires homework. I will never say it is easy—much like anything in life worthy of our time and money. Approach thetask as the steward of your estate while considering what is at stake. Once the concepts of the process are understood, then prudent investment selection can take place. That is the next step.

Step 5: Make Suitable Investments

As a Certified Financial Planner^® and aCertified Portfolio Manager^®, I rely on the blend of unique skill sets when working on Step 5 of the investment planning process. With the benefit of learning from the first three steps of the process, along with a careful analysis of a person’s current portfolio and an educational discussion of prudent alternatives; strategic, unemotional decisions are made. Two of my ten investment tenets are “Know Yourself” and “Go With What You Know.” I prescribe a healthy dose of both as they relate to this step of the investment planning process. “Invest-sense” is a term I use to imply the combination of intuitive common sense and a sound psychology necessary to enable an individual to be a successful investor. The simple awareness of what you trust, buy, use, and like can lead to a common-sense approach to investing. Only you know best your unique investment parameters and constraints. They will guide you in making the right investment choices.

Step 6: Monitor Your Plan

Indeed, in and of itself, the investment planning process is a never-ending process. At the very least, it involves as one step the ongoing monitoring efforts of the investments held. To ensure you meet your goals, the on-going monitoring process will be comprised of the three “E’s”: Evaluate, Educate and Exchange. Through consistent review of your account’s positions and performance you will determine if any reallocation is necessary. All changes are made pragmatically, not emotionally. I am often asked, “How is the market doing?” In response I like to ask perhaps a better question. That is, “How is your investment plan doing?” So long as your investment plan is on track, the investment markets matter less. Stocks, nor any other single investment class, should define our entire investment plan.

Throughout the investment planning process keep this investment tenet in mind: Every seasoned investor knows two hard-learned lessons about risk and returns: If you focus on risks, the returns will eventually come to you. If you focus on returns, the risks will eventually come to you. Strive to minimize the risk inherent in all investments before chasing returns.

Happy & Heathy Holiday Wishes to All!

Investment Planning: A 2-Part Series

November 10, 2018 by John Gardner Leave a Comment

Investing is a process. It starts with a rule book that states your investment plan. This is often referred to as an Investment Policy Statement (ISP). Your ISP should clearly state your general investment goals and objectives, serving as a guide that will govern how your assets are managed. I view the investment planning process as a fluid, six-step check list. The process is essentially an ongoing, lifetime effort. It requires discipline.

I believe a proper investment plan, over time, leads to wealth accumulation and preservation. It is this time in the investment markets, not “market timing,” that results in a secure financial future. Maintaining a long-term, strategic investment plan consistent with your unique investment constraints and parameters will likely deliver returns far superior to “playing the market.”

I am happy to share my experience and thoughts regarding the investment planning process. I will do this in a 2-part series. Today’s article, part 1, will cover the first three steps of the process. I hope you enjoy. Look for part 2 in December’s issue of ALIVE Magazine.

Step 1, as the diagram above shows, is to “Learn About You.” This is critically important if you seek advice from a qualified investment professional. Even if you are a “DYI’r,” choosing to do it yourself, this first step requires that you honestly assess yourself as an investor. For example, one of my favorite questions working with a new client at this early stage is (and one of the most basic), “Are you a loaner or an owner?” In other words, a saver or an investor. This question leads to a conversation about a fundamental trait about the individual. A “loaner”/saver is someone who is ultra conservative, seeking safety and income. CD’s, bonds, bank deposits are the suitable securities for this person. On the other hand, the “owner”/investor is a person who can tolerate some degree of risk to have equity in an investment for a desired higher potential return. My dad, for example, once told me that if I didn’t want any risk, put money in the bank and get some interest. If, instead, I could handle the risk for the chance of a much greater return, then buy the bank stock.

There are many other variables about your “investor-self” you need to recognize and/or your advisor needs to discover about you. I have often said since my early years as an advisor, “I seek to understand before I am understood.” It is imperative that your advisor learns about all the needs and concerns unique to you as an investor.

Step 2 is “Set Investment Goals.” This step should be expressed in your Investment Policy Statement that you write, with or without an advisor. It will establish your investment goals and objectives and direct all investment decisions. Creating your IPS provides guidance for informed decision-making and serves as both a roadmap to successful investing and a bulwark against potential mistakes or misdeeds. Here your investment time horizon, income needs, and tax considerations are stated. Special attention should be given to describing your risk/return profile, including naming asset classes that should be avoided as well as naming preferred asset classes. For example, an individual may have an IPS stating that by the time he is 60 years old, his job will become optional, and his investments will return $65,000 annually in today’s dollars given a certain rate of inflation.

Step 3: “Review Existing Assets.” In step three I strive to diagnose before I prescribe. A thorough, unbiased evaluation and analysis of a new client’s existing investments is done. This is necessary to avoid investment over-concentration, achieve diversification, and determine whether or not current holdings are suitable relative to risk tolerance and consistent with overall goals and objectives. You need to be able to answer critical questions about your investment accounts such as: How much risk am I taking? Do I have a strategy to avoid large losses? What are all the costs I’m paying? Should my asset allocation change? Is my portfolio diversified enough? How should I rebalance my portfolio? I refer here to investment success defined by the 4-E’s: Educate + Evaluate + Eliminate = Enjoy. As you educate yourself more about the investment process, evaluate what you own, and eliminate the bad, you will enjoy a successful investment plan.

We say when SCUBA diving, “Plan your dive and dive your plan.” As investors, we should say, we “plan our investments and invest in our plan.”

I’m looking forward to sharing Part-2 in December’s ALIVE Magazine. Until then, Happy Thanksgiving!

Covered Call Writing: The 9% solution

October 11, 2018 by John Gardner Leave a Comment

Let’s say you own stock in a company that you like, but you would like it even more if it paid you extra income. Additionally, you might like to reduce your risk in owning the stock. You accomplish both by using a strategy called the “Covered Call Writing Strategy.” Simply put, this is selling the right to buy your stock to the market. The buyer (who is paying you) is the gambler. He/She is betting the stock will go up by a certain amount in a specified time.

The advantages, again, are increased income and decreased risk. The increased income comes from selling (“writing”) a “call” option on your stock. This strategy is conservative and fairly simple. For every 100 shares of stock, you can sell one call option. So, on your 500 shares of ABC stock, for example, you could sell five contrasts. You pick two important variables: the strike price and the expectation date. The strike price is the price you [should be] willing to sell your stock; aka having it “called” away from you. You are obligated to sell your stock at the strike price if called. The expiration date is when the option expires.

Here’s how it works using the hypothetical ABC stock example. Suppose ABC stock is currently trading near $81, you could sell a call option with an $85 “strike” and a December “expiration,” expiring in two months. At this time, the market for that call option is $1.50 per share. Remember, you are selling call option contracts, each one representing 100 shares of your stock. So, in this example you would collect $150 per contract, which is $750 from covering all of your 500 ABC shares. This option income is called the option “premium.”

In this example, the option income equates to an annualized return of 11.11% (6 x (1.50/81). I call this “manufacturing dividends.” If done just once a year with a dividend paying stock, you would get paid five times per year; four dividends and one option premium. Your frequency of receiving cash flow from your stock could increase to 16 times, 12 monthly option premiums plus four quarterly dividends. That’s clearly an increase in stock investment income.

How is your risk decreased? By lowering you stock cost basis by the amount of option premiums you receive. The stock can fall below your original cost basis equal to the option premiums you collected before you have a loss on your investment. However, while you have reduced your downside risk, you have also limited your upside return. This is the “opportunity cost” of the covered call writing strategy (notice I don’t call it risk). Any time your stock rises above your strike price, you could have it called away. That results in a forced sell of your stock. In the ABC example, you may have your stock sold at the $85 strike in the next two months. While you made $5.50 per share ($4 gain from 81 to 85, plus the $1.50 of option premium), which is nearly 7%, you would have missed out on gains over $85. So, if ABC unexpectedly jumped to $105, you would get only $85. Less money was made on the investment; however, money was still made. Not a situation of principal risk, but rather of missed opportunity.

The 9% Solution
When you consider owning a stock that pays a modest dividend, provides a small capital gain, and generates additional income from option premiums, you can see why I call this, “The 9% Solution.” Making $9 on a $100 stock in a year from all three positive inputs is realistic. As mentioned above, the covered call strategy is conservative. Aside from the opportunity loss, there is no principal risk with this strategy. One must never forget, though, that there is always risk of loss of money in a stock investment; regardless of option income that is received.

Not for all investors. Not for all stocks.
We can all think about those great growth stocks, especially now, that seem to just go up and up. The likes of the “FAANG” stocks (Facebook, Apple, Amazon, Netflix, and Google) have been remarkable investments over the last few years that have provided market-crushing returns. They would not have been the ideal type of stock for this strategy. I say, “Let growth grow and cover income stocks for more income.” The best candidates for this strategy are moderate-to-high dividend paying stocks that typically are unlikely to shoot up in price in the short term.

There, of course, are exceptions to these general rules of thumb. The more risk averse, conservative investor is best suited for the covered call strategy. It is not a wise approach for all investors, though. Younger, growth-oriented investors with lots of time on their side should pass. For the rest of us, the covered call writing strategy is a proven, conservative way to approach double-digit returns from stocks year in and year out.

2 Investment Rules to Tune-in To Now

September 3, 2018 by John Gardner Leave a Comment

You’ve heard it all before. Now it’s time to listen.

#1- Know your investor-self

We all have investment parameters and constraints unique to us. Considerations like risk tolerance and tax consequences are two common investment parameters. Time and money are investment constraints. You may be fed up with work and want to retire tomorrow, but with the cost of living so high, you may not have enough money for a secure retirement just yet. You must know your investment parameters and constraints as they should serve to govern how you invest.

What is your risk tolerance? I have found it helpful to ask clients to state their risk by grading it on a scale of 1 to 10. It helps to quantify your risk tolerance. For help with that, I suggest 6 to be the risk “Of the Market,” or the S&P 500. So, a risk number greater than 6 on the scale is saying you are willing to take on more risk than the market index. A more conservative risk tolerance (below 6) is the opposite. An investor’s asset class and investment allocation should be consistent with their risk number.

Your investment income needs, time horizon, and tax consequences also need to be known before you invest. These are critical variables in any sound investment plan. Here is a classic case of less being more, especially in our high tax state: A high income earner in California seeking safe investment income is typically best advised to buy state bond issues (a municipal bond) paying less interest than a comparable corporate bond because the lower interest rate from the “muni” may be higher on a “taxable equivalent yield” basis. So he would earn less interest, but keep more income net of taxes.

The results of the answers to your investor-self should be clearly and simply reflected in your personal Investment Policy Statement (IPS). If you are not a DIY investor, be sure to only have an investment advisor who provides you with an IPS.

#2 – Know your investments

The one constant element inherent in all investments is risk. Bernard Baruch said, “There is no such thing as an investment without risk.” Know your investment risks. Bonds fall as interest rates rise. Stocks can decline dramatically due to market and unique risk. Even CD’s, or other short-term time deposits have risk. This is not the risk of principle loss, but what’s called, “Opportunity Risk.” That is the risk of not receiving a greater return, especially over a long-term. Even a U.S. guaranteed government obligation has the risk of losing money if sold before it matures.

The risk list is long. There are currency risks, political risks, market risks, systematic risks, timing risks, and as mentioned, interest rate risk, which is related to inflation risk. Market and economic risks are manageable, so don’t worry. Just know the risks to begin with. “Surprise!!” Should only be experienced at your unexpected party, not in your investment portfolio.

All investments have costs. Know them. Even “No Load” mutual funds and “Free” ETF’s have costs. In fact, these fund’s management fees and other expenses combined often exceed 1% per year. They are all disclosed in their prospectus. Like lunch, there are no free investments. Further, low, discount investments and services are often costly. “Caveat Emptor.”

Looking forward to sharing more investment concepts and strategy in next month’s Investor’s Edge column. ~ John

Rules-Based Investing

August 5, 2018 by John Gardner Leave a Comment

Be disciplined and decisive, not arbitrary and emotional.

Investing Tenet #1: Be Disciplined
As a stock investor, a disciplined approach to research, buying and selling rules are critical to success. Achieving long term success requires discipline. It’s life: Whether striving to get in better physical condition, becoming proficient at a new skill, or just managing time more effectively, discipline is required in order to succeed.

Investing Tenet #2: Know Yourself
Legend tells us “Know Thyself” was written on the forecourt of the Temple of Apollo at Delphi by the seven sages of ancient Greece. One of them, Thales, when asked what the most difficult thing was, replied, “To know thyself.”An investor must know him/her-self to be successful. This is the ‘Be true to you’ rule. Knowing your investment parameters and constraints will help you stay true to you.

Investing Tenet #3: Control You Emotions
The one important lesson I want to impart on anyone wishing to invest successfully is: control your emotions. Emotions can be an asset in life, but liability in investing. Successful investing requires a high “EQ” (“Emotional Intelligence”). Greed, fear and hope have no place in investing. Build a plan based on your goals and stick with it. That’s the only story that matters. As Don Hays once said, “Emotions are your worst enemy in the stock market.”

Investing Tenet #4: Time-In, Not Time-ing
Throughout the ’80’s and ’90’s I taught an investment class. “Market timing” was a popular topic with the students. I talked them out of it. A key to successful investing is time; it is the amount of time in, not the timing, that matters. Time in the stock market does two things: It reduces risk and avoids the cost of being out. The longer the time in the market, the lower the risk.

Investing Tenet #5: Process before Product
Investing is a process. In fact, it is a never-ending process. At the least, it involves the ongoing monitoring of investments held. Every investor should understand the investment planning process before buying any investment product. Think, “Put the cart before the horse.” I maintain a six-step process, beginning with clear investment goals and objectives. The last step is “On-going Monitoring,” which is comprised of the “3 E’s”: Evaluate, Educate & Exchange.

Investing Tenet #6: Go With What You Know
Being aware of what you trust, buy, use, and like can lead to a common-sense approach to investing. My “Top Ten Tenets” share one theme: invest-sense. “Invest-sense” is a term I use to imply the combination of intuitive common sense and a sound psychology leading to successful investing. As Warren Buffet puts it, “If you don’t understand it, don’t buy it.” The “go with what you know” tenet is simple and can make investing more engaging. Couple this with more analysis. You have to do the work. Investing requires research.

Investing Tenet #7: Minimize Losses & Maximize Gains
It’s intuitive: Cut your losses. Most of us have heard this before. “Cut your losers; let your winners run.” It may be as common as the basic investment axiom, “Buy low and sell high.” Minimizing losses is a critical, non-negotiable investing rule. Avoiding large losses and holding on for possible extreme gains precludes potentially unrecoverable losses and allows for big winners.

Investing Tenet #8: Concentrate to Accumulation & Diversify for Preservation.
Common wisdom isn’t always the best wisdom. Diversification is common investment wisdom. For some it may not be wise. The opposing investment approach to diversification is “concentration.” Maintaining a ‘less-is-more’ conviction, concentrated stock investors choose to invest a lot of money in a few companies. $1,000,000 evenly invested among 8 – 10 stocks is a concentrated portfolio. The best of the two should be answered by which is best for a specific investor. Too much diversification can dilute profit potential. Too much concentration can be dangerous. Knowing your investor-self will help you with concentration vs. diversification.

Investing Tenet #9: Be Contrary, not Ordinary
Sir John Templeton contends, “To buy when others are despondently selling and to sell when others are euphorically buying takes the greatest courage but provides the greatest profit.” Contrarian investing can feel counter-intuitive. Many think, “buy low and sell high.” The bargain hunting approach is often wrong. A contrarian investor would prefer to “buy high and sell higher.” Contrarian investing was famously expressed by Baron Rothschild, who said “The time to buy is when there’s blood in the streets.”

Investing Tenet #10: Put Risk Before Return
Last on the list, but not in importance, #10 is the heart of my investment philosophy: “Investing is a process that should be based on a disciplined approach to risk management.” As Bernard Baruchsaid, “There is no such thing as an investment that doesn’t have some degree of risk.” Strive to minimize the risk inherent in all investments before chasing returns.
In 1999, 15 years into my career, I compiled my Top 10 Tenets list as I realized the need to establish a reliable, rules-based investment process. These guiding principles have been invaluable to me and I hope they are to you, too.

John is a Certified Financial Planner® and veteran investment advisor and portfolio manager in Blackhawk. He began his career as an investment advisor professional in 1984. For 34years, John has researched stocks, managed equity portfolios and provided strategic investment advice to individuals, families and businesses. John founded Equity Research & Portfolio Evaluation, Inc. (ERPE) in 2001 to provide independent equity research and an unbiased evaluation of investment accounts to high net-worth investors. John has worked closely with employees and executives to prepare for retirement and develop post-retirement investment plans. He is dedicated to providing comprehensive investment advice and unbiased management to individuals consistent with their risk tolerance and objectives to enable them to achieve their investment goals.
John can be reached at 800-925-6496 or by email at jg@erpeinc.com. See more at www.erpeinc.com