Featured entries from our Journal

Details Are Part of Our Difference

Podcast Episode – Meir Statman

With the Recent Events in Ukraine, Should I Make Changes to My Portfolio?

Embracing the Evidence at Anheuser-Busch – Mid 1980s

529 Best Practices

Author: PJ McDaniel

Helping You Avoid the Behavior Gap

We talk a lot about the importance of education because we believe that educated investors are disciplined. In our experience, discipline builds confidence —and confident investors have a better experience. But we also know that we can go months, even years, without a real test of confidence. A test like we are facing now.

The coronavirus pandemic has shaken nearly every aspect of life and sent the markets into wild swings of despair and euphoria depending on the day’s headlines. With this much uncertainty and this level of market volatility, investors must be especially vigilant against falling into the Behavior Gap.

The Behavior Gap is the name coined by author and podcast guest, Carl Richards, to describe the fact that most investors earn less than the market’s returns, simply because they make poor decisions. Chasing hot stocks when the markets are booming or panicking and moving your money into cash—this is the kind of behavior that creates the gap. And it’s a real, quantifiable number.

For 25 years, the research firm DALBAR has been publishing its analysis of the difference between the average investment return, and the average investor return—and it looks bad for the average investor (though some journalists discount the findings and methodology).

For example, stocks have delivered an average annual return of roughly 9% over the last 30 years, while bonds have delivered an average annual return of 6%. If we imagine a 50/50 balanced stock and bond portfolio, that means the investment markets have delivered a 7.5% average annual return over the past 30 years. The average investor, though? They’ve only achieved a 4% average annual return. That difference of 3.5 percentage points per year for the last 30 years adds up to a huge number.

Say you had $1 million in your retirement account. A 4% annual return for 30 years would result in a balance of about $3 million. But if you’d gotten the market’s combined 7.5% investment return, you’d have almost $9 million after 30 years. The Behavior Gap in your savings, then, is missing out on $6 million—all because you let emotions into your investment decisions.

Right now, the risk of succumbing to emotion is especially high. A friend of mine, who is  a successful businessman, recently sent me a note saying he was day-trading while sitting at home in quarantine. He’s buying stock in Zoom and pharmaceutical companies, thinking he can predict what’s going to happen and pick up a few wins. He’s a smart guy who really understands commercial real estate, yet here he is making classic investment mistakes. He’s in the Behavior Gap.

I urged him stop gambling with his money and consider allocating it into 13,000 stocks spread all over the world, like we do. Then I encouraged him to get off the couch and find some other way to pass his time. Because the pernicious thing about the Behavior Gap is that it doesn’t just cost us money. It can have the same draining effect on our happiness as it does on our investment accounts.

As Carl Richards told Matt in his recent podcast interview, he now applies the Behavior Gap concept to any activity that we engage in hoping to improve our situation, but which in fact produces a suboptimal result. Just as making ill-timed, emotional investment decisions hurts our long-term returns, spending emotional energy on things that aren’t useful produces a lot of unnecessary pain, suffering and anxiety.

That’s why we also emphasize to clients the importance of focusing on the things that bring real meaning to their lives. In fact, a framed print of one of Carl Richards’ famous sketches hangs on the wall of Matt’s office, reminding us that our job is to help people stay focused on the small overlap between things that matter and things they can control.

So even as we face ongoing uncertainty about what the post-coronavirus world will look like, remember to focus on what matters, and what you can control. That includes having faith in the evidence that this market downturn, like others, will end. Stocks will recover and disciplined investors will be rewarded. In the meantime, we will be taking care of what we can control, like rebalancing your portfolio and harvesting losses.

Keeping the faith, staying disciplined—that’s exactly what makes our clients different from the “average” investor. And it’s how we help you avoid falling into the Behavior Gap.

Two Notifications Worth Caring About During a Volatile Market

While millions of people frantically check their smartphone notifications about the coronavirus disrupting the stock market, here are a few notifications that catch my attention.

These reminders are reassuring, especially when the 24-hour news cycle tempts us to hit the panic button. Most importantly, they keep me focused on things that I can control. In this case, my investment accounts have been busy taking advantage of the volatility in the stock market by using intelligent portfolio management.

Let’s quickly break down both of these notifications:

The first alert I received was for tax-loss harvesting, which is a nerdy term for converting market downturns (such as the one we’re seeing right now) into tangible tax savings. When properly applied, tax-loss harvesting turns your financial lemons into lemonade. A successful tax-loss harvest lowers your tax bill without substantially altering or impacting your long-term investment outcomes.  

The second alert I received was for rebalancing – also known as buying what’s cheap in the market and making sure my overall risk profile, also known as my asset allocation, is on target. This happens automatically—and without additional fees. It’s the investing equivalent of having your GPS re-route your trip to maximize efficiency.

These are the little things that add up over time. In fact, last month we posted a popular article titled “No Tipping on Taxes” which explores how important tax-loss harvesting is to avoid paying unnecessary taxes. No one likes to be surprised by a larger-than-expected tax bill.

In times like these you need to focus on the things you can control (automating your portfolio management) and avoid worrying about the things you can’t control (fear-mongering news alerts). In fact, the smartest financial decision you make could be putting your phone away. If you’re curious about how these simple yet important investment management tools could help you during this period, schedule a short call with us here.

No Tipping on Taxes

Much like people scramble to shed a few pounds before summer vacation, it’s not uncommon to see people frantically searching for ways to minimize their taxes due as April looms. Inevitably, when the vacation ends or tax season is over, many of the procrastinators look back despondently and think, I could have done better.

This pattern appeared again recently, as I heard steady chatter from investors who ended up paying more taxes than they had anticipated. But could it have been possible for them to save themselves from that unpleasant surprise (and spare a good chunk of change in the process)? You bet—if only they had been planning all year. But don’t just take our word for it. This sketch by our friend Carl Richards sums it up perfectly.

There are, of course, facets of wealth management that lie outside the realm of our control. At first, taxes would seem to fall into that category. Truthfully, though, there are steps all investors can take to minimize their taxes due. But planning can’t wait until the last minute.

Moving forward, here are four best practices to tame your taxes before April.

Tax-Loss Harvesting: Those familiar with tax-loss harvesting may assume that losses are best harvested in April, when taxes are top of mind. In reality, tax-loss harvests can be utilized whenever market conditions and the investor’s best interests warrant it.

Enroll in Tax-Favored Accounts: Examples of tax-favored accounts include IRAs, Roth IRAs, 529 plans, and Healthcare Savings Accounts (HSAs). Opening these accounts as appropriate can keep a lid on your taxes when April rolls around.

Asset Location: To put it simply: minimizing a portfolio’s overall taxes due entails locating the most tax-efficient holdings in taxable accounts and the least tax-efficient holdings in tax-deferred or tax-free accounts.

For example, income from real estate investment trusts (REITs) are best-suited for an IRA where it won’t be taxed until retirement. Alternatively, mutual funds, ETFs, and stocks are best-suited for taxable investment accounts since capital gains taxes are generally lower than typical income taxes.

Tax-Wise Charitable Giving: In addition to helping a cause you believe in, charitable giving is also favorable for optimizing your taxes. Specifically, opening a Donor Advised Fund can enable investors to avoid capital gains tax on their securities and deduct the total value of the contribution from their federal income taxes. Appreciated long-term investments are the ideal asset to contribute to a Donor Advised Fund.

Do you want to get ahead of the curve in 2020 with these tax-planning strategies? I’m happy to walk you through them in detail. Schedule a quick call with me.

Featured entries from our Journal

Details Are Part of Our Difference

Podcast Episode – Meir Statman

With the Recent Events in Ukraine, Should I Make Changes to My Portfolio?

Embracing the Evidence at Anheuser-Busch – Mid 1980s

529 Best Practices

Hill Investment Group