Lakeside Financial Planning – Advisor Insights

International Investing – How a Diversified Portfolio can Mitigate Risk

MONEY TALKS

Often times when I review a prospective client’s portfolio it’s heavily tilted toward U.S. equities and contains little to no internationally based stocks. Many of us will readily admit to having a hometown bias when it comes to our favorite sports teams; however, we may be unaware that these same biases carry over to our own investment philosophy. The reality is, many investors are selling themselves short by not fully utilizing the global equities market, often resulting in higher risk portfolios with lower returns. In fact since 1970; international stocks from developed regions have outperformed the U.S. stock market about half of the time.

The most common example of these “hometown” biases is in portfolios that are heavily invested in U.S. based, multinational corporations such as Apple, Exxon Mobil, or Coca-Cola. While it’s human nature for people to avoid things that are unfamiliar to them and take comfort in what they know, this can lead to a false sense of security. The brand recognition of these conglomerates, along with their international presence, leads investors into thinking that they don’t need to diversify their portfolios with any international stock. In truth, while they are gaining some international exposure, it is very limited and lacks exposure to major asset classes such as small-cap and emerging markets.

Academic research has shown that investors have better outcomes when their portfolios are diversified among different asset classes because each responds differently to various market cycles and events. Although international funds are historically more volatile than similar domestic funds, adding international funds to a portfolio can provide greater diversification while potentially lowering the volatility of the entire portfolio. By seeking investments that are not highly correlated with one another you are increasing the potential for gains in one part of your portfolio to offset losses in another part. In other words, a well balanced portfolio with international exposure can help to reduce large swings and keep you cruising in the center lane of performance.

Diversification aside, international markets offer growth opportunities that the United States simply cannot compete with. International economies, benefiting from less mature markets, attractive demographics, and availability of natural resources are growing at higher rates than developed-market economies. In the last fifteen years international emerging market stocks have outperformed the S&P 500 10 times. In fact, over that same period the Morgan Stanley Capital International Index has been the top performing major asset class 7 times, with an average return of nearly 13%. This is not to say that international stocks are not without risk, but an investor without any international exposure over that time period would have missed out on a tremendous opportunity to grow their portfolio.

Most of us are unaware that the United States accounts for just over half of the global equity market. However, if recent trends continue the international equity markets will gain the majority of the market share before long. So before you purchase your next stock or equity fund, remember that investing internationally can help to diversify your portfolio, mitigate risk, and maybe even increase your return!

Tip of the Week – Keep College Savings in Your Name

Keep College Savings in Your Name

Parents often start a college savings account in their child’s name because it’s the intuitive thing to do. After all, it’s the child that will be attending college, not the parent. Unfortunately there can be adverse consequences to this arrangement particularly as it relates to financial aid. When applying for financial aid, 20% of the assets in the student’s name are taken into consideration, however only 5.6% of the parental assets are considered. This means that an account with $3,500 in the child’s name will reduce the students financial aid the by same amount as a parental account with $12,500 would. Take the time to properly title college savings assets under your name, it could result in your college bound child receiving a much larger financial aid award.

Speculative trading, no thanks. I’ll take my chances at the casino.

A good friend of mine called the other day and we quickly got into the run-of-the-mill chatter about the kid’s going back to school, last week’s Patriots game, and how things were going at work. Before long, the conversation turned into a story about an airline stock he had just bought. As it turns out, his purchase was prompted by a recent drop in the share price and his perception that it couldn’t go any lower. Yet, after he purchased the stock, the price dropped ominously further. Fearing he would lose everything, he panicked and sold his holdings at a loss. Being the empathetic friend that I am, I sarcastically responded by asking if he wanted to go to the casino – because he might as well have been betting his money at the Roulette Table. I then tried to explain to him that what he was doing was called speculative trading, and he would be much better off if he developed an investment strategy instead.

Speculation is defined as the act of taking on considerable risk for the opportunity to generate large gains. We have all heard the old adage; no risk, no reward. However, the word “risk” by default means that the reward is never guaranteed. In the case of my friend, he assumed or speculated that the price of the airline stock had dropped so low that it could only go up from there. When the price dropped even further, he had no long term investment plan to rely on, and ultimately let his emotions take control over his investment objectives. This over reactive mentality is shared by many and is basic human nature. It’s the same reason why, for the last 20 years, the S&P 500 Index averaged 9.22% per year, while the average equity fund investor earned just 5.02% over that same time period. Even though my friend was correct in that the airline stock had indeed dropped over 15% in the last 10 days, its year to date performance was actually up over 9%. So you tell me, was the stock up or down when my friend made his purchase?

An investment strategy on the other hand captures your investment objectives while taking into account your time horizon as well as your risk tolerance. A good investment strategy should be a clearly defined written document that you can refer to in times of distress. While investing with a disciplined approach may not be as exciting as speculative trading, it has been proven to yield higher returns over time. In fact, most experts will agree that trying to time the market is nearly an impossible strategy. Instead of purchasing an individual airline stock based on speculation, a better alternative would be to develop your own long term investment strategy that meets your goals and objectives. One might decide to invest consistent amounts of money in a mutual fund at regular periodic intervals. By investing over time, you are lessening the risk of investing a large amount in a single investment at the wrong time. Likewise, by investing in a mutual fund, it provides you with broad market exposure at a fraction of the costs of diversifying into individuals stocks.

Many of us let our own emotions get in the way of making logical investment decisions. The most common of all is to buy when the market is high in hopes of riding the wave or to sell when the market is down out of fear of losing everything. Yet logically we all know that the market will eventually auto correct itself given enough time. Developing a sound investment strategy and sticking to it will likely yield you higher returns than any other investment moves you make. If fact I would argue that the actual selection of the funds within your portfolio is far less important than the strategy behind them.