It’s a Good Thing Investing Isn’t Like the Olympics

It’s a Good Thing Investing Isn’t Like the Olympics

By: Tim Maurer Imagine that your entire life revolves around a single performance lasting less than 14 seconds. You’ve sacrificed your youth, close friendships and any semblance of a career in pursuit of validating your Herculean effort on the world’s largest stage. The hopes of your country on your shoulders. Tens of millions of gawkers eager to praise perfection — and condemn anything less. And then. You dork it. That’s precisely what happened to Haitian hurdler Jeffrey Julmis in the Olympic 110-meter semifinal heat when he crashed into the very first hurdle, tumbling violently into the second. Wow. I love the Olympics, the pinnacle of athletic competition. I even see past all the corporate corruption and commercial sensationalism, drinking in every vignette, simply in awe of all that the human body, mind and spirit can accomplish in peak performance. But thank God life isn’t like the Olympics (even for Olympians). We aren’t subject to the imperial thumbs up or down based on a single momentary contest (or even a handful of them). But we’re certainly capable of treating life that way, often to our detriment. Don’t believe me? When was the last time you said (or thought): “This is the most important thing I’ve ever done.” “It’s all leading up to this.” We’re trained to think this way because that narrative is more likely to keep you from switching the channel, more likely to motivate you to buy that car (or house or hair product), all of it promising to be that singular moment or lead you to it. This script is especially common in the world of financial...
Investors Should Re-Examine Annuity Aversion

Investors Should Re-Examine Annuity Aversion

By: Larry Swedroe Numerous academic studies advocate for the partial-to-full annuitization of financial assets. Yet despite the evidence, a majority of investors remain reluctant to annuitize for both behavioral and financial reasons. The reluctance to purchase annuities has been called the “annuity puzzle.” I’ll try to shed some light on why this puzzle exists, as well as offer a solution. Why Or Why Not Annuitize? An annuity is not an investment vehicle; rather, it’s an insurance product that protects individuals from a catastrophic risk; specifically, the risk of running out of money in retirement. It allows an individual to convert a lump-sum payment, or a series of premiums, into a stream of income that continues for life. The annuity’s future payments protect an individual from financial market risk and, more importantly, longevity risk (the risk of outliving your assets). Despite the risk reduction benefits, most individuals still hesitate when it comes to buying annuities. One reason is behavioral. Many investors exhibit what is called “loss aversion.” They feel converting to an annuity “gambles away” their assets should they die earlier than expected, thus leaving their heirs a smaller estate. Another reason is that some investors dislike giving up control of their assets, believing they might do better if the money remained and grew in their investment accounts. In addition, investors can be deterred by the financial restrictions of some annuities. Because most annuities are illiquid and irreversible, assets can’t be accessed should unexpected needs, such as health-related costs, arise. And once assets are converted, the payouts often cease when the annuity holder dies, leaving nothing for bequest purposes. (Note...
Are Mutual Funds “Smart Money”?

Are Mutual Funds “Smart Money”?

By: Larry Swedroe Despite the very long-term trend showing that individual investors are moving assets to passively managed investment vehicles (such as index funds), the vast majority of individual assets are still in the hands of active fund managers. About 70 percent of mutual fund assets are now invested in actively managed funds, although for institutional investors (pension plans and endowments, for instance) that figure is likely now below 60 percent. That means individual investors must have more than 70 percent of their collective investments in actively managed funds. This data – along with evidence demonstrating that the vast majority of actively managed funds persistently underperform and recent studies showing that only about 2 percent of them are generating statistically significant alpha even before taxes – leaves us with an anomaly. Why are so many investors engaged in a losing strategy? There are several likely explanations. The first is that investors are unaware of the evidence, and the fund industry certainly isn’t about to educate them. Instead, it spends huge sums selectively advertising returns. Another likely candidate is that, while investors may be aware of the evidence, they are, on average, overconfident in their ability to reliably select the few future outperformers. Overconfidence is an all-too-human trait, and it has been found to exist even among those with little knowledge or skill in a given field. Some studies have actually found that when it comes to choosing mutual funds, there is such a thing as “smart money.” For example, in his 1996 study, “Another Puzzle: The Growth in Actively Managed Mutual Funds,” which covered the period from 1985 through...
The Fading Benefits of Low Volatility Strategies

The Fading Benefits of Low Volatility Strategies

By: Larry Swedroe Low-volatility strategies have quickly become the darling of many investors, thanks largely to trauma caused by the bear market that arose from the 2008-2009 financial crisis combined with academic research showing that the low-volatility anomaly exists in equity markets around the globe. Earlier this week, we took a detailed look at a 2016 study from David Blitz, “The Value of Low Volatility,” which explored whether low volatility was a unique investment factor or if its performance could be explained by other well-known factors (specifically, value). Today we’ll review some additional research on this issue. A Deeper Dive Into Low Volatility Ronnie Shah, author of the 2011 study “Understanding Low Volatility Strategies: Minimum Variance,” found that for the period 1963 through June 2010, the low-beta strategy had exposure to term risk. Its “loading factor” (degree of exposure) on term risk was a statistically significant 0.09 (with a t-stat of 2.6). As further evidence, Tzee-man Chow, Jason Hsu, Li-lan Kuo and Feifei Li, authors of “A Study of Low-Volatility Portfolio Construction Methods,” which appears in the Summer 2014 issue of The Journal of Portfolio Management, found a correlation of 0.2 between the betting-against-beta factor and the duration factor. Given their positive exposure to term risk, low-volatility stocks have benefited from the cyclical bull market in bonds we have experienced since 1982. That rally can’t be repeated now, with interest rates at historic lows. In addition, the low-volatility factor may not be as unique as Blitz found. Robert Novy-Marx has also examined the low-volatility factor. His 2016 study, “Understanding Defensive Equity,” covered the period 1968 through 2015. Novy-Marx found...
The Costs of Socially Responsible Investing

The Costs of Socially Responsible Investing

By: Larry Swedroe Socially responsible investing (SRI) aligns ethical and financial concerns for investors. SRI has gradually developed over time to include the consideration of firms’ environmental, social and governance (ESG) performance. Of note is that, while SRI has evolved, the original practice of negative screening for the stocks of companies involved in harmful or controversial activities (so-called sin stocks) remains the most common SRI strategy today. Pieter Jan Trinks and Bert Scholtens contribute to the literature on SRI investing with their study, “The Opportunity Cost of Negative Screening in Socially Responsible Investing,” which appears in the May 2015 issue of the Journal of Business Ethics. The authors employed a comparative analysis on 14 potentially controversial issues over the period 1991 through 2012. In contrast to most other studies, they did not rely on broad industry classification, discarding complete industries. Instead, they checked the 14 issues at the level of the individual firm, investigating more than 1,600 stocks (about 7% of the global investment universe, and an even higher 12% of the U.S. equity universe). Their sample population consisted of firms in developed and emerging markets across the world (30% from North America, 28% from Asia, 27% from Europe, 7% from Australasia, 5% from South America and 3% from Africa). It appears that most controversial stocks are from the United States (23%), Australia and Japan (7%), and Canada, India and China (5%). Returns were value-weighted. The issues the authors analyzed in their study were abortion/abortifacients, adult entertainment, alcohol, animal testing, contraceptives, controversial weapons, fur, gambling, genetic engineering, meat, nuclear power, pork, (embryonic) stem cells and tobacco. Some of these...
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