Advisors' Roundup - February 27, 2015

On my radar this week:

Investors REALLY don't like losses:
The Irrelevant Investor

TJ Maxx joins the wage hike bandwagon:
NPR Marketplace

RIP Irving Kahn 1905 - 2015
Bloomberg

Loss Aversion

A couple of weeks ago on the heels of a CFA Society of St. Louis Luncheon with BlackRock's Benjamin Kelly, I wrote about cutting out a layer of behavioral bias with the use of index funds (or index-based ETFs). Today, we'll begin to look at some of these biases by introducing the concept of Loss Aversion.

Consider two sets of choices:

CHOICE 1

You can pick between:

A: A 100% chance of receiving $15,000 -or-

B: A 20% chance of receiving nothing and an 80% chance of receiving $20,000

Go ahead and make your choice and write it down.

CHOICE 2

You can pick between:

A: A 100% chance of losing $15,000 -or-

B: A 20% chance of losing nothing and an 80% chance of losing $20,000

Write that choice down.

MODERN PORTFOLIO THEORY vs BEHAVIORAL FINANCE

Modern portfolio theory, the underpinning of finance for years, assumes that people are risk averse, that is, given the same expected return, people will choose the less risky option. In fact, what behavioral finance has discovered is that many people are loss averse. What's the difference? Let's look at the two choices above:

In CHOICE 1, the expected return of option B is 0.80 * $20,000, or $16,000 - more than option A. If you're extremely risk averse, you may pick the 'sure thing' of option A. If you are risk neutral, you'll pick option B due to its higher expected payout.

A funny thing happens when you look at CHOICE 2 though. Here we are talking about losing money, not gaining. If you look at it closely, it's the same problem in reverse. Here though, many of the most risk averse individuals will not take a sure loss even though picking option B is both riskier and has a worse expected income. Investors get anchored to their current level of wealth and as a result, losses hurt much worse than the satisfaction you get from a similar upside gain.

How does this manifest itself in investing? If you (or your portfolio manager) pick individual stocks, you are more likely to sell winners to 'lock in gains' and hold losers too long in hopes they will 'bounce back'. Capital-weighted index funds (like S&P 500) avoid this because as the stock price grows, so does the stock's weight in the index.

In the next few weeks we'll look at some other biases, such as overconfidence.

Financial Advisors in the News

Today's St. Louis Post-Dispatch headline has stirred up concerns touting President Obama's focus on reform of financial advisers.

The changes are aimed at broker-dealers (B-Ds) such as Edward Jones or Merrill Lynch, not registered investment advisers (RIAs) such as Compton Advisors, LLC and are focused on raising the standards with which B-D firms must treat their clients.

Under current SEC rules, advisers are held to a higher "fiduciary" standard while brokers are held to a lower "suitability" standard, meaning they must sell "suitable" products even if they are not the most cost-effective. - Reuters

By "fiduciary", the SEC means that RIAs are required to put their clients' best interests first. Broker-Dealers, in an arrangement with the SEC known as the "Merrill Lynch Rule" may put their own interests before those of their clients. As the SEC has dragged its feet against efforts to hold B-Ds to a higher standard, the Obama administration has turned to its Department of Labor to formally propose rules raising the level of consumer protection required of brokerages to that maintained by RIAs.

Compton Advisors, LLC has always maintained a fiduciary standard.

For more information, here is the Reuters article:

Obama takes aim at brokers' fees on U.S. retirement accounts

CFA Society of St. Louis Retirement Conference

I would like to extend an invitation to the CFA Society of St. Louis-sponsored retirement conference being held March 5 at the Frontenac Hilton at Clayton & Lindbergh.

Featured speakers are Juli Niemann (a familiar voice to KWMU listeners over the years) and the Federal Reserve's Bill Emmons. My fellow CFAs will be leading breakout sessions later in the day. The event is strictly educational. NO SALES.

If you wish to attend, please let me know how many you need and who will be attending at john@comptonadvisors.com by March 1 and we'll get you complimentary tickets.

Full details below:

Thursday, March 5      Open House Wide ranging retirement insight from local CFA investment experts.      Some of our speakersBill Emmons Retirement Demographics Assistant VP at the Federal Reserve Bank of St. Louis and Senior Economic Adviser at the Center for Household Financial Stability Juli Niemann Smith Moore Current Investment EnvironmentOpen House come for all or part of the event   Time: Program details below 3-4:30pm Bill Emmons and Juli Niemann 4:30-7pm.    Two tracks - Individual and Institutional Appetizers and Drinks 5-6:30pm., Cash Bar 7-8pm. (Soft drinks and snacks will be available throughout the event) Location: Hilton St. Louis Frontenac 1335 Lindbergh Blvd, St. Louis, MO 63131 (Clayton Ballroom building entrance as pictured)     Garage Parking is Complimentary

Conference Schedule (Clayton Ballroom) 3:00 - 3:15pm. Introduction John P. Dwyer, CFA, CAIA, Mercer, President, CFA Society of St. Louis Jack will provide an overview of the Future of Finance. Providing information about the Statement of Investor Rights created by the CFA Institute.  We will also discuss the Essentials of a more Secure Retirement. 3:15-4:00pm. Retirement Demographics William Emmons, Assistant Vice President at Federal Reserve Bank of St. Louis and Senior Economic Adviser at the Center for Household Financial Stability. Bill will discuss the impact of demographics on savings, highlighting a number of risks facing current and future retirees including uncertainty around Social Security, Medicare, corporate pensions, and retiree healthcare. Bill will also provide insights into how workers' flexibility as they approach retirement may improve outcomes. 4:00-4:30pm. Current Investment Environment Julianne C. Niemann, CFA, Smith Moore Juli will present a brief overview of the current investment environment highlighting both pockets of return potential and risks. 4:30-4:40pm. Breakout leaders introduce themselves and their topic 5:00 - 6:20pm. Separate into Individual & Institutional Tracks Institutional Track (Clayton Ballroom)  Shaum Shrinivas, CFA & Joe Libbra, Mercer Todd Grizzle, CFA, Fiduciary Advisors Plan Structure Default contribution rate Automatic increases Default investment option Matching contribution structure Life Cycle / Target Date Funds Inflation protection options Individual Track(Breakout Room)  Michael Schoppet, CFA, CAIA, CIPM, Benefit Finance Partners Richard Baldwin, CFA, Baldwin Wealth Management Barbara Turley, CFA, The Commerce Trust Company Peter J. Lazaroff, CFA, CFP®, Acropolis Investment Management Choosing a financial advisor Creating an investment plan Defining investment objectives Investor Pitfalls Impact of Taxes Inflation Asset Allocation Passive vs Active investing Asset location 6:30-7:00pm.  Closing Remarks (Clayton Ballroom) 7:00-8:00pm. Cash bar and table toppers

Advisors' Roundup - February 20, 2015

Here's what caught my eye this week:

Don't expect to be a hare in a tortoise world:
The Certifiable Planner

Another nail in the coffin of active management?
The Reformed Broker

The largest private employer in the U.S. announced a wage increase
The New York Times

Completed Trade

John Dutemple bought, for a family account, 350 shares of Franklin Resources (BEN) with a market order.

Proposed Trades

John Dutemple will place the following trades, for a family account, after market open Tuesday, February 17, 2015:


Buy Disney (DIS) limit order @95 good 'til close 2/27/15

Buy Franklin Resources Inc. (BEN)

Buy 3M Co. (MMM) if under $164.60

Advisors' Roundup - February 13, 2015

On my radar this week:

With apologies to my pension consultant friends (and family):
ETF.com

Leave that thing alone
Investment News

Why pay more for active (biased) management?
Compton Advisors, LLC: Cutting Out a Layer of Bias

Cutting Out a Layer of Bias

We all have flaws in our thinking that get in the way of making the best decisions. Even professionals.

It was my pleasure to hear Dr. Benjamin Kelly speak at today's CFA Society of St. Louis luncheon on the topic of Behavioral Finance in Investment Decision Making. Kelly, an investment strategist with BlackRock, is a charming fellow (despite being a Blackburn Rovers fan) with a knack for explaining Behavioral Finance.

The field has been around for a few decades - its earliest practitioners receiving the Nobel Prize in 2002. I'll dive a little deeper into some of the more relevant aspects in subsequent posts, but the gist is this: people are wired such that they do not always make the best decisions, especially when it comes to money.

The surprising part of today's talk (and others like it to CFA societies across the globe) is that it was being given to money professionals with the message that essentially says: you too.

This means that not only do investors have to overcome these detrimental biases, the next layer managing their money - the stock pickers, the active mutual fund managers - have to as well. And this is even before you factor in behavior caused by misaligned goals (poorly performing funds taking on huge risks to 'catch-up' by year-end, churning by brokers, etc.).

The easiest thing to do then to avoid multiplying the cognitive biases involved is to remove the opportunities for them to occur. Index funds instead of active management removes the opportunity for bias (and is a heck of a lot cheaper). Target asset allocation with rules for rebalancing avoids flawed subjectivity by swapping in objective boundaries. And avoidance of overconfidence leading to undue concentration of 'bets' on the market (or, God forbid, single stocks) can be had through diversification.

These are all 'unforced errors' that can be avoided once we are aware of them. The market will beat you enough days, don't beat yourself.

Advisors' Roundup - February 6, 2015

Here's where my mind is this week:

A 75% tip! Not in this lifetime. One more reason to brew at home:
New York Times

World's Best Stockpicker beats hedge funds by not picking stocks:
Fortune

Even advisors need advisors:
A Wealth of Common Sense

Completed Trade

John Dutemple sold, for a family account, 100 shares Amgen (AMGN) with a market order via stop.