3 Risks of Investing in the Stock Market

Risk and reward are inextricably intertwined, and therefore, risk is inherent in all financial instruments. As a consequence, wise investors seek to minimize risk as much as possible without diluting the potential rewards. Warren Buffett, a recognized stock market investor, reportedly explained his investment philosophy to a group of Wharton Business School students in 2003: “I like to go for cinches. I like to shoot fish in a barrel. But I like to do it after the water has run out.”

Reducing all of the variables affecting a stock investment is difficult, especially the following hidden risks.

  1. Volatility

Sometimes called “market risk” or “involuntary risk,” volatility refers to fluctuations in price of a security or portfolio over a year period. All securities are subject to market risks that include events beyond an investor’s control. These events affect the overall market, not just a single company or industry.

They include the following:

  • Geopolitical Events. World economies are connected in a global world, so a recession in China can have dire effects on the economy of the United States. The withdrawal of Great Britain from the European Union or a repudiation of NAFTA by a new U.S. Administration could ignite a trade war among countries with devastating effects on individual economies around the globe.
  • Economic Events. Monetary policies, unforeseen regulations or deregulation, tax revisions, changes in interest rates, or weather affect the gross domestic product (GDP) of countries, as well as the relations between countries. Businesses and industries are also affected.
  • Inflation. Also called “purchasing power risk,” the future value of assets or income may be reduced due to rising costs of goods and services or deliberate government action. Effectively, each unit of currency – $1 in the U.S. – buys less as time passes.

Volatility does not indicate the direction of a price move (up or down), just the range of price fluctuations over the period. It is expressed as “beta” and is intended to reflect the correlation between a security’s price and the market as a whole, usually the S&P 500:

  • A beta of 1 (low volatility) suggests a stock’s price will move in concert with the market. For example, if the S&P 500 moves 10%, the stock will move 10%.
  • Betas less than 1 (very low volatility) means that the security price fluctuates less than the market – a beta of 0.5 suggests that a 10% move in the market will produce only a 5% move in the security price.
  • A beta greater than 1 (high volatility) means the stock is more volatile than the market as a whole. Theoretically, a security with a beta of 1.3 would be 30% more volatile than the market.

According to Ted Noon, senior vice president of Acadian Asset Management, implementing low-volatility strategies – for example, choosing investments with low beta – can retain full exposure to equity markets while avoiding painful downside outcomes. However, Joseph Flaherty, chief investment-risk officer of MFS Investment Management, cautions that reducing risk is “less about concentrating on low volatility and more about avoiding high volatility.

Strategies to Manage Volatility

Strategies to reduce the impact of volatility include:

  • Investing in Stocks With Consistently Rising Dividends. Legg Mason recently introduced its Low Volatility High Dividend ETF (LVHD) based on an investment strategy of sustainable high dividends and low volatility.
  • Adding Bonds to the Portfolio. John Rafal, founder of Essex Financial Services, claims a 60%-40% stock-bond mix will produce average annual gains equal to 75% of a stock portfolio with half the volatility.
  • Reducing Exposure to High Volatility Securities. Reducing or eliminating high-volatility securities in a portfolio will lower overall market risk. There are mutual funds such as Vanguard Global Minimum Volatility (VMVFX) or exchanged traded funds (ETFs) like PowerShares S&P 500 ex-Rate Low Volatility Portfolio (XRLV) managed especially to reduce volatility.
  • Hedging. Market risk or volatility can be reduced by taking a counter or offsetting position in a related security. For example, an investor with a portfolio of low and moderate volatility stocks might buy an inverse ETF to protect against a market decline. An inverse ETF – sometimes called a “short ETF” or “bear ETF” – is designed to perform the opposite of the index it tracks. In other words, if the S&P 500 index increases 5%, the inverse S&P 500 ETF will simultaneously lose 5% of its value. When combining the portfolio with the inverse ETF, any losses on the portfolio would be offset by gains in the ETF. While theoretically possible, investors should be aware that an exact offset of volatility risk in practice can be difficult to establish.
  1. Timing

Market pundits claim that the key to stock market riches is obvious: buy low and sell high. Good advice, perhaps, but tough to implement since prices are constantly changing. Anyone who has been investing for a time has experienced the frustration of buying at the highest price of the day, week, or year – or, conversely, selling a stock at its lowest value.

Trying to predict future prices (“timing the market”) is difficult, if not impossible, especially in the short-term. In other words, it is unlikely that any investor can outperform the market over any significant period. Katherine Roy, chief retirement strategist at J.P. Morgan Asset Management, points out, “You have to guess right twice. You have to guess in advance when the peak will be – or was. And then you have to know when the market is about to turn back up, before the market does that.”

This difficulty led to the development of the efficient market hypothesis (EMH) and its related random walk theory of stock prices. Developed by Dr. Eugene Fama of the University of Chicago, the hypothesis presumes that financial markets are information efficient so that stock prices reflect all that is known or expected to become known for a particular security. When new data appears, the market price instantly adjusts to the new conditions. As a consequence, there are no “undervalued” or “overvalued” stocks.

Coping with Timing Risk

Investors can mollify timing risks in single securities with the following strategies:

  • Dollar-Cost Averaging. Timing risks can be reduced by buying or selling a fixed dollar amount or percentage of a security or portfolio holding on a regular schedule, regardless of stock price. Sometimes called a “constant dollar plan,” dollar-cost averaging results in more shares being purchased when the stock price is low, and fewer when the price is high. As a consequence of the technique, an investor reduces the risk of buying at the top or selling at the bottom. This technique is often used to fund IRA investments when contributions are deducted each payroll period. NASDAQ notes that practicing dollar-cost averaging can protect an investor against market fluctuations and downside risk.
  • Index Fund Investing. In the classic example of “If you can’t beat them, join them,” Fama and his disciple, John Bogle, avoid the specific timing risks of owning individual stocks, preferring to own index funds that reflect the market as a whole. According to The Motley Fool, trying to accurately call the market is beyond the capability of most investors, including the more prominent investment managers. The Motley Fool points out that less than 20% of actively managed diversified large-cap mutual funds have outperformed the S&P over the last 10 years.
  1. Overconfidence

Many successful people reject the possibility of luck or randomness having any effect on the outcome of an event, whether a career, an athletic contest, or investment. E.B. White, author of Charlotte’s Web and a longtime columnist for The New Yorker, once wrote, “Luck is not something you can mention in the presence of a self-made man.” According to Pew Research, Americans especially reject the idea that forces outside of one’s control (luck) determine one’s success. However, this hubris about being self-made can lead to overconfidence in one’s decisions, carelessness, and assumption of unnecessary risks.

In October 2013, Tweeter Home Entertainment Group, a consumer electronics company that went bankrupt in 2007, had a stock price increase of more than 1,000%. Share volume was so heavy that FINRA halted trading in the stock. According to CNBC, the reason behind the increase was confusion about Tweeter’s stock symbol (TWTRQ) and the stock symbol for the initial offering of Twitter (TWTR).

J.J. Kinahan, chief strategist at TD Ameritrade, stated in Forbes, “It’s a perfect example of people not doing any homework whatsoever. Investing can be challenging, so don’t put yourself behind the eight-ball to start.” Even a cursory investigation would have informed potential investors that Twitter was not publicly traded, having its IPO a month later.

Stock market success is the result of analysis and logic, not emotions. Overconfidence can lead to any of the following:

  • Failure to Recognize Your Biases. Everybody has them, according to CFP Hugh Anderson. Being biased can lead you to follow the herd and give preference to information that confirms your existing viewpoint.
  • Too Much Concentration in a Single Stock or Industry. Being sure you are right can lead to putting all your eggs in a single basket without recognizing the possibility that volatility is always present, especially in the short term.
  • Excessive Leverage. The combination of greed and certainty that your investing decision is right leads to borrowing or trading on margin to maximize your profits. While leverage increases upside potential, it also increases the impact of adverse price movement.
  • Being on the Sidelines. Those who feel the most comfortable in their financial capabilities often believe that they can time the market, picking the optimum times to buy, sell, or be out of the market. However, this can mean you will be out of the market when a major market move occurs. According to the DALBAR 2016 Quantitative Analysis of Investor Behavior, the average investor – moving in and out of the market – has earned almost half of what they would have made for the last 15 years if they had matched the performance of the S&P 500. J.P. Morgan’s Roy notes that if an investor had been out of the market just the 10 best days over the past 20 tears – a span of 7,300 days – the return would be slashed in half.

Strategies to Stay Grounded

Strategies to reduce the impact of overconfidence include:

  • Spread Your Risk. While not a guarantee against loss, diversification protects against losing everything at once. Jim Cramer of TV’s Mad Money recommends a minimum of 10 stocks and a maximum of 15 in a portfolio. Less than 10 is too much concentration, and more than 15 is too difficult for the average investor to follow. Cramer also recommends investing in five different industries or sectors. Investors should note that one benefit of mutual funds and ETFs is automatic diversification.
  • Buy and Hold. Warren Buffett is perhaps the most famous and ardent proponent of the buy and hold strategy today. In a 2016 interview with CNBC’s On the Money, Buffett advised, “The money is made in investments by investing, and by owning good companies for long periods of time. If they [investors] buy good companies, buy them over time, they’re going to do fine 10, 20, 30 years from now.”
  • Avoid Borrowing. Leverage is when you borrow money to invest.  And while leverage can magnify profits, it can also amplifies losses. It increases the psychological pressure to sell stock positions during market downturns. If you tend to borrow to invest (to pay for your lifestyle), you would do well to remember the advice of popular financial gurus such as Dave Ramsey, who warns, “Debt is dumb. Cash is king.” Or Warren Buffett, who claims, “I’ve seen more people fail because of liquor and leverage – leverage being borrowed money. You really don’t need leverage in this world much. If you’re smart, you’re going to make a lot of money without borrowing.”

Final Word

“It’s not what you make, it’s what you keep that matters.” The source of this widely recognized quote is uncertain, but it can be found in almost every list of famous quotes about the stock market. The saying illustrates the need to reduce risk as much as possible when investing. Achieving significant stock market gains, only to lose them when a disastrous event occurs, is devastating – and often unnecessary.

Robert Arnott, founder of the Research Affiliates asset management firm, identified the dilemma in the relationship between risk and return: “In investing, what is comfortable is rarely profitable.” By employing some of these strategies, such as dollar-cost averaging, reducing portfolio volatility, and diversification, you can protect your wealth and sleep better at night.

Are you concerned about the risks in the stock market? What steps do you take to reduce your exposure to negative events?

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How to Secure Your Savings (Part 2)

What does ‘financial institution’ exactly refer to?

There is no cut-and-dry answer. For many years, banks have been absorbed by others or merged with other banks, making the definition hard to delineate. It all depends on the technical nature of the company’s personality as it is registered at the FCA.

Some difficulties, therefore, arise – for instance:

If you save money in the Bank of Scotland, Halifax and BM Savings, which belong to one group, the covered amount is also considered as one. Hence, you get only £85,000.

If you save money in the Royal Bank of Scotland, Ulster and NatWest, which all belong to the giant RBS conglomerate; you get £85,000 protection for every one of three banks where you have put money.

Which banks are linked?

You may visit websites to help you find out if your bank shares its savings protection.

Or you may check the FCA registration number on your bank’s website. If the institution is not among those listed, it does not necessarily mean it has no protected. Their last complete update of list was on April 2017.

What about bank takeovers?

In the even that your bank has been taken over, the actual protection on your money can depend on the date you opened your savings account. A merger-by-merger guide is given below:

  • Santander (Alliance & Leicester and Bradford & Bingley)
  • Lloyds Banking Group, Halifax and TSB
  • Barclays and ING Direct
  • Virgin Money and Northern Rock
  • AA Savings and Bank of Ireland UK
  • Marfin Laiki Bank and Bank of Cyprus UK

What happens when my building society has merged with another?

As a result of a financial crisis in the past, several building society takeovers flooded the news. At the start of such an occurrence, the Government acted to cover savings in two different building societies that merged; however, that applied only until December 2010.

Hence, if you have savings in several of the institutions listed under the groups listed below, you only stand to receive £85,000 cover within that group:

  • Co-operative Bank and Britannia
  • Yorkshire, Chelsea, Barnsley, Norwich & Peterborough building societies, plus Egg
  • Nottingham and Shepshed building societies, trading as Nottingham BS

Nationwide previously shared its protection with Derbyshire, Cheshire, and Dunfermline Building Societies, but all products under the three minor building societies are now branded as Nationwide. This also goes for Coventry BS and Stroud & Swindon BS – all previous accounts with S&S are now branded as Coventry.

What of foreign-bank savings?

Numerous banks originating from overseas operate in Britain, such as Santander, Yorkshire Bank and ICICI. Unless they are not technically “offshore” accounts, the parent bank does not matter.

If the bank is UK-regulated, you will receive the same £85,000 coverage for every individual. However, there is a grayish area:

In the event that a bank falls into difficulties, a bailout might cover your savings, providing protection for your money (although there is no full guarantee to that effect). This happened not only to UK-owned Northern Rock and Bradford & Bingley, but also to Iceland-owned (but UK-regulated) Kaupthing Edge.

As much as possible, limit your savings under the £85,000 limit, since the protection is a goal but not a guaranteed promise in case of a bank run. Nevertheless, this is specifically applicable to non-European banks, as this has not been proven in reality so far (and we are hoping it will never happen!).

Not all European banks are UK protected

A bank could be operating in the UK with the FCA’s complete approval; but the FSCS may not provide protection for the money you put into them. Be more careful then about European-owned banks than those owned by overseas companies.

The reason behind this caveat is that banks from the European Economic Area may choose to have a protection that is slightly variant, referred to as the ‘passport’ scheme, meaning you would have to claim compensation for your money from the compensation program in the bank’s originating country.

Overseas banks are not allowed to do this in Europe; hence, they have to provide complete UK compensation if they operate in UK.

Remember, if you save with one of those banks owned by overseas companies, the safety of your savings will depend on the foreign nation’s stability and solvency or their authorized financial regulator.

Certainly, there are some countries that have greater financially stability than the UK; however, you will then rely on a government upon which you do not have complete trust to protect your savings.

But on the bright side, beginning in 2010, every European nation has been required to set a compensation cap of €100,000 (which is equivalent to £85,000 in UK, which does not use the euro).

In case you have savings in a European bank that is presently protected by the FSCS at the maximum limit and it converts to the ‘passport’ scheme, the bank should inform you of the change.

Finally, a European bank may also operate in the UK while applying its own home-compensation program that may be below the UK limit, giving you protection only for that lower amount. Under this arrangement, the overseas bank will not be FCA-regulated but remains regulated by its government’s own protection program.

Nevertheless, accounts with these banks sometimes provide higher rates compared to UK-protected banks.

Remember then that dealing with non-UK regulated banks may result in difficulty of getting back your money in the event of a bank failure.

How to Secure Your Savings (Part 1)

How to Secure Your Savings (Part 1)

The collapse of Northern Rock, Bradford & Bingley, and Icelandic banks caused a lot of panic several years back, leading people to wonder whether their savings are safe at all. What steps can we take to secure our savings from such a terrifying and real threat?

We will provide a detailed safety checklist as well as what safeguards you can apply in case of averse economic scenarios.

The essential facts you need to know

At least 6 facts will let you prepare for worst-case scenarios, namely:

  • Increased protection limit. At present, your savings now gets £85,000 protection based on UK-regulated financial institution instead of the former £75,000 only

Every UK-regulated savings and current account as well as cash ISAs in banks, credit unions and building societies are protected by the Financial Services Compensation Scheme (FSCS).

From £75,000, the cover was raised to £85,000 on 30 January 2017 after the pound’s post-Brexit fall led to a review by the Bank of England. However, the amount of £85,000 is not given for each account but for each financial institution. Hence, if the bank runs, you receive £85,000 for each person, for each financial institution. Most savers will get the amount within seven days.

  • You get a temporary £1-million-protection after ‘life events’

Based on rules established in July 2015, savings of up to £1m may be protected for a six-month period in case your bank fails.

The increase will cover such life events as selling your home (but not when you buy-to-let or a second home), redundancy, inheritances, and insurance or compensation payouts that could result to you holding a temporarily-high savings amount.

The additional protection will apply starting from the day on which the money is transferred into the account, or the day on which the depositor becomes eligible to have the amount, whichever comes later. You have to provide documents to show where the funds came from in case you file a claim for the amount. It might take at most 3 months for any release of cash above £85,000.

This development is beneficial as it provides the saver time to prepare on how to utilize the money. Moreover, you can maximise savings by adding more money into higher interest-paying accounts instead of the usual lower-paying accounts.

  • Not every UK savings account is UK-regulated

Majority of banks, also foreign-owned ones such as Spain’s Santander, are regulated by the UK government. But certain EU-owned banks prefer to use the ‘passport scheme’ where protection only comes from their HOME government. Examples are Fidor, RCI Bank and others.

Joint accounts count as doubly protected

Since cash in joint accounts are considered as half each, it gets a £170,000 protection.

If you also have a personal account with the same bank, half of your joint savings stands as your total exposure; hence, and any additional amount above £85,000 is not protected.

An institution is a distinct entity from a bank

Remember, the protection is for every institution, not for every individual account. Therefore, having 4 accounts with a single bank only entitles you to only £85,000. The meaning of the word ‘institution’ depends on a particular bank’s license and huge banking conglomerates complicate the meaning.

For instance, Halifax and Bank of Scotland are sister-banks and their accounts are covered for only £85,000, for one institution. RBS and NatWest, also sister-banks, however, have separate limits.

Distribute your savings to protect them

To achieve fail-proof safety, save at the most £83,000 in every institution (which gives you a safety allowance of £2,000 for interest growth). Doing so will spread your money in perfect safety even if you stay below the £85,000 mark; hence, in case your bank fails, your money will not be inaccessible for a certain period. Having two accounts will reduce such a risk.

What the FSCS protects

The Financial Services Compensation Scheme (FSCS) only covers organisations under the auspices of the Financial Conduct Authority (FCA). This led to the tragic failure of the Christmas savings scheme Farepak, which had no protection at all. Thus, when the scheme went caput, all the money disappeared.

The primary types of protected savings include the following:

  • Bank and building society accounts

FSCS covers all UK bank, credit unions, or building society current and savings accounts; and it also partially covers small business accounts.

Some forms of protected equity bonds, which are ‘deposit accounts’ whose interest growth relies on the stock market’s performance, may likewise qualify for ‘savings’ protection.

  • Any savings within a SIPP pension

For those who have a self-invested personal pension scheme and saved cash money there (in contrast to investment funds), FSCS provides complete protection for their money, separate from any other investment protection.

SIPP service-providers will help you determine the banks holding your money; hence, you can find out if it is linked to others you where you also have savings.

Any cash ISA (includes Help to Buy ISAs)

These refer to simple tax-free savings accounts, provided with FSCS protection like other savings accounts. Among those under this coverage is the cash ISA’s forerunner, the Tessa-Only ISA (Toisa). Moreover, the ISA money does not lose its tax-free status in case the institution holding it fails.

Ask yourself these questions: Do I have protection for my investment in a company? Does my insurance have protection in case the company fails?

How protection works

FSCS covers all UK-regulated deposits – including money saved and accrued interests – that you have put into a bank or a building society savings instrument.

An independent government-sponsored fund regulated by the FCA, FSCS protects some of your money in the event of a bank collapse, although you will lose temporarily any access to your money during the period of compensation.

As long as the bank is UK-regulated, the following rule applies to all, whether children or adults, or wherever they may reside, as stipulated thus:

100% of the first £85,000 in your savings, for each financial institution, is covered.

You may ask: What is considered an institution and what is a UK-regulated institution? And other issues to consider, such as the following:

  • A joint account has a limit that is doubled
  • Rates were different prior to February 2017
  • Savings are not considered along with debts
  • Interests are part of the threshold
  • Compensation will take time for release
  • Offshore accounts are not often protected

Evaluating Your Investment Returns

According to David Fabian, “A vital part of Investment success depends upon one’s ability to compare historical returns with an index or benchmark.

Doing so will let you measure if your approach meets the performance expectations or evaluate the efficiency of somebody else’s recommendation prior to hiring them. Although is may be very common in the entire industry, many investors still make knee-jerk conclusions based on unreliable or biased information.

Two primary conditions that must be satisfied when determining the viability of any investment approach are discussed below:

A proper standard of evaluation

We now lay down the reasons why these concepts are essential to your decision process.

Let us talk about time.

In reality, time is a commodity that has lost its overarching value in the fast-evolving dynamics of our daily existence. People so often fall prey to the temptation of immediate gratification provided by modern technology that they totally overlook how much time is required to accumulate wealth through the process of compounding.

For instance, if you start saving and investing starting at your mid-20’s and then you retire in your mid-60’s; it would have taken you 40 years to accumulate your wealth. But it does not end there. You need to sustain your wealth’s security for another 20 years through managing and conserving your investable assets. The growth period alone will take 480 months or 40 years, while the distribution or income period could last for 240 months or 20 years more. You need enough patience to see it through.

You cannot simply compare returns over very short time-durations. That is why you can hear people cry: My portfolio has been stagnant in four months! I’m below the benchmark on a 6-month rack record! Alas, my portfolio is 250 basis points lagging from the S&P 500 this year – I am done for!

The truth is that even the most efficient investment method will suffer some setbacks through underperformance. It may take some months or even last for a couple of years or more at a time. The best step to take during such doubt-filled or self-pitying moments is to recall why you chose this strategy in the first place.

Is your investment strategy still consistent with your risk tolerance level?

Could there be an intervening and temporary factor that is causing the adverse conditions?

Can you do something to manage this factor in order to enhance your long-term returns?

Have you really considered the risks of shifting to another approach in mid-stream?

Experts would advise that you analyze the performance of any investment method over a period of 3 to 5 years, enough time to determine the strengths and weaknesses over several conditions of the markets (bear, bull, transitional, and others).

The bond or stock markets can proceed for a few years along a particular direction. While that may favor some investors, it can also hurt others. Not that either side is bad investing; it all has to do with each group being exposed to different risks.

Creating and protecting your wealth is not a 100-meter dash — a short-distance race, so to speak. Rather, it is a marathon — a sustained race where risk conditions must be considered at close-range and behavioral principles applied with accuracy. Great patience is, therefore, of utmost importance in order to succeed as an investor. There are no short-cuts in this industry.

A Suitable Benchmark

A common pitfall among investors is the tendency to compare apples and oranges.

A prime example is that of a company whose primary approach is to have a mix of bonds and stocks allocated through ETFs that are adjusted according to meticulously-developed strategies. As such, it has a total of 20 to 40% stocks and 50 to 70% bonds in the Strategic Income Portfolio at any particular period.

However, the most common feedback the company derives when evaluating performance is how its portfolio stacks up against the S&P 500 Index. It seems that people are programmed to think that the S&P is the singular reliable benchmark available, such that it has become the darling standard of many index lovers throughout the world.

Obviously, there is no basic logic to comparing the returns of a 100% stock portfolio (the S&P 500) versus a multi-asset portfolio that contains less than 50% exposure in stocks. A better and more suitable benchmark for such a type of investing method would be the 40/60 allocation in the iShares Core Moderate Allocation ETF (AOM). That is where the data will exhibit a clearer picture of actual performance.

In a similar manner, comparing the 0 to 60 mph rate of starting acceleration of a Porsche in a few seconds to that of a Suburban would not make sense either, would it? Although that is an accepted truth, in general, only a few investors consistently apply that universal principle in their investment practices.

It is vital to appreciate that fundamental concept in the process of accurately measuring risks or comparing similar approaches.

Never compare investing in bonds and stocks to the revenues of a CD or a money market account.

Never relate a portfolio of technology stocks to closed-end funds.

And never compare hedge-fund revenues to that of a bunch of ETFs.

We can continue down the line. . . .

Perhaps, the most difficult hurdle to making this logical conclusion is the fact that most investors do not know the suitable benchmark for comparison objectives or where to locate them. They merely gravitate to the S&P 500, the NASDAQ Composite or the Dow Jones Industrial Average because they see them flashed on the news or on the web daily.

In the end, every particular asset type or investment instrument should be weighed or evaluated by a similar group of equals. ETFs have made that process less difficult for many years now; however, you must always undertake the task of finding an appropriate index to serve as a benchmark. Ask a professional analyst how and where to find a good benchmark as a reliable yardstick.

The Ultimate Goal

Investing involves a lot of psychology and comprehension of the relationship of certain facts and information. This article hopes to develop a new perspective not considered previously or to strengthen an existing point-of-view. It is hoped that either way, the reader will attain a more reliable and more solid frame of reference for evaluating a portfolio’s performance in the future.

Why value investing could be the riskiest investment strategy

Why value investing could be the riskiest investment strategy

For many years, value investing has grown to become a very popular and profitable investment strategy. Among those who consider value investing as a viable choice are Benjamin Graham and Warren Buffett – two of the most successful value investors with spectacular gains over a long period of time.

The expected returns from value investing are comparatively high, although the risks are oftentimes much higher than most investors can handle. This is because value investing can result in an investor being subject to value traps, which occurs when a stock’s price is low for a very valid reason. What are value traps?

Value traps

Surprisingly, value traps are more common than most investors realize. In spite of global share prices having increased from the beginning of the year, many other shares will still actively trade at significantly low prices in comparison to the broader index.

Although some might catch up and recover, others will not. Nevertheless, low-priced shares commonly appeal to value investors since the capital gain potentials are attractive. In short, for a good number of conservative investors, value investing may provide a high-risk option which could bring a substantial loss.

Beyond prices

Value traps may indeed provide a trading risk for value investors who do not realize that “value” goes beyond merely having a low share price. According to Warren Buffett, “It is better to buy a great company at a fair price than to buy a fair company at a great price.” Ultimately, the viability of a company must be measured along with its share value.

Hence, if a firm’s shares are selling at a lower price than their net asset value, a potential risk in the future might keep them from recovering the valuation deficit. Likewise, a stock which is valued according to the wider index may in reality provide significant value for money if there is a positive expectation of a rapid increase in returns over a medium-range period. In short, value investing can be a great strategy when you consider certain essential factors, such as price, prior to acquiring the shares of a company.

Periodic changes

Obviously, with rising stock prices, value investing loses its appeal. As investors all over are buying, value investors are selling and choosing to invest in other assets, such as cash. Conversely, when market prices are down, value investors will be buying stocks instead of selling them, contrary to the overall market consensus.

Being a value investor then can be a challenging occupation; and, on the short-term basis, it is quite easy to suffer paper losses as past trends continue to prevail. However, on the long-term basis, it has proven to be a viable strategy for investors of a certain level of experience and capability. It is not totally risk-free. So, by not merely focusing on price, this approach can serve as a highly-dependable road to financial success in the long run.

Tips for Avoiding Financial Mistakes for Millennials

Tips for Avoiding Financial Mistakes for Millennials

If you are in your early and feel you should prepare yourself for financial success while avoiding serious mistakes, what do you need to do?Here are some valuable tips.

Firstly, relax! You are in the best time to be enjoying life; and getting started on the road to a secure financial future is one of the wisest moves you can do. Go ahead and have some fun, discover exciting avenues and be open to potential ventures and adventures you can pursue for a lifetime. Do not become paralyzed with the fear of making mistakes or you will miss out on fruitful and gratifying opportunities. That would be counterproductive – learn to embrace mistakes as they can be stepping stones to learning and growing.

Nevertheless, some mistakes can cause disastrous and long-term financial effects compared to others, although they may seem harmless on the surface.

Go over these five financial missteps that can adversely undermine your financial life. Knowing how not to commit the same mistakes will greatly enhance your potential for building your personal wealth.

Mistake #1: Delaying on Your Savings Plan

This mistake tops all other mistakes in terms of keeping people from achieving a certain degree of financial stability. According to a survey, 39% of all respondents admitted regretting not having saved much earlier on while 63% claimed that saving early is the best advice they could offer to people.

Old people should know better than the young ones on this matter. Consider this: At 25, a millennial who tucks away 10% of her $30,000 income yearly will accumulate more than $620,000 at 65, based on a 2% annual raises and a 6% yearly rate of return on investments. If she postpones it for only five years, the nest egg goes down by about $140,000 and waiting 10 years reduces it by over $250,000.

You see how delaying on your plan to save can reduce your potential earnings in the future? Check out online apps that help you calculate how much you will accumulate if you start now.

However, there is a way to avoid this error. If your employer offers a 401(k) plan, contribute the minimum allowed amount to avail of full benefits of your employer matching funds.

Open a Roth IRA or Traditional IRA account at a mutual fund firm if your employer does not offer 401(k). Contribute to your fund using automatic transfers from your checking account every month.

While doing that, set up an emergency fund amounting to a minimum of 3 months’ worth of living costs in a savings account, as a buffer in case you lose your job or for other emergency needs.

Remember, the important thing is to develop the habit of saving weekly or monthly and to continue doing it in your entire working life.

Mistake #2: Borrowing money you do not need

There are times when borrowing is essential, such as for a house, a car or for a college education to enhance your earning capacity. However, taking out a loan to sustain a kind of lifestyle above your pay level will cause big problems.

You have to realize that paying off a loan can greatly affect your budget. NerdWallet’s latest yearly survey on consumer debt revealed that the regular household spends over $6,650 just for interest payments yearly.

Before you do take out a loan, answer these questions: Do you really need it? If so, can you live with a cheaper alternative? Finally, calculate if the monthly principal and interest you pay for so many years will yield for you a more beneficial alternative in terms of savings and investment accounts that can accumulate and serve to protect you from financial straits.

Mistake #3: Believing the Wall Street’s byline “investing is complicated”

Investors often understand Wall Street companies to be saying that one needs to monitor the financial markets at all times, distribute your money over all kinds of complicated and cryptic assets and always be on your toes at any time in order to invest in new promising stocks. And the catch is that to make any substantial return, you must seek their help – obviously for a high price worth their “expert” advice.

Don’t you believe it! Even veterans in the market cannot accurately predict what the financial markets will end up doing. Terrance Odean, professor at the University of California Berkeley, conducted research which showed that outguessing the market by constant trading tends to reduce an investor’s chances to gain good returns.

The better alternative is by doing less: Create a basic portfolio of widely assorted stock and bond funds that suits your risk tolerance level and leave it as it is through market highs and lows, except for a rebalancing adjustment once in a while. Check out online tools which will help you do proper asset allocation consistent with your risk capacity in order to find a balanced mix of bonds and stocks that works for you.

Mistake #4: Paying too much for financial counsel

The annual fees you pay for a mutual fund manager or the occasional fees in exchange for advice in choosing potential funds and other financial counsel will affect whatever returns you expect from your investments by reducing your savings. Minimize such costs as much as possible.

In terms of investments, you can gain greatly reduced costs by sticking to low-cost ETFs and index funds. You can readily gain savings of at least 1% annually in relation to the regular stock mutual fund.

Go ahead and consult a financial adviser, if you feel you need to; however, be sure you get the precise amount you have to pay and the specific benefits you will receive, before giving out any money. Likewise, make sure the price is reasonable and comparable to fees charged by other advisers.

You may also hire an adviser on an hourly scheme rather than shelling out a specific percentage of your assets or using an online-adviser app or service utilizing algorithms that recommend affordable investing tips.

Mistake #5: Not monitoring your progress

One thing you should not do is to become money-obsessive. Neither should you be a Pollyanna and let things take their course, hoping everything will come up roses. Take time to regularly assess your financial status at least once-a-year to determine if you are on the right path.

The best overall measure of your financial health is through knowing your net worth, which is the value difference between your assets and liabilities, that is, how much you have and how much you owe.

For those who regularly save and invest wisely, their net worth should gradually increase. Once your net worth is static, you must increase your savings, invest more sensibly or reduce your indebtedness.

Calculate your net worth using simple online tools. A yearly estimate and comparison with the results of past years will easily show whether your net worth is increasing or not.

Likewise, make use of other free online tools which will help you evaluate your other financial aspects, including a check on how your present saving habit and investing pattern will create a stable retirement future for you.

It goes without saying that in order to increase your wealth-building potential, you need to cultivate your talents and abilities to a point where you can earn and save more during your professional life. And remember the value of having a solid defense against the five mistakes mentioned here. Doing so will significantly enhance your chances of reaching your financial goals and spending a secure future.

How and When to be Average Joe or Average Jane

Most people fall in the so-called “average” or “median” range. After all things are counted and considered, the statistical middle-ground is where all things tend to gravitate – the world of the, sorry for the term: mediocre.

To be honest, no one wants to be mediocre, run-of-the-mill or commonplace. People in the city park may take selfies that are quite ordinary compared to people who challenge the heights of the Nepalese mountains or the Alaskan wilderness. People do not just want a few likes but viral likes, so it seems. We want to be among those who make an impression for being extraordinary. And that takes a lot of effort to achieve and sustain.

But as investors, the average can provide a lot of benefits.

The idea of being average is the very foundation of the biggest changes to investing in recent years – the surge of the passive index fund.

In the past, you (or a broker) selected a portfolio of stocks that has the potential to bring you wealth. The more adventurous investors opted for a chance to benchmark themselves (while the newspapers aimed for a chance to “score” the stock market). That gave birth to the index.

One possible choice is the ASX 200, which tracks the overall market performance, giving investors a view on how the total market value shifts in a day, a week, a month or a year. It is expected to rise by about 10% yearly, within a long-term period.

And, obviously, we are talking of averages — the average firm and the average year. Choosing to buy an index-tracking fund, as investors usually do as a rule, is quite alright. You can expect to gain average return (minus some fees) over a long duration, enough to produce a sizeable profit in the end.

However, do not expect to get 10% yearly. Moreover, not all firms will gain a value growth by such an amount. Some can go broke. Others come up with the latest “hot product”. Some may exploit the advantages of their product and market, to offer years of market-crunching returns (for instance, Domino’s share price). And there are also those that remain stagnant for ten years (check out Westfield).

The market can spiral downward sometimes. We all know how the last global financial meltdown brought the market down by over half its value from late 2007 to early 2009. That occurred after it had doubled in value from 2003 to 2007.

The idea of “average” provides a restful, promising relief for investors, which may not be absolutely true. Nevertheless, that is no reason to avoid it; for a 10% annual return across 30 years will convert an investment of $100,000 into $1.74 million.

So it is with real estate properties — the quoted prices are national averages, which include stellar Sydney and lagging Perth and Darwin. At the very least, they are city-level average prices, such as those of inner- city apartments, harbourside mansions and suburban residential projects, everything that is traded in the market in a year.

Furthermore, for both assets and real property, the quoted prices reflect only those that actually moved from one hand to another and not the bulk of assets that were kept in a private safe or properties still in use by their happy owners.

Although it is not wise to be foolhardy, the average point (where half of the data is either above or below) presents a totally different picture. You need more than luck to get over the average-trap. Hence, if you can succeed in “buying” the average – that is, by using an index fund – you made the right initial step. Just remember that it will require big challenges along the way, whether you do buy or not.