Shorting Stocks and the Open Market

In 1984, 33-year-old Gary Kusin started an educational software retailer named Babbage’s. Started in Dallas, Texas, Babbage’s quickly expanded from educational software to focusing on Atari and Nintendo video games. Little did Gary know at the time, but his company would one day become a symbol of a market movement and capture the attention of households, Congress and regulators across the United States. But before we get into what Gary Kusin’s small company became, we need to understand a few key terms and mechanics of a stock market.

Stock markets are exchanges, and in their simplest form are simply open-market auctions. Think Sotheby’s or a local estate auction, where potential buyers raise their paddle until only one buyer remains – but at a much larger scale. Thousands of buyers meet thousands of sellers every day through brokers on stock exchanges,(2) and the items of interest are shares of a company’s stock. Generally, none of the money in these transactions goes to the company; rather the two parties barter for existing shares of the stock. Most of this activity has moved digitally, but the fundamentals are the same: every transaction has a buyer and a seller, and presumably both sides think they are getting a good deal.

Occasionally an investor may see a stock that they believe is overvalued. In other words, they believe that buyers are willing to pay more for that stock than what it is actually worth. For those brave investors who are so convicted that a stock price is trading higher than its true value, a process exists for them to bet against the company. Through a broker, the investor connects with another investor who owns shares of the stock, borrows the shares and then sells them. This is called shorting the stock. Assuming the price of the stock declines, the investor can buy back the shares at a lower price and return them to the lender, pocketing the difference in price. However, just as a bank may monitor a borrower’s creditworthiness, the lender of the shares needs protection to ensure that the borrower will eventually be able to repay the loan. The broker of the deal monitors how much it would cost for the borrower to purchase the shares compared to how much money the investor has available in their account. If the price of the stock rises too much, the broker can demand the investor either put more cash into their account or return the shares. If the investor is forced to return the shares, they must go back out to the market, find a buyer willing to sell, and repurchase them. This, known as a margin call in financial jargon, essentially just protects the lender against someone taking on a loan they can’t repay.

So, what does all this have to do with a software retailer from the 80s? In 1999, fifteen years after being founded, Barnes & Noble purchased Babbage’s for nearly $200 million.(4) Three years later, Babbage’s was combined with other similar retailers, and the company went public under a new name, GameStop.(5) Now, nearly 20 years after going public, GameStop has become a stock market phenomenon with the stock price jumping from $18.84 on December 31, 2020 to $325 at the end of January, a 1,625% jump in a single month.

For those watching the financial media (or social media for the matter), the obvious question is how can this happen? Well, a lot of investors were betting against GameStop at the end of last year – a lot. In fact, every share of GameStop had been borrowed and sold, at least once. In January, more investors started to take interest in buying shares of GameStop, partially spurred by speculative investors in an online forum, and that demand pushed the price of GameStop higher. As the price continued to climb, the investors who had borrowed shares were forced to either put more money into their account or buy shares at a higher price to close their loan. As the price of GameStop’s stock climbed, more investors bought shares to cover their loans, which created more demand for shares of GameStop’s stock, which continued to push the price higher. This phenomenon is called a short squeeze, and the cycle continued throughout January, with the stock hitting a high of $483 on January 28.

What does this all mean for your portfolio? Honestly, not a lot if you are our Investment Management client. You own thousands of stocks to mitigate the risk of any short-term dysfunction of any single name in the markets. Investors who bet against GameStop were wrong, at least for now, and they had to buy a lot of GameStop stock to make up for their error. If margin calls didn’t exist, January may have looked very different for the price of GameStop’s stock. But, margin calls exist to protect lenders and they functioned as expected. Thousands of buyers met thousands of sellers, and they agreed to exchange shares of a stock for an agreed-upon price. And if you are not our client & need to know what it does mean, feel free to contact us.

We know that on any given day, the stock market can look like a casino with random outcomes. But, when viewed over longer horizons, the outcomes are logical. That is why we continue to encourage our clients to look past the daily noise – no matter how entertaining – and keep a long-term focus. And in case you’re wondering, I don’t think that it’s a good time to buy GameStop’s stock.

Sincerely,

Neel Shah

 

Resources: 

This information is for educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. Investing involves risk including loss of principal. Information from sources deemed to be reliable but its accuracy and completeness cannot be guaranteed. IRN-21-1776

Tales from the Crypto: How to Think About Bitcoin

“Everything you don’t understand about money combined with everything you don’t understand about computers.”—HBO’s Last Week Tonight with John Oliver, March 11, 2018

Bitcoin and related cryptocurrencies (now numbering in the thousands) are the subject of much debate and fascination. Given bitcoin’s dramatic price changes, it is not surprising that many are speculating about its possible role in a portfolio.

In its relatively short existence, bitcoin has proved extraordinarily volatile, sometimes gaining or losing more than 40% in price in a month or two. Any asset subject to such sharp swings may be catnip for traders but of limited value either as a reliable medium of exchange (to replace cash) or as a risk-reducing or inflation-hedging asset in a diversified portfolio (to replace bonds).

Assessing the merits of bitcoin as an investment can be problematic. Adding it to a portfolio could mean paring back the allocation to investments such as stocks, property, or fixed income. The owner of stocks or real estate generally expects to receive future income from dividends or rent, even though the size and timing of the payoff may be uncertain. A bondholder generally expects to receive interest payments as well as the return of principal. In contrast, holding bitcoin is similar to holding gold as an investment. Even if bitcoin or gold are held for decades, the owner may never receive more bitcoin or gold, and unlike stocks and bonds, it is not clear that bitcoin offers investors positive expected returns.

Putting aside squabbles over the future value of bitcoin or other cryptocurrencies, there are other issues investors should consider:

  • Bitcoin is not backed by an issuing authority and exists only as computer code,
    generally kept in a so-called “digital wallet,” accessible through a password chosen by the user. Many of us have forgotten or misplaced computer passwords from time to time and have had to contact the sponsor to restore access. No such avenue is available to holders of bitcoin. After a limited number of password attempts, a user can permanently lose access. Since there is no central authority responsible for bitcoin, there is no recourse for the forgetful owner: a recent New York Times article profiled the holder of more than $200 million worth of bitcoin that he can’t retrieve. His anguish
    is apparently not unusual—a prominent cryptocurrency consulting firm estimates that 20% of all outstanding bitcoin represents stranded assets unavailable to their rightful owners.
  • Mt. Gox, a Tokyo-based bitcoin exchange launched in 2010, was at one time the world’s largest bitcoin intermediary, handling over one million accounts in 239 countries and more than 90% of global bitcoin transactions in 2013. It suspended trading and filed for bankruptcy in February 2014, announcing that hundreds of thousands of bitcoins had been lost and likely stolen.
  • The UK Financial Conduct Authority cited a number of concerns as it prohibited the sale of “cryptoasset” investment products to retail investors last year. Among them were the inherent nature of the underlying assets, which have no reliable basis for valuation; the presence of market abuse and financial crimes in cryptoasset trading; extreme price volatility; an inadequate understanding by retail consumers of crypto assets; and the lack of a clear investment need for investment products referencing them

The financial services industry has a long tradition of innovation, and cryptocurrency and the technology surrounding it may someday prove to be a historic breakthrough. For those who enjoy the thrill of speculation, trading bitcoin may hold appeal. But those in search of a sound investment should consider the concerns of the Financial Conduct Authority above before joining the excitement.

By: Weston Wellington
Vice President

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Resources: The opinions expressed are those of the author and are subject to change. The commentary above pertains to bitcoin cryptocurrency. Certain
bitcoin offerings may be considered a security and may have different attributes than those described in this paper. Dimensional does not offer bitcoin.

This material is not to be construed as investment advice or a recommendation to buy or sell any security or currency. Investing involves risks including possible loss of principal. Stocks are subject to market fluctuation and other risks. Bonds are subject to increased risk of loss of principal during periods of rising interest rates and other risks. There is no assurance that any investment strategy will be successful. Diversification does not assure a profit or protect against loss.

The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information
only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide
a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform
themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this
document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.

“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.

UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

How to Avoid a Trust

Asset protection, tax planning, or legacy control are just some of the numerous reasons why trusts can be used. However, the most common use for a trust is to avoid probate, therefore allowing for an easier transition of assets. This is most likely accomplished using a revocable living trust.

For some, it may be important or even desirous to avoid or sidestep the use of a trust. This may be because individual circumstances do not allow for planning using the trust due to factors such as cost considerations.

The benefit of a trust is that it allows the creator to establish their own set of rules, rather than rely on those of a beneficiary designation or probate courts. The biggest detriment of trust planning typically is the creation and fermentation of it. If it is not done properly, it could have disastrous impacts, or at a very minimum, be a waste of time and money to create.

Often, folks will resort to using legal strategies or titling strategies to avoid a trust. This might be done by adding beneficiary designations, transferring on death/payable on death titling, or just including family members or other beneficiaries on title during lifetime. But taking a shortcut is not without its unintended consequences. For example, naming someone as a beneficiary means they will get the asset outright. There is no guarantee that the asset will be protected against creditors, lawsuits, divorcing spouses, etc. Additionally, if the beneficiary were to pass away, you can then see the assets making their way to individuals or organizations who may not have been intended contingent beneficiaries. A trust can prevent that. You may also want to avoid having certain classes of beneficiaries receive assets outright, such as feeling members, receiving government benefits, or have special needs or substance abuse issues. In such cases, one should strongly consider using trust planning.

When asset protection is a concern, one should consider trust planning, but they may also consider using certain legal planning strategies. In many states, life insurance proceeds are protected from creditors and lawsuits. In other states, one’s home may be protected from creditors. Individual retirement accounts are treated differently from state to state, while ERISA governed plans such as most 401(k)s and defined-benefit plans have federal asset protection rules built in already.

If you are not sure if a trust is right for you & would like guidance, please feel free to call us at 732-521-9455. 

YOLO, Meme, and EMH: What’s Your Investment Style?

You only live once! Social media investors have banded together on unconventional platforms to drive up the prices of a handful of “meme stocks,” seemingly without traditional evaluation of investing risks and rewards. They made headlines with their “short squeeze” of GameStop (GME), and, as they garner media attention, their tactics continue. While it’s not the intended victim of the YOLO traders, will the efficient market hypothesis be a casualty of these events? The answer depends a lot on your definition of efficient markets. Perhaps long-term investors would be better served questioning the potential impact on their investment philosophy.

Fama (1970) defines the efficient market hypothesis (EMH) to be the simple statement that prices reflect all available information. The rub is that it doesn’t say how investors should use this information. EMH is silent on the “correct” ways investors should use information and prices should be set. To be testable, EMH needs a companion model: a hypothesis for how markets and investors should behave. This leaves a lot of room for interpretation. Should asset prices be set by rational investors whose only concerns are systematic risk1 and expected returns? It seems implausible to link recent meme-stock
price movements to economic risks. Rather, they seem fueled by investor demand to b part of a social movement, hopes to strike it rich with a lucky stock pick, or plain old schadenfreude.

There is a vast ecosystem of investors, from individuals investing in their own accounts to governments and corporations who invest on behalf of thousands. Ask investors why they invest the way they do, and you’ll likely get a range of goals and approaches just as diverse. It’s this complex system that generates the demand for stocks. Another complex system fuels the supply of stocks. Supply and demand meet at the market price. People may contend that the market is not always efficient, or rational, but the stock market is always in equilibrium. Every trade has two sides, with a seller for every buyer and a profit
for every loss.

There are plenty of well-studied examples that show supply and demand at work. The huge increase in demand for stocks added to a well-tracked index often creates a run-up in the stock price. Some of this price increase can be temporary and reversed once the tremendous liquidity demands at index reconstitution2 are met. Index reconstitution is just one example; instances of liquidity-driven price movements happen all the time. It is well documented that liquidity demands can produce temporary price movements.
Investors may wonder if temporary price dislocations motivated by users of r/
WallStreetBets differ from those caused by changes to an index. Lots of buying puts temporary upward pressure on prices, which later fall back to “fundamental value”–it sounds familiar. The more relevant observation may be that markets are complex systems well adapted to facilitate the supply and demand of numerous market participants.

There are numerous reasons people may be willing to hold different stocks at different expected returns. Can all those differences be explained by risks? Doubtful. To quote Professor Fama, “The point is not that markets are efficient. They’re not. It’s just a model.” EMH can be a very useful model to inform how investors should behave. We believe investing as if markets are efficient is a good philosophy for building long-term wealth. Trying to outguess markets might be a quick way to destroy wealth.

It’s true, you only live once. The good news is that investors can look to market prices, not internet fads, to pursue higher expected returns. Theoretical and empirical research indicate higher expected returns come from lower relative prices and higher future cash flows to investors. Long-run investors can be better served by using markets, rather than chatrooms, for information on expected returns.

– Marlena Lee, PhD
Global Head of Investment Solutions


Resources: The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information
only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.

“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong 2 Dimensional Fund Advisors
Please see the end of this document for important disclosures.

Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.

Named securities may be held in accounts managed by Dimensional. This information should not be considered a recommendation to buy or sell a particular security. Diversification does not protect against loss in declining markets. There is no guarantee strategies will be successful.

Eugene Fama is a member of the Board of Directors of the general partner of, and provides consulting services to Dimensional Fund Advisors LP.

UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Think Investing Is a Game? Stop.

It’s easy to view the stories of market speculation that have dominated the news recently as cautionary tales for individual investors. But we can also look at the current moment as an opportunity to welcome a new group of investors to the market: those who have been drawn in by all the high-stakes action, and yet may want a consistent, long-term investment solution that doesn’t keep them up at night. This is probably a good time to mention that investing and gambling are not the same thing.

If you’re not the type of person who feels comfortable betting your life savings on a long shot, the good news is that you don’t have to find the next big stock to win in the stock market. Concentrating your whole investment on one or two companies means the stakes are high enough to expose you to unnecessary risk. Even if you manage to land a few big winners, our research has found that good luck is unlikely to repeat throughout a lifetime of investing. For every individual who got in and out of a hot stock at the right
time, there’s another who bought or sold at the wrong time. If you treat the market like a casino, not only do you have to pick the right stock, but also the right moment.

I’ve always believed you’re better off betting with the whole market than on individual stocks, through a low-cost, highly diversified portfolio. Then let time and compounding do their work. Compounding is the investor’s best friend: if an investment grows at a rate of 10% a year, that means a dollar invested has doubled every seven years.1 As a point of reference, the S&P 500 has grown at rate of 10.26% since 1926, though it’s worth noting that the path is rarely smooth.

With all the options now available to investors, putting together a solid investment plan —one that you can stick with—is key. Markets have never been so accessible, and information has never been so widely available. And despite the fact that stories of stockmarket gambling keep making the news, many investors have managed to enjoy growth in their investments using low-cost, highly diversified strategies like index funds

Indexing has turned out to be a good solution for many people. I was involved in the creation of one of the first index funds early in my career, and I’ve enjoyed watching the positive impact indexing has had on the industry. For those who want more customization and flexibility, there are ways to build on the strengths of indexing while correcting for some of its weaknesses. At Dimensional, we’ve been working on improving upon indexing for the past 40 years.

If you’re looking to become a long-term investor, commit to a long-term strategy that takes your own personal goals, situation, and risk tolerance into account. (A financial advisor can help with this part.) And remember that although the US stock market has returned about 10% a year on average, returns for individual companies and individual years can vary wildly. (We call these uneven distributions “fat tails.”) It’s always important to look at the big picture. A huge win on a stock bet today doesn’t mean much if you lose it tomorrow.

Investing is a lifelong journey. Making money slowly is much better than making—then losing—money quickly.

– David Booth
Executive Chairman and Founder

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Resources: The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information
only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide
a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform
themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this
document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.

“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are
Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund
Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd, Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong
Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and
does not provide asset management services.

Copyright 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment;
therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

CANADA: These materials have been prepared by Dimensional Fund Advisors Canada ULC. It is provided for educational purposes only,
should not be construed as investment advice or an offer of any security for sale and does not represent a recommendation of any particular
security, strategy or investment product. Commissions, trailing commissions, management fees, and expenses all may be associated with
mutual fund investments. Unless otherwise noted, any indicated total rates of return reflect the historical annual compounded total returns,
including changes in share or unit value and reinvestment of all dividends or other distributions, and do not take into account sales,
2 Dimensional Fund Advisors
Please see the end of this document for important disclosures.
redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Please read
the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be
repeated.

UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Should I convert my Term Life Insurance to Permanent Life Insurance?

The decision as to whether or not to convert from a term policy to a permanent life insurance policy is very fact-specific and dependent upon the family circumstances.

There have been circumstances where term policies were taken for a temporary reason. It may have been because children were younger, or for a business purpose such as a buy/sell policy. However, as the term marches on, or sometimes comes close to expiration, the importance of those temporary reasons varies extremely. For example, if one has a child or spouse who is dependent on the insured and their earning capacity (such as a special needs situation or a nonworking spouse), there might be a need for financial security well after the term would have expired. In this situation, it does make sense to consider a conversion. However, many circumstances must be considered. In addition to the need, the financial means to pay for the insurance is a huge factor. Will the insured or the owner have the capacity to continue paying premiums on a permanent policy, which are generally higher than a term policy. What other insurances are available? What is the health situation of the insured-they qualify for a new policy today?

It is recommended that you do not wait until the end of the term or close to the end of the term to convert a policy if you have already recognized the need for permanent insurance. The insured health circumstance is unpredictable, as it might give rise to an increased premium, or even a lack of insurability, which is a high risk to take. However, if you choose not to convert your policies, you may elect to self-insure. This usually means allocating certain savings for potential future needs. The decision of whether or not to let a term policy expire should be made proactively. It is a factor in one’s financial plan just like any other financial consideration.

Feel free to contact us If you need help deciding whether or not you should convert a term life policy into a whole life, universal life, or other types of life insurance policy”

FANMAG: Because FAANGs Are So Yesterday

KEY TAKEAWAYS

  • FANMAG returns have been extreme relative to their contemporaries, but not their predecessors—their performance has been in line with the average top performers throughout US stock market history.
  • The FANMAGs were the big winners from a broader group of large tech companies, most of whom have lagged the market.
  • Following the popularity of the FAANG stocks, FANMAGs are the current fad. But history suggests fad-based investing is no substitute for broad diversification and a consistent approach.

A handful of large technology stocks have garnered attention for outsize returns in recent years. Collectively referred to by the FANMAG acronym, Facebook, Amazon, Netflix, Microsoft, Apple, and Google (now trading as Alphabet) all substantially outperformed the US market1 in the eight calendar years that they have all been public companies (Facebook went public in May 2012).2 Emerging as winners from among a large number of companies that fared less well during 2013–2020,3 these juggernauts bested most of their surviving peers with annualized outperformance versus the US market ranging from 7.31 (Alphabet) to 42.58 percentage points (Netflix), as shown in Exhibit 1.

While this performance dazzled investors and dominated headlines during 2013–2020, a more complete picture emerges when accounting for the many companies whose investors were less fortunate over the period. As shown in Exhibit 2, of the 10 largest US technology stocks as of January 2013, all but Apple, Microsoft, Alphabet, and Amazon underperformed the US market over the same period that elevated their tech peers to financial market stardom.

Exhibit 3 shows the hypothetical growth of wealth for an investor who put $1 in each of the 10 largest technology stocks and the US market in January 2013. While the $1 invested in Amazon and Apple, for example, would have grown to $12.63 and $7.18, respectively, by November 2020, the returns of their non-FANMAG tech contemporaries would have failed to even surpass the US market.

FANMAG returns certainly stand out among those of their contemporaries, but the range of individual stock outcomes has often been immense. A historical look shows that FANMAG performance has been quite ordinary in the context of past top-of-the-market performers. Drawing on stock return data since 1927, Exhibit 4 indicates that historical top performers often experienced larger outperformance relative to the US market than the FANMAG stocks realized during 2013–2020. For example, Apple’s 2013–2020
annualized excess return of 13.00 percentage points places it at the 93.67 return percentile among all US stocks that were trading in January 2013 and survived the eightyear period that followed. However, the average outperformance of stocks at the 93.67 percentile over eight-year rolling periods from 1927 to 2020 was 15.60 percentage points, or about 2.60 percentage points higher. With the exception of Netflix, the same holds for
the other FANMAG stocks, with historical outperformers at the same return percentile outperforming the market by more than the FANMAG stocks did in 2013–2020.

A defining trait of the FANMAG performance is that these outsize returns have come from among the largest companies in the US, implying they were meaningful contributors to the overall US market’s return. However, historical data show that this too is nothing new.
Defining a stock’s return contribution as its total return weighted by its beginning-ofperiod market capitalization weight, we see that Apple’s contribution to the US market for the period 2013–2020 was 19.68%. How does this figure compare to other top return contributors? Exhibit 5 illustrates the top return contribution and the annualized US market return over rolling eight-year periods since 1927, revealing instances of return contributions by the likes of AT&T, General Motors, and General Electric that were
comparable to, or even exceeded, that of Apple in 2013–2020.

FOTW (FLAVOR OF THE WEEK)
If history is any guide, the FANMAG acronym will eventually be replaced by another trendy name. For example, stock market historians will remember the Nifty Fifty in the 1960s and 70s, a set of 50 blue-chip stocks like Coca-Cola and General Electric. The early 2000s witnessed increasing adoption of the acronym BRIC, representing investment opportunities in the fast-growing emerging economies of Brazil, Russia, India, and China. More recently, the WATCH companies—Walmart, Amazon, Target, Costco, and Home Depot—have also gained traction in the market’s lexicon.

While documenting trends in finance is entertaining, there is little evidence that investors can spot these trends in advance in a way that would enable market-beating performance. Moreover, concentrated bets on high-flying stocks can expose investors to idiosyncratic risks and a wider range of possible outcomes. By contrast, a sound investment approach based on financial science emphasizes the importance of broadly diversified portfolios that provide exposure to a vast array of companies and sectors to help manage risks, increase flexibility in implementation, and increase the reliability of outcomes.

–  Kenneth French, PhD
Director and Consultant

_____________________________________________________________________

Resources: The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information
only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein. “Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund
Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd, Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services. Named securities may be held in accounts managed by Dimensional. This information should not be considered a recommendation to buy or
sell a particular security.
UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
CANADA: These materials have been prepared by Dimensional Fund Advisors Canada ULC. Commissions, trailing commissions, management
fees, and expenses all may be associated with mutual fund investments. Unless otherwise noted, any indicated total rates of return reflect the
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is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

How We Embraced The ‘Swirl’

A Taoist story tells of an old man who accidentally fell into the river rapids leading to a high and dangerous waterfall. Onlookers feared for his life. Miraculously, he came out alive and unharmed downstream at the bottom of the falls. People asked him how he managed to survive.
“I accommodated myself to the water, not the water to me. Without thinking, I allowed myself to be shaped by it. Plunging into the swirl, I came out with the swirl. This is how I survived.”

Think back to March when the government shutdowns were starting. Think about the forecasts and predictions being made.

By late March, the S&P 500 had sold off over 30% of its value from its high in the middle of February, and small caps had sold off even more. Looking back on the markets and the dreary expectations, would you have expected global markets to post double-digit returns for the year? Would you have guessed that emerging market stocks would perform in line with the S&P 500 for the year, with both markets up over 18%?(3) What about small caps? Would you have expected U.S. small cap stocks to return 20% for the year when there was so much uncertainty around whether many of these companies could survive the pandemic?

The changing landscape from COVID benefited companies like Amazon and Zoom, so their growth during the year made sense, but would you have expected Tesla to post such extraordinary gains? The stock closed 2019 at less than $84 per share, but by the end of 2020, it was trading over $700 per share.(5) Tesla was added to the S&P 500 in December with a total market value of over $600 billion, making it the largest stock ever added to the index.(6) Looking back, we would like to believe we saw it coming (or at least that the signs were there), but if we are honest – doubling down on Tesla in January 2020 looked like a bet against the ‘smart money.’ At the end of 2019, roughly one out of every five shares of Tesla were betting on the stock price falling, not going up!

When I look at 2020, I am reminded that whether we are talking about industries or individual stocks, predicting the market is extremely difficult. Some people get lucky, but the skill to have repeat performance is rare. A recent study performed by S&P Dow Jones found that the top-performing funds from June 2010 through June 2015 were more likely to liquidate or change their investment style than to continue to outperform over the next five years. And that is the smart money – these are funds managed by professionals that invest millions in trying to be the best and have the “edge”.

We call this the loser’s game, and we choose not to play it – you are working & have worked too hard to accumulate your wealth. Instead,
  •  We have designed our clients portfolios to flow with the markets, not to time or try to predict the markets;
  • We invest across hundreds of stocks, dozens of countries and all sectors;
  • In 2020, amidst the uncertainty, we rebalanced our client’s portfolios to take advantage of lower prices and (if possible) tax losses harvested to offset capital gains in other areas of your portfolio – we focused on what we could control;
  • We continue to balance the stock risk in your portfolio with high quality fixed income to dampen changes in your total portfolio value; and
  • We stick with the strategy that we decided upon before the emotions took over.
In other words, we plunge with the swirl, and we come out with the swirl – this is how we help you progress towards achieving success with your financial plan.

 

 

 

 

 

 

 

 

 

 

Untangling Intangibles

Many companies use intangible assets such as patents, licenses, computer software, branding, and reputation to earn revenues. These intangible assets have always been part of the economic landscape. We study the impact of intangibles on our ability to identify differences in expected stock returns and find no tangible performance benefit from adjusting for intangibles.

It is important to begin by distinguishing between two types of intangible assets. Under US generally accepted accounting principles (GAAP), externally acquired intangibles are reported on the balance sheet. They currently represent about a quarter of the reported value of assets for the average US company. These assets are accounted for when computing book equity. Internally developed intangibles, on the other hand, are generally not capitalized on the balance sheet. Instead, they are expensed and thus reflected on the income statement. The difference in accounting treatment is primarily due to the higher uncertainty around the potential of internally developed intangibles to provide future benefits and the difficulty to identify and objectively measure such benefits.1 After all, internally developed intangibles do not go through a market assessment, while externally acquired intangibles get evaluated in the competitive market for mergers and acquisitions, and at that time, they might already be generating tangible benefits for the company that developed them. For example, Disney bought the Star Wars franchise, an externally acquired intangible, in 2012, many years after the franchise began generating economic benefits for Lucasfilm.

Some argue that to more effectively infer differences in expected returns across firms sourcing most of their intangibles externally and firms sourcing them mostly internally, we should capitalize internally developed intangibles. Several academic studies do that by accumulating the historical spending on research and development (to capture the development of “knowledge capital”) and selling, general, and administrative (SG&A) expenses (to capture the development of “organizational capital”). In the present study, we follow the approach suggested by Peters and Taylor (2017)2 and find that while intangible assets comprise more of companies’ assets over time, this stems mainly from growth in externally acquired intangibles. Estimated internally developed intangibles have not meaningfully increased as a proportion of total assets (see Exhibit 1).

Moreover, the estimation approach for internally developed intangibles has several important caveats in addition to the lack of market valuations. First, the estimation of internally developed intangibles assumes that the development of intangible capital can be captured fully through spending reported on the income statement. Second, the approach is critically dependent upon the availability of reliable and comprehensive R&D and SG&A data. However, we observe R&D data for about half of the US market even today. As a result, the estimated knowledge capital is zero for about half of the US market. Thus, we would adjust the value and profitability metrics of half of the market for knowledge capital and leave the rest unadjusted, potentially making firms in the adjusted and unadjusted groups less comparable, not more, after the adjustments. Further, while SG&A data are available for most US companies since the 1960s, the breakdown of operating expenses into cost of goods sold and SG&A varies often across companies and data sources, which might add noise to the estimation of organizational capital. The estimation approach can also produce noisy results because it applies constant amortization rates through time and does not allow for impairments. As a result, a company can be approaching bankruptcy and still appear to have billions of dollars’ worth of internally developed intangibles.

Because of all those different sources of noise, capitalizing estimated internally developed intangibles might not be helpful in identifying differences in expected stock returns. Our empirical research lends support to this expectation. Estimated internally developed intangibles contain little additional information about future firm cash flows beyond what is contained in current firm cash flows. Moreover, we do not find compelling evidence that capitalizing estimated internally developed intangibles yields consistently higher value and profitability premiums.

Given the large challenges with estimating internally developed intangibles, an alternative approach to infer more effectively differences in expected returns among
firms with different sources of intangibles might be to strip out externally acquired intangibles from the balance sheet. Our empirical analysis shows no compelling performance benefit of excluding externally acquired intangibles from fundamentals. Historically, the exclusion of externally acquired intangibles would not have generated higher value or profitability premiums. Therefore, we believe investors are better off continuing to incorporate externally acquired intangibles reported on the balance sheet and not adding noisy estimates of internally developed intangibles to value and profitability metrics.

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Investing in FAANG Stocks: Should You Expect Unexpected Returns?

Investment returns have two parts: the expected return and the unexpected return. The expected return is the best guess of what will happen based on all the information currently available. The unexpected return is the surprise, the difference between what does happen and what was expected. Investors should base their portfolio decisions on expected future returns, not recent realized returns, and the two can differ by a lot.

Look at the returns on the so-called FAANG stocks–Facebook, Amazon, Apple, Netflix, and Google’s parent company, Alphabet. Over the 10 years from September 2010 to August 2020, a portfolio of the five stocks held in proportion to their market caps would have delivered an average annual return of 34.25% per year. That means on average, the value of the portfolio doubled about every 2.5 years.

Given their great returns over the last 10 years, what is our best guess of how the FAANG stocks will do over the next decade? Should we expect an average annual return of almost 35% again? Absolutely not. Who wouldn’t buy these stocks if their expected returns were 35%? But buyers need sellers. The demand driven by such high expected returns would simply push prices up and drive expected returns down to a more
reasonable level. For the same reason, I’m confident that if we could go back to August 2010, we would find few investors predicting the FAANG stocks would do as well as they did from 2010 to 2020.

So what does explain the FAANG stocks’ high realized returns? Their unexpected returns. Things turned out much better for them than investors expected. The companies’ cash flows over the last 10 years were much higher than investors expected 10 years ago, and their prospects looking forward from today are almost certainly better than investors expected they would be 10 years ago.

All this unexpected good news produced high unexpected stock returns over the last decade. It would be wrong, however, to expect high unexpected returns to persist. After all, it doesn’t make sense to count on good luck. The expected value of the unexpected returns must be zero.

In short, the past decade of extraordinary realized returns tells us little about the FAANG stocks’ future expected returns. And unfortunately, this is a general result. For most investments and most investment horizons—a month, a year, five years, even ten years—the realized return is driven far more by the unexpected return than the expected return.

–  Kenneth French, PhD
Director and Consultant

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

How Much Impact Does the President Have on Stocks?

The anticipation building up to elections often brings with it questions about how financial markets will respond. But the outcome of an election is only one of many inputs to the market. Our interactive exhibit examines market and economic data for nearly 100 years of US presidential terms and shows a consistent upward march for US equities regardless of the administration in place. This is an important lesson on the benefits of a long-term investment approach.

NOTES AND DATA SOURCES

• This material is in relation to the US market and contains analysis specific to the US.

• In US dollars. Stock returns represented by Fama/French Total US Market Research Index, provided by Ken French and available at http://mba.tuck.dartmouth.edu/ pages/
faculty/ken.french/data_library.html. This value-weighed US market index is constructed every month, using all issues listed on the NYSE, AMEX, or Nasdaq with available
outstanding shares and valid prices for that month and the month before. Exclusions: American depositary receipts. Sources: CRSP for value-weighted US market return.
Rebalancing: Monthly. Dividends: Reinvested in the paying company until the portfolio is rebalanced.

• Growth of wealth shows the growth of a hypothetical investment of $100 in the securities in the Fama/French US Total Market Research Index. Growth of wealth for the full
sample from March 4, 1929, through June 30, 2020. Growth of wealth for each presidential term starts on the election day of each president up to but not including the
election day of a successor. For presidents who are not initially elected, the growth of wealth period starts from the day of inauguration up to but not including the successor’s
election day.

• Federal surplus or deficit as a percentage of gross domestic product, inflation, and unemployment data from Federal Reserve Bank of St. Louis (FRED). GDP Growth is annual
real GDP Growth, using constant 2012 dollars, as provided by the US Bureau of Economic Analysis. Unemployment data not reported prior to April 1929. Federal surplus or
deficit as a percentage of gross domestic product data is cumulative.

• US Government Presidential and Congressional data obtained from the History, Art & Archives of the United States House of Representatives. US Senate data is from the
Art & History records of the United States Senate.

• For Herbert Hoover, the federal budget is calculated from 1929 to 1932. Annual real GDP growth is calculated from 1930 to 1932; GDP data not available prior to 1930.

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

What History Tells Us About US Presidential Elections and the Market

It’s natural for investors to look for a connection between who
wins the White House and which way stocks will go. But as
nearly a century of returns shows, stocks have trended upward
across administrations from both parties.

• Shareholders are investing in companies, not a political
party. And companies focus on serving their customers
and growing their businesses, regardless of who is in the
White House.

• US presidents may have an impact on market returns,
but so do hundreds, if not thousands, of other factors—the
actions of foreign leaders, a global pandemic, interest rate
changes, rising and falling oil prices, and technological
advances, just to name a few.

Stocks have rewarded disciplined investors for decades,
through Democratic and Republican presidencies.
It’s an important lesson on the benefits of a long-term
investment approach.

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Why Investors Might Think Twice About Chasing the Biggest Stocks

Average Annualized Outperformance of Companies Before and After The First Year They Became One Of The 10 Largest In The US
Compared to Fama/French Total US Market Research Index ,1927–2019

As companies grow to become some of the largest firms trading on
the US stock market, the returns that push them there can be impressive.
But not long after joining the Top 10 largest by market cap, these
stocks, on average, lagged the market.

• From 1927 to 2019, the average annualized return for these
stocks over the three years prior to joining the Top 10 was nearly
25% higher than the market. In the three years after, the edge was
less than 1%.

• Five years after joining the Top 10, these stocks were, on average,
underperforming the market—a stark turnaround from their earlier
advantage. The gap was even wider 10 years out.

• Intel is an illustrative example. The technology giant posted average
annualized excess returns of 29% in the 10 years before the year
it ascended to the Top 10 but, in the next decade, underperformed
the broad market by nearly 6% per year. Similarly, the annualized
excess return of Google five years before it hit the Top 10 droppedby about half in the five years after it joined the list.

Expectations about a firm’s prospects are reflected in its
current stock price. Positive news might lead to additional
price appreciation, but those unexpected changes are
not predictable.

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Market Returns Through a Century of Recessions

What does a century of economic cycles teach investors about investing? Our interactive exhibit examines how stocks have behaved during US economic downturns. Markets around the world have often rewarded investors even when economic activity has slowed. This is an important lesson on the forward-looking nature of markets, highlighting how current market prices reflect market participants’ collective expectations for the future.

1926—1927
A few years before the Depression, the US experienced a mild, yearlong recession accompanied by a minor bout of deflation. The stock market slipped 2.9% in the first month of the downturn.

Great Depression
The Depression decimated the US economy—unemployment climbed to 25.2%, and industrial production plunged 48.6%. Before the collapse ended, stocks collectively lost 83.6% in a 33-month market downturn.

1937—1938
A sharp, 13-month recession—marked by high unemployment and a big dip in industrial production—occurred in the midst of the nation’s recovery from the Depression. Stock market investors suffered a 49.2% loss.

World War II Recession
Industrial production plunged 26% during the eight-month recession near the end of World War II. But the stock market dipped only 3.9% early in the recession before rebounding.

1948—1949
A modest stock market slide (—11.0%) began five months before this relatively small economic

1953—1954
The Korean Armistice was signed in the summer of 1953. A stock market slump that had begun in March was over by August, but the recession continued until early 1954.

1957—1958
A huge drop in industrial production (–11.3%) and a contraction in GDP (–3%) interrupted the 1950s boom. Stocks retrenched 14.9% in the midst of a decade-long climb.

1960—1961
This four-month pause followed the previous decade’s bull market. In the election year of 1960, unemployment rose to 6.6%, and the stock market dropped 7.9%.

1969—1970
High inflation and a big jump in unemployment punctuated the 11-month recession that began in December 1969. A volatile

Oil Crisis
Inflation hit double digits during the 1973–75 recession. The stock market lost nearly half its value in the first 11 months of the 16-month economic downturn.

1980
A 12% stock market decline occurred early in 1980’s six-month recession, during which unemployment hit 7.6%. But the market finished the year with an impressive gain of 33.4%.

1981–1982
Historically high interest rates preceded a harsh recession that dragged on for 16 months and saw unemployment peak at 10.4%. The stock market experienced a 15.9% slide before beginning a long rally.

Gulf War
Stocks reacted negatively to the onset of the Gulf War in August 1990, dropping 17% over five months as the price of oil doubled. When the market regained its footing, stocks were set to start a nine-year bull market that peaked in the dot-com era.

Tech Boom and Bust
Many investors may not realize that the stock market had started a deep decline before the relatively mild

Global Financial Crisis
During the Global Financial Crisis, the worst of the 50.4% stock market dive happened in the latter half of an 18-month recession that saw unemployment hit 9.4% and industrial production tumble 17%. But after falling for 16 months, the market started a nearly 11-year bull run.

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Ins and Outs of Emerging Markets Investing: Market Behavior and Evolution

Emerging markets are an important part of a well-diversified global equity portfolio. However, recent history reminds us that they can be volatile and can perform differently than developed markets. In this article, we provide a longer historical perspective on the performance of emerging markets and the countries that constitute them. We also describe the emerging markets opportunity set and how it has evolved in recent years.

RECENT PERFORMANCE IN PERSPECTIVE

In recent years, the returns of emerging markets have lagged behind those of developed markets. As shown in Exhibit 1, over the past 10 years (2010–2019) the MSCI Emerging Markets Index (net div.) had an annualized compound return of 3.7%, compared to 5.3% for the MSCI World ex USA Index (net div.) and 13.6% for the S&P 500 Index. While recent returns have been disappointing, it is not uncommon to see extended periods when emerging markets perform differently than developed markets. For example, just looking back to the prior decade (2000–2009), emerging markets strongly outperformed developed markets, with the MSCI Emerging Markets Index (net div.) posting an annualized compound return of 9.8%, compared to 1.6% for the MSCI World ex USA Index and –0.95% for the S&P 500 Index.

The magnitude of the return differences from year to year can be large. For example, relative to the US, the biggest underperformance in the past 10 years was in 2013, when emerging markets underperformed by over 34 percentage points. Exhibit 2 helps to put this difference into historical context: between 1988 and 2019, emerging markets outperformed US stocks by 34 percentage points or more per year four times (1993, 1999, 2007, and 2009) and underperformed US stocks by that same magnitude four times (1995, 1997, 1998, and 2013).

Over the entire period from 1988 to 2019, investors with a consistent allocation to emerging markets were rewarded. The MSCI Emerging Markets Index (gross div.) had an
annualized return of 10.7% over this period. That exceeded the 5.9% annualized return for the MSCI World ex USA Index (gross div.) and was similar to the 10.8% average annualized return for the S&P 500, even when including the recent decade of strong performance of the US equity market. However, emerging markets returns were also more volatile. Looking at the same indices, the annualized standard deviation was higher for emerging markets: 22.4% vs. 14.1% for the US and 16.4% for developed markets outside the US. This higher volatility, as well as the potentially sizable performance deviation from developed markets, underscores the importance of patience, discipline, and an appropriate allocation that investors can stick with when considering investing in emerging markets.

A CLOSER LOOK AT EMERGING MARKETS COUNTRY PERFORMANCE

Diversification across emerging markets countries can improve the reliability of investment outcomes, as dispersion among country returns can be wide. Exhibit 3 displays individual emerging markets country returns by calendar year for the past two decades. Each country is represented by a different color, and countries are ranked each year from the highest to lowest performer. In the 20 years ended December 2019, no country had the worst-performing market for more than two consecutive years, and no country had the best-performing market in consecutive years. The illustration shows that country performance is volatile and that countries that rank low in one year may rank among the highest performers in the next year.

Focusing on the countries at the top and bottom of the columns for each year reveals substantial differences in returns between the best-performing and worst-performing market. Exhibit 4 shows that, over the past two decades, the annual return difference between the best- and worst-performing emerging markets has ranged from 39 percentage points in 2013 to 159 percentage points in 2005. On average, that difference has been approximately 80 percentage points per year. Perhaps somewhat counterintuitively, the extreme performers were not necessarily dominated by a handful of countries or by the smaller countries. In fact, 13 different countries were the worst annual performers, and similarly, 13 different countries were the best annual performers. These data illustrate the extreme outcomes that investors may be exposed to by concentrating in a few countries. There is no compelling evidence that investors can reliably add value through dynamic country allocation.1 By holding a broadly diversified portfolio, investors are instead well positioned to capture returns wherever they occur.

THE EVOLVING EMERGING MARKETS OPPORTUNITY SET

As a group, emerging markets represent a meaningful opportunity set for investors. The size and composition of the investible universe of emerging markets have steadily evolved since the late 1980s, when most comprehensive data sets and benchmarks for emerging markets begin. Over the years, major geopolitical, economic, and demographic changes have contributed to shifting weights for individual countries and companies within emerging markets, but in aggregate they have continued to grow. As of the end of 2019, the total free-float adjusted market capitalization of Dimensional’s emerging markets universe was $7.8 trillion and included 24 countries and over 7,000 securities. As shown in Panel A of Exhibit 5, emerging markets represented 12.5% of global markets’ free-float adjusted market capitalization. Measured by gross domestic product (GDP), emerging markets’ share increases to 38.0% (Panel B), reflecting the fact that emerging markets typically have smaller market capitalizations compared to GDP than most developed markets. Regardless of the metric, emerging markets represent a significant component of global markets.

Panel A of Exhibit 6 examines the country composition of Dimensional’s emerging markets universe. The top five countries in terms of market capitalization—Brazil, China, India, Korea, and Taiwan—represented 73.2% at the end of 2019, slightly higher than at the beginning of the decade, when these same five countries represented 68.8% of the universe. A more significant development over the past decade has been the rise in the weight of China, from 17.2% of the universe at the end of 2009 to 31.4% at the end of 2019. This increase has been driven primarily by new equity issuance and new avenues for foreign investors to gain exposure to Chinese companies, including securities listed on the local Shanghai and Shenzhen stock exchanges through Hong Kong stock connect programs.

In addition to changes in size and country composition, emerging markets have undergone important improvements in their market mechanisms and microstructures over the past decade. Generally, emerging markets have become more open to foreign investors with fewer constraints on capital mobility. Evidence of these developments includes fewer instances of market closings, capital lockups, and trading suspensions of individual stocks in many markets. Finally, emerging markets have broadly adopted international accounting and reporting practices over the last decade. Our analysis suggests more than 90% of the firms in most emerging markets now report their annual financial statements according to International Financial Reporting Standards (IFRS) or US Generally Accepted Accounting Practices (GAAP). In countries like China, India, and
Taiwan, the national standards have substantially converged with IFRS. This has helped improve the reliability and transparency of financial data in emerging markets.

SUMMARY

In sum, emerging markets represent a meaningful opportunity set within global markets. They continue to evolve in their structures, market mechanisms, and accessibility.
Investors in emerging markets can benefit from a long-term perspective, expertise and flexibility in navigating these changing markets, and an approach that emphasizes diversification and discipline.

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

When Something Just “Doesn’t Feel Right?”

“I don’t know…something just doesn’t feel right,” you mumble through your mask to your primary care doctor while sitting on the examination table under a flickering fluorescent light in a room decorated with anatomical charts and hand-sanitizer dispensers. After listening to your heart and your lungs, the doctor diagnoses your feelings of worry as a mild condition that is easily treatable but could become serious if a proper treatment regimen isn’t followed. The doctor gives two treatment plans: one coming from the New England Journal of Medicine and the other from a health magazine that can be purchased at your local convenience store. Which plan do you choose?

The health magazines are filled with tips and tricks, such as how to burn body fat, jump start the body’s metabolic rate and build immune system strength. And they might even work sometimes. If you want to choose the treatment plan with the highest odds of success, it might give you more confidence to know that the medical journal, and its recommendations, are based on decades of data collected from research studies performed by medical experts and peer-reviewed by the medical community.

We face the same decision when it comes to investing. Numerous publications tout the latest investment trends and implore their readers to jump on the bandwagon or miss out on the impending financial windfall. And to their credit—sometimes they work. But just like our physical health, we can place more confidence in an evidence-based approach to support our long-term investment plans and ultimately our financial well-being.

Evidence-based investing and evidence-based planning, the foundation of your financial life plan and our philosophy, is an approach guided by thoroughly vetted, peer-reviewed research and carried out by industry thought-leaders, academicians, and practitioners that is tested against decades of empirical data. We used this research to design your portfolio so that you can focus on today and know that your portfolio will be there to support your lifestyle in the future, regardless of what the pundits claim are the latest investment trends in the markets today.

The next time you find yourself questioning your financial well-being or if your portfolio “just doesn’t feel right,” look at what the evidence says. Are you giving yourself the best odds of long-term success?

When you have any questions about your investments, need to inform us of family or work-related changes, or want to discuss your financial planning needs, please reach out. We are ready to help.

Election Year Politics and Stock Market Forecasts

A recent New York Times article discussed the stock market impact of Joe Biden winning the 2020 presidential election. The article quoted Lori Calvasina, head of US equity strategy at RBC Capital Markets, who said “The market is starting to worry that Trump will not be re-elected. Trump is consistently viewed as a positive for the stock market.” Before you make changes to your portfolio as a result of these predictions, consider the following three points:

1. Markets have already priced in the possibility of a Biden presidency.
2. Two-step forecasting is difficult.
3. Your political beliefs can lead to investing mistakes.

Markets Have Already Priced in the Possibility of a Biden Presidency

Right now, if you look at the odds on betting markets, the consensus estimate is that Biden has about a 55% chance of winning the election, while Trump has about a 40% chance. The remaining 5% is allocated to various candidates and non-candidates. What will wind up moving financial markets is if conditions change such that the odds of Biden becoming president significantly increase or decrease. President Trump was a heavy underdog in 2016; betting markets gave him just a 20% chance of winning the day before the election. And yet, even after the surprise outcome, market moves were relatively muted the day after the election (the S&P 500 was up 1.1% that day). It should be noted that some forecasters were predicting a sharp decline if Trump won. Dallas Mavericks owner and TV personality
Mark Cuban said “there is a really good chance we could see a huge, huge correction” in the event of a Trump victory.

Two-Step Forecasting is Difficult

Two-step forecasting is when someone says, “I forecast X, and as a result Y will happen.” Let’s say you’re 60% sure Biden is going to win (which is roughly in line with the consensus estimate). Let’s also assume that you’re 60% sure a Biden victory means stocks will decline in value. Then assume that if you’re wrong and Trump wins (a 40%chance) there’s another 30% possibility that stocks will decline for other reasons.

Keep in mind that going back to 1926, the S&P 500 has had negative returns in 27% of calendar years, so these assumptions are essentially saying that a Biden presidency is more than twice as likely to cause a stock market decline as has happened historically, while a Trump presidency means that the chances are roughly the same as history.

Using the above assumptions, the math works out on this so that there is a 36% probability (60% x 60%) that you’re right about Biden winning and then also right about the market declining as a result, plus another 12% probability (40% x 30%) that you’re wrong about Biden winning but accidentally right about the market decline anyway. This totals out to a 48% chance of getting your two-step forecast correct, or essentially a coin-flip.

Of course, so far I haven’t even mentioned how difficult it is to get the first prediction correct, much less getting both predictions right. Philip Tetlock, who teaches psychology, business and political science at the University of California, Berkeley is the author of “Expert Political Judgment: How Good Is it? How Can We Know?” The book, which was published in 2006, discusses the findings of his 20-year study, the first scientific study on the ability of experts from various fields to predict the future. Tetlock found that so-called experts who make predictions their business are no better than random luck. RBC head of US equity strategy Lori Calvasina should have learned this lesson in October 2019, when a Bloomberg Businessweek article shared her analysis of the Democratic presidential primary: “If politicians were stocks, she would advise shorting Joe Biden. Elizabeth Warren, on the other hand, looks like a buy.”

Your Political Views Can Lead to Investing Mistakes

There’s actually evidence that election results have the power to affect how investors handle their portfolios. The 2010 study “Political Climate, Optimism, and Investment Decisions” examined the link between investors political affiliations and their investment choices. Simply put, when your political party is in power, you feel much more confident about the economy and markets, and vice versa. Being aware of your biases can help you make better investment decisions. Trying to time the market due to concerns about the upcoming election is not likely to be a winning strategy. The reason is that you have to be right not once, but twice. In order for market timing to work, you need to know when to get out and when to get back in. Suppose you get out now. Do you get back in if Trump wins? Or if, Biden wins, do you stay out of the market for four full years waiting for the 2024 election? The bottom line is that you shouldn’t let the latest economic or political news cause you to abandon your well-developed plan.

Sources: © 2020 Buckingham Wealth Partners. Buckingham Strategic Wealth, LLC, & Buckingham Strategic Partners, LLC (Collectively, Buckingham Wealth Partners) IRN-20-748

Large and In Charge? Giant Firms atop Market Is Nothing New

The world is changing, this crisis has cemented the dominance of a handful of very large technology companies (FAANG – Facebook, Amazon, Apple, Netflix, Google). Why shouldn’t investors just focus on them?

Investors may be surprised to learn that it is not unusual for the market to be concentrated in a handful of stocks, but keep in mind that any expectations about the future operational performance of a firm are already reflected in its current price.

Tech standouts are drawing attention for their perceived sway on stocks, but history undercuts that view.

A top-heavy stock market with the largest 10 stocks accounting for over 20% of market capitalization and a marquee technology firm perched at No. 1? This sounds like a description of the current US stock market, dominated by Apple and the other FAANG stocks,1 but it is actually a reference to 1967, when IBM represented a larger portion of the market than Apple at the end of 2019 (5.8% vs. 4.1%).

As we see in Exhibit 1, it is not particularly unusual for the market to be concentrated in a handful of stocks. The combined market capitalization weight of the 10 largest stocks, just over 20% at the end of last year, has been higher in the past.

A breakdown of the largest US stocks by decade in Exhibit 2 shows some companies have stayed on top for a long time. AT&T was among the largest two for six straight decades beginning in 1930. General Motors and General Electric ranked in the top 10 at the start of multiple decades. IBM and Exxon were also mainstays in the second half of the 20th century. Hence, concentration of the stock market in a few large companies such as the FAANG stocks in recent years is not a new normal; it is old normal.

Moreover, while the definition of “high-tech” is constantly evolving, firms dominating the market have often been on the cutting edge of technology. AT&T offered the first mobile telephone service in 1946. General Motors pioneered such innovations as the electric car starter, airbags, and the automatic transmission. General Electric built upon the original Edison light bulb invention, contributing to further breakthroughs in lighting technology, such as the fluorescent bulb, halogen bulb, and the LED. So technological innovation dominating the stock market is not a new normal; it is an old normal too.

Another trend attributed to a new normal is the extraordinary performance of FAANG stocks over the past decade, leading some to wonder if we should expect these stocks to continue such strong performance going forward. Investors should remember that any expectations about the future operational performance of a firm are already reflected in its current price. While positive developments for the company that exceed current expectations may lead to further appreciation of its stock price, those unexpected changes are not predictable.

To this point, charting the performance of stocks following the year they joined the list of the 10 largest firms shows decidedly less stratospheric results. On average, these stocks outperformed the market by an annualized 0.7% in the subsequent three-year period. Over five- and 10-year periods, these stocks underperformed the market on average.

Past performance is no guarantee of future results.

The only constant is change, and the more things change the more they stay the same. This seems an apt description of the dominant stocks atop the market. While the types of businesses most prominent in the market vary through time, the fact that a small subset of companies’ stocks account for an outsized portion of the stock market is not new. And it remains impossible to systematically predict which large companies will outperform the stock market and which will underperform it. This underscores the importance of having a broadly diversified equity portfolio that provides exposure to a vast array of companies and sectors.

Sources: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Original article can be found at https://us.dimensional.com/perspectives/large-and-in-charge-giant-firms-atop-the-market-is-nothing-new

When & How do I Find an Elder Care Planning Attorney?

Americans are living longer than ever but that doesn’t always mean a longer quality of life. A proper elder care plan should account for not only having the right people in the right roles in order to make the proper financial & health Care decisions, but also guidance and direction with respect to your wishes should you not be able to speak for yourself.

When should one look for an Elder Care Attorney?

There is not an exact time when one should look for an elder care attorney but I see it most commonly when one is considering retirement, most commonly in the late 50s and onward. The need for elder care planning evolves from a properly structured financial plan & estate plan. Another way to regard it is as “Estate Planning with a very specific purpose.” If estate planning is most often is associated with ‘death planning’, then elder care planning is more ‘life & longevity planning.’

How does one choose an Elder Care Attorney?

The ideal way to choose an elder care attorney is by speaking with him or her.  Referrals can be extremely helpful, as are testimonials.  Credentials, such as Certified Elder Law Attorney and other such designations are helpful – but those are often an indication of standardized exams, experience, an ongoing continuing legal education & a commitment to the practice. Not to diminish those very important aspects – but elder Care planning is a personal endeavor.  Traditionally, Estate Planning and Elder Care planning was done with a cookie cutter-like approach. But it’s important that the attorney who guides you on this level of planning emphasize customized solutions and listens to you. Although your pattern and your facts might be similar to others, every family has unique and deserves to be treated as such.

What should one expect when dealing with an Elder Car Law Firm?

When working with an elder care attorney, you should expect to be heard, and to have conversations. Much like going to a physician who needs to have x-rays, MRIs, lab work, etc prior to guiding you on your health needs, an Elder Care attorney is going to need baseline information with respect to your finances, health, family situation, goals and concerns, among other aspects.  Be prepared to be open and forthcoming. You wouldn’t hesitate to tell your doctor if you are taking medications that may have contraindications & adverse effects – treat elder Care attorney with the same manner if you desire proper, effective advice.

Anything else I should know?

It’s important to know that Elder Care attorneys typically handle only the legal aspect of planning. However your elder care plan needs to be integrated with your financial plan, investment plan, tax planlong-term care plan, and insurance plan. Not all attorneys are going to be equipped to handle all of these services in-house. At Shah Total Planning I handle them in-house because my clients prefer that integrated, one-stop shop. But if you can’t find somebody who does it all in the house, it’s important to find someone who is willing to communicate with your team of professionals.

Can you put limitations in a Will?

When I’m speaking with a client regarding their Estate Planning, and we are discussing their Will specifically, I encouraged them to think of the Will as a recipe:

If I was going to write a recipe for a cake which required one to get the milk, sugar, eggs, etc. from various places, then blend them in a certain way, then put the mix the oven that’s been preheated, and follow the rest of the instructions – will they get a cake at the end if they follow the recipe properly? Yes.

What if I inserted instructions in the recipe that they must hop on one leg while they are mixing the ingredients? Is that going to be enforced? Will that play into the desired outcome of having a cake? Probably not.   One can regard certain provisions is a Will in a similar manner.

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If there are specific steps you are seeking for someone to take when carrying out your wishes or conditions to be met – you’re probably better off looking at a trust (bake the cake now, instead of leaving behind a recipe.) It allows you much more flexibility and control.

Remember a Will is a public record document once somebody passes away. The Will doesn’t have any “power” until it goes through probate. At that point the Will would be submitted to the surrogates court and the executor is given the appropriate documentation to carry out the wishes.

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That means having a provision such as “everything goes to my spouse as long as they don’t get remarried” would then be part of the public record. That may not be your intention.

But even beyond that – most courts will generally try to find ways to NOT enforce provisions if they are deemed to be against public policy, such as discouraging marriage.

Also, circumstances may make those restrictions inconsistent with your ultimate wishes. What if you had a provision that said a grandchild will only receive an inheritance upon receiving a degree from a four-year college institution, but then that grandchild is diagnosed with a learning disability or another condition which makes it impossible for that condition to be met? Is that consistent with the grandparents planning objective? Possibly not. But to undo that might require Court approval or even a challenge.

I don’t have an exact percentage as to how many Wills get challenged versus how many Trusts get challenge, but I would wager that it’s at least 5:1 if not 10:1 with Wills being challenged much more often.

That’s not to say you shouldn’t have specific incentive provisions or conditions which are consistent with your wishes in your Wills. However, your attorney should guide you as to whether or not there is a potential challenge looming due to either ambiguity in your desires or a difficulty in enforceability.

Challenges can be costly, but attorneys generally make more money when litigating Will disputes than they do simply administering trusts or properly carrying out the intentions in a Will. Therefore, much care should be taken in ensuring that the will is clear, enforceable, with as little complication as possible to carry out your wishes.

And if you need us, we’re here to help.