Top 10 Good/Bad Things in 2018
My favorite exam in college was a senior economics final. The professor handed out one blue book with one problem: Make a persuasive argument for why the Chinese model of economic growth will be successful. We had 30 minutes. He then handed out another blue book and we now had 30 minutes to make a persuasive argument for why the Chinese model will fail. For me, I was in my element, for I love looking at problems through different lenses and from different perspectives.
As I thought of my 2018 Top 10 list of good and bad things for investors, it was hard to make a case that any were fully GOOD or fully BAD. So, here is my Top 10 list of “Good/Bad” things for investors in 2018. In no particular order:
Increased Volatility of Markets
2018 reminded us that markets go up and down, and sometimes really fast. It is important to keep volatility in perspective.
Good: Volatility increases perceived risk. Increased perceived risk increases return expectations. While we don’t necessarily like volatility, in the long run, it is good for investors who are trying to increase their wealth. See our blog “Are You Getting Queasy with These Markets?”
Bad: Volatility can elicit emotional responses. In the last few months, the Investment Company Institute has reported strong outflows from equity funds. Yet, when markets turn down, it might be time to rebalance back into equities. We saw this trend in 2008-09 as millions of investors left billions of dollars on the table when the markets rebounded in the following years. Short-term, emotion-driven decisions may be costly. Have a plan. Follow it.
The Rise of Interest Rates
In 2018, the Federal Reserve raised short-term rates four times and for the ninth time since 2015. And there are indications that there will be a few more increases in 2019. We have come a long way in 2 years towards “normality,” but long-term interest rates still remain low based on historical averages. (I remember 30-year mortgages well over 10% per year!)
Good: With increased Fed rates, yields on bonds and cash are increasing. A few years ago, it was hard to earn anything on short to intermediate-term bonds with any quality. Now we are looking at rates on 10-year Treasuries approaching 3%. This is good news for more conservative investors.
Bad: Increased rates generally hurt current bond investors (many older folks) as well as dividend-paying stocks, and of course, increase the cost of borrowing which can impact the housing market, company investment plans, and businesses using debt to fund growth. All this may eventually have an impact on the equities market.
The New Tax Law
Technically, this was last year but this is the first year that we are starting to experience it. Overall, it was a good directional change, but for those who think strategically about managing taxes year over year, we have lost many levers. (Perhaps that was one of the goals of the Congress who is collecting record high levels of taxes?)
Good: For smaller clients, preparing for taxes is simpler: most deductions don’t matter in light of the bigger standard deduction, which is a net positive for many middle-class families. For larger clients, estate and gifting exemptions are at historically high levels opening the door for creative estate planning in the coming years. Overall, most clients are paying less taxes.
Bad: There are some people who are paying more in taxes (and they are not necessarily the ultra-rich) as there was a loss of deductions such as charitable giving, property taxes (which are big in Texas!), accounting/investment fees, business-related expenses, etc. And, taxes still remain too complex overall!
The Democratization of Private Investments
The world of private investments is opening up to more investors in several forms. Traditionally used by institutions to diversify away from public markets and to capture the “illiquidity” premium, smaller investors can now gain access.
Good: Smaller investors may be able to tap selected private investments to build more diversified portfolios. We continue to move accredited investors carefully in this direction. These aren’t for everyone, but they do offer some portfolio diversification benefits. See our blog on Private Investments.
Bad: I am seeing a lot of pitchbooks and hearing seemingly attractive radio ads promising high returns with “low-risk”. The new laws and systems that are lowering barriers may also invite increased risk-taking and poor portfolio design. Much caution should be used, and you should seek wise counsel before making any investment. (See our blog, please!)
The Marketing (and Sales) of Complex Products
There are complex strategies that are delivered transparently and efficiently (I generally like these), and then there are complex products that are delivered with opaque investment strategy, significant costs, restrictive conditions, and huge (often undisclosed) fees (I mostly don’t like these). Most investors don’t have degrees in Math or Finance to unravel these products so transparency and liquidity are critical.
Good: (Disclosure) Kings Path uses “factor-based investments.” While “factor-based” strategies by nature are quite complex, they are delivered in efficient, liquid forms (e.g. ETFs, mutual funds) and can be explained on one page (try us!). The leading firms in this arena are often staffed with Nobel Laureates and PhDs and focus on highly diversified strategies that invest in “factors” such as value, quality, low volatility, and momentum. We continue to be excited about how these complex products are being offered with increasing lower costs and more liquidity.
Bad: Contrast this to complex products that are hard to understand, come with high fees, include restrictive terms, and often favor the salesperson or product producer more than the investor. As market volatility (and fear) increases, the promotion of complex products that emphasize “asset or income protection” or “the timing market volatility” increase. You see these with investment options such as Annuities and Structured Products. We can’t say enough to caution investors here. In most cases, you will way overpay for what you might be able to get elsewhere or buy something you may not really need. It is very important for you to seek unbiased (non-commissioned) advice before investing in these. Buyer beware!
Broker/Adviser Regulation and Clarity
Investors need protection. I am typically not a fan of regulation but almost every day I get an email on another Ponzi scheme or athlete/Hollywood star that has been ripped off, or another advisory firm fined for misrepresentations. Clearly, something isn’t working, and the regulators need to fix this.
Good: The SEC and DOL are making strides, and more firms are moving toward greater transparency and disclosure. Still, it is hard to tell if you are being “advised” or “sold”, and if your “adviser” is legally committed to putting your best interests first. So, some progress has been made, but there still isn’t clarity and problems still abound. See our blog “Does Your 'Adviser' Work for You?”
Bad: Consumers/investors need more help. Most don’t understand investment products and even the definition of adviser versus broker (yes, they are different). I believe most people want and need an adviser (and think they have one), but what they are often getting are brokers who aren’t legally bound to put their client’s best interests first. While the broker model is not always bad, it is fraught with conflicts of interest which most investors just don’t understand and therefore cannot manage well.
Increased (Price) Competition
Competition is good. Lower fees are good. We see increased competition for investor money with lower fees on ETFs, mutual funds, and institutional investments. However, we are seeing increased industry concentration. Custodians (e.g. Schwab, Fidelity) have ramped up competition for assets with their “zero” trading fees on an increasingly larger number of ETFs.
Good: Lower fees lead to higher net returns (simple math). Competition for investor money across very similar strategies is good for investor returns. The biggest firms continue to scale and reduce costs to serve. This is good.
Bad: The concentration of managers can create issues by raising barriers to entry, decreasing market efficiency, or causing good investment strategies to be pulled/closed because fees were too low to cover costs. That could be bad for investors. And, price alone shouldn’t be the deciding factor as net returns is more relevant. Finally, “free” generally isn’t free so investors should be cautious when they see these offers.
Increased Influence and Presence of ETFs
The ETF market continues to grow as they offer improved cost- and tax efficiency and generally wide diversification. As an investment vehicle, these continue to steal market share from more expensive mutual funds.
Good: With this increased investment base bid/ask spreads are tightening, and trade volume is increasing. Both are wins for investors who might want more assurances of liquidity. We continue to increase our usage thoughtfully.
Bad: There is an increased presence of speculative and very narrowly-defined products that may encourage too much risk-taking. Investing should be made on solid investment theory and evidence, not creative ticker symbols. See our blog on ETFs.
Traditional Equity Investing
When I speak of traditional equity investing, I am referring to traditional “stock pickers.” Historically, these are the Peter Lynch’s of the world. The world of investing has changed dramatically. Investment managers who think they can outsmart millions of other investors, thousands of hedge fund managers, and a multitude of computer programs that work hard each day to make markets efficient seem to be lost in their hubris. Data/evidence continues to show that a super-majority of traditional active managers fail to beat their benchmarks. (I wish they could, but they don’t, so we generally won’t use them until there is evidence of persistent outperformance.)
Good: Money continues to move away from traditional active management into index funds and systematic funds, so investors appear to be learning and are therefore losing less often while reducing their overall investment fees (and frustrations).
Bad: Traditional equity investors tend to hog the airways. They tell good stories, which the media need. But, the data repeatedly shows very poor performance relative to their benchmarks over most 1-, 3-, 5-, 10-year windows. Yet, investors want to believe and hope, which is not a very good long-term investment approach. See our blog “Gambling on Active Management”.
The Year is Over
At my former university of Texas A&M (whoop!), we have many great traditions. One of these is that A&M never loses - we just run out of time. This is a year when almost every investment class/category is down. Are we losing? No, we are running out of time! It is important to keep a few things in mind:
1) In regard to measuring performance, 12/31 is just a date. There is nothing magical about it, yet we tend to measure returns based on this date. Don’t overweight this day for performance measurement.
2) In regard to tax management, 12/31 is very important. Don’t underweight this day for planning taxes.
3) One year is a very short investment horizon. Keep your eyes on your appropriate investment horizon.
Good: The year is (almost) over. With most markets down for the year, this was/is a good time to review portfolios for rebalancing and tax management strategies. Ups and downs create opportunities to make something good of things that might feel bad. Turn those lemons into lemonade!
Bad: Barring a miracle week, pretty much every asset class is down in 2018: equities domestically and internationally, fixed income domestically and internationally, commodities, etc. My Wall Street Journal (as of 12/26/2018) shows that natural gas, India, pharma, and volatility had gains (a very small list). This is a year when correlations moved toward one and diversification did not provide much protection. It is a humble reminder that portfolio design and performance is a multi-year process.
We tend to get focused on one side of the coin or the other, yet few things are that clear. Investing takes time, perspective, and patience. Each year, there are good things and bad things, still, the world doesn’t end. Didn’t end this year and probably won’t end next year either. Here’s to a great 2019!