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Beware the sales pitch of “downside protection”

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Ben Felix

By Ben Felix, PWL Capital Inc.

Special to the Financial Independence Hub

I often hear the phrase protect your downside. It’s the sales pitch that a large part of the investment management industry thrives on, and it plays to the myopic loss aversion that most investors exhibit.

Myopic loss aversion is the tendency of investors to evaluate their portfolios frequently with greater sensitivity to losses than gains, causing them to act as if their time horizon is much shorter than it actually is.

Let’s look at the example of John, who wants to invest for his retirement 30 years from now. After happily watching his portfolio increase with steady returns for a few years, he panics when the market trends down slightly for a week. He knows he doesn’t plan to touch the money for a long time, but the thought of a decline, even over a relatively short period of time, makes him feel sick. He may even pull his money out of the market until things feel safe again.

Myopic loss aversion

An obvious path to safety would seem to be hiring a person or a company that knows how to protect your downside, and the investment industry has answered this calling. Continue Reading…

Another bad day on markets — try Meditation

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41KxcsypMRL._SX356_BO1,204,203,200_Panicky stock markets in China are spreading to Asia and the rest of the world today. Over the weekend my Twitter feed provided links to various stories arguing the case against panic but clearly there’s extreme anxiety in the air and investors are going to do what they’re going to do.

At the Wall Street Journal, Jason Zweig described five things investors shouldn’t do right now. The New York Times advised Take some deep breaths and don’t do a thing. Here in Canada, the Globe & Mail’s Rob Carrick took a similar stance: Relax, a stock market pullback was overdue.

Deep breaths, relaxing? Sounds a bit like meditation. And that might be as valuable a thing to try right now than a belated attempt to lock the stock market barn after the horse has already escaped.

Here’s a review I did for the FP four years ago of the book illustrated to the left:  The Mindful Investor, Maria Gonzalez. The advice then was that the next time the markets crash, try to calm your mind with meditation. For a video interview I conducted with the author then, click on Mindfulness over Market Matters.

On page 152, the book specifically mentions how to deal with a stock market correction through a relaxation technique. “Once you feel calmer and more stable, you’ll be be better able to listen and make good decisions, ones that aren’t based on panic and fear.”

Of course, the more you watch the carnage through the media and web, the harder this is going to be. You might want to reread Steve Lowrie’s Hub post: Stop reacting to market noise.

Vanguard:  Consider doing nothing at all

Continue Reading…

Retirement – Heaven or Hell?

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Jesus Christ in blue sky with clouds, bright light from heaven, burning doorway in dark red sky, road to hell, way to hell, heaven and hellby Michael Drak

Special to the Financial Independence Hub

Recently, while reading an article relating to the risks of boredom in retirement, I was reminded of a TV show that I had seen more than 40 years ago. I’m always amazed at how something can trigger a memory and we can recall it with such clarity as if we just viewed it yesterday.

The show was a Twilight Zone segment entitled “A Nice Place to Visit.” In it, the main character is Rocky Valentine, a small time thief who is shot during a robbery and passes out. He wakes up and at some point he realizes that he’s in fact dead, but by some mistake he’s in heaven and has been assigned a guardian angel by the name of Mr Pip.

Life for Rocky is great for a while as all his wishes are catered to: there are beautiful women, an expensive penthouse, fancy clothes and all the money he desires. In fact every time he goes to the casino, no matter what game he plays he wins: he can’t lose. But eventually Rocky gets bored of the predictability of his life, the excitement is gone and with that all of the fun.

Finally Rocky pleads with Mr Pip to send him to the other place where he belongs and that he doesn’t deserve to be in heaven. At this point Mr Pip’s says “Whatever gave you the idea that you were in heaven? This is the other place!”

I love the punch line and the lesson here is that Rocky goes crazy because there are no challenges in his life, there is no effort required and there’s nothing to hope for because it all exists as soon as he wants it.

The boredom of endless leisure

Continue Reading…

Weekly Wrap: Dow Theory sell signal?, Electoral goodies for homeowners, will Robos make your dreams come true?

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Mark Hulbert, Marketwatch.com

Influential investment newsletter ranker and market analyst Mark Hulbert says the Dow Theory just flashed a Sell Signal as Thursday’s swooning stock markets closed.

Two of three conditions for a “sell” signal were already in place before this week’s meltdown: the Dow Jones Industrial Average and the Dow Jones Transportation Average both must experience a significant correction from their joint new highs; then in any significant rally attempt following that correction, one or both  Dow averages must fail to rise above their pre-correction highs. As Hulbert notes, the first two conditions were met earlier this year: after sharp declines in January, the Dow Transports were not able to join the Dow Industrials in rising to new highs.

The third condition is that both averages must then drop below their respective correction lows. Hulbert says the “third and final hurdle of a Dow Theory ‘sell’ signal was generated at Thursday’s close when it broke under the low identified in step 1, which was 17,164.95.”

However, Hulbert says not all followers of the Dow Theory are throwing in the towel just yet, at least until the action in the broader S&P500 index confirms the negative action of the far narrower Dow indexes. Hulbert says Jack Schannep, editor of TheDowTheory.com, “acknowledges the original version of the Dow Theory has indeed emitted a ‘sell’ signal” but Schanne’s modified theory that focuses on the S&P500 as well as the Dow averages won’t generate a “Sell” signal until the S&P 500 closes below its January closing level of 1992.67. Even after Thursday’s carnage, the S&P500 was still 2.2% above its January low. Something to watch in Friday’s action: if that occurs, you can expect some pretty gruesome reading in this weekend’s financial pages.

It’s probably a good time to talk to your financial advisor but before taking drastic action of any nature, you might want to go back and read Steve Lowrie’s Hub posts that began each of the last three weeks, such as Stop reacting to Market Noise or Stop feeding on Junk Media.

The commodities sell-off

About the only thing that wasn’t headed south this week is gold, which has been in the doldrums for ages, along with oil and most other commodities. This week’s The Economist has a good summary of the dire situation of the commodities market: The Sell-off in Commodities: Goodbye to all that. It warns “the latest leg down in crude prices may not yet have run its course.”

Continue Reading…

“Of Course . . . But Maybe” — How to cultivate sober second thoughts on various financial decisions

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By Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

Comedian Louis C.K. closed his 2013 comedy special Oh My God with a hilarious (albeit crude) bit called, “Of course . . . but maybe.” I thought it would be fun to apply the same thinking to personal finance and some of the situations we run into every day.

On sense of entitlement

Of course you deserve a vacation. You worked hard all year, and sure, while you didn’t make much progress paying off your credit-card debt, and your New Year’s resolution to reign-in the impulse shopping was busted by February, a week spent soaking up the tropical sun will re-charge your batteries and give you a fresh start on your financial goals.

But maybe you shouldn’t add to your debt-misery by putting that all-inclusive resort vacation on your credit card. Maybe burying your head in the sand won’t make your financial problems go away. Maybe you should hold off on the tropical vacation for a year or two while you get a handle on your finances. Maybe then you can truly say, “I deserve this.”

On education and doing what you love

Of course you should go to University and study whatever you want. Of course you should find your passion, however long it takes. You can be whatever you want. You can do whatever you want. Post-secondary education is an investment in your future.

Related: When doing what you love doesn’t pay the bills

But maybe spending $100,000 and eight-years of your life on that double-major in history and fine arts, only to spend the next few years working as a Starbucks barista, wasn’t the wisest use of your time and money.

On investing in mutual funds

Of course mutual funds offer an easy way for investors to put their hard-earned savings into a diversified basket of stocks and bonds. You can start investing with as little as $25 per month and build up your portfolio without any transaction costs.

But maybe you didn’t notice the annual management expense ratio eating into your returns. Maybe, as Vanguard founder Jack Bogle estimates, the 2.5 per cent a year in fees over a typical investor’s lifetime means that an astounding 80% of compounding returns ends up in the hands of the manager, not the investor. And maybe your financial advisor is really a salesperson in disguise, recommending funds that may not be in your best interest.

On insurance needs

Of course you should buy insurance to protect your loved ones in case something terrible should happen to you. Of course you want to provide for your dependents in case you die or become disabled.

Related: 5 myths about insurance

But maybe asking your insurance broker if you need insurance is like asking your barber if you need a haircut. Maybe if you are single and have no dependents you might not need life insurance. Maybe a simple term life insurance policy that pays off your debts and provides 5-10 years of income for your spouse and children is all the insurance you need. And maybe mortgage life insurance and balance protection insurance really just protect the bank at your expense.

On budgeting and tracking expenses

Of course you don’t need a budget. You have a great handle on your finances. You pay yourself first. You’re debt-free. You live within your means.

But maybe if you spent three months tracking your spending you’d discover several hundred dollars a month worth of unaccounted for expenses in categories such as dining out, gifts, and “miscellaneous.”

On home ownership

Of course you should aspire to own your own home one day. After all, you’re just throwing your money away on rent every month. Why not build up some equity of your own? And with house prices continuing to rise, of course it’s better to get into the market now before you’re priced out forever.

But maybe home ownership isn’t the panacea it’s made out to be. Maybe new expenses, such as property taxes, home maintenance, and lawn care cost more than you thought. A big-fat mortgage means you can’t afford to save for retirement, or even the odd dinner out. It turns out that maybe renting was a lot cheaper and gave you the freedom to pursue and achieve your other financial goals. (See also The Real Cost of Buying Your Home.)

RobbEngenIn addition to running the Boomer & Echo website, Robb Engen is a fee-only financial planner. This article originally ran on his site on August 16th and is republished here with his permission. See also Boomer & Echo’s 5th Anniversary contest, with prizes galore (including a copy of Findependence Day).