Ongoing financial woes in Greece remind us we live in a world of uncertainty. Currently Greece is the lowest credit rated country in the world. “Global Economic Collapse” has been the byline of choice when the media has reported on this story since 2009. Newsvendors have pulled all stops when it comes to connecting the dots between the possibility of Greece defaulting on its debt and worldwide economic disaster.
If raising angst in investors is the intent of the media, it has done a fine job. I’m asked at least 3 times a week about what might happen if Greece does this or that. The root of these questions is the fear that whatever the ifs ands or buts, the result will be a negative impact on our investments.
Here are some things of which I am certain: We cannot know in advance how any crisis will affect anything or for how long, including the value expressed on our investment statements. Moreover, from a larger view, this news item is the epitome of risk– which is the very nature of investing. If stocks, bonds, countries, economies, etc., did not experience risk and volatility, there would be no premium over time for investing in them. If that were the case, no one would do it. See if this sounds familiar:
Economic Risk: “In financing a project, the risk that the project's output will not generate sufficient revenues to cover operating costs and to repay debt obligations.”
12 years ago this perfectly defined Brazil. It teetered on economic ruin that, given its global energy contribution, could have create a far greater problem than Greece threatens. Now we see that Brazil has turned into a major economic player and its stock market has had the highest returns of any other since that time.
But back to Greece. As for the things I’m not certain about… but still seem reasonable: As a global economic player, Greece is quite small. The total debt outstanding is 432 Billion in U.S. dollar terms. Compared to the near failure of a single company in 2008, AIG, this isn’t particularly scary. When compared to the size of the entire problem at the time, this amount would hardly be worthy of a conversation.
If I am to buy into the potential catastrophe as described, the possibility of default has the world teetering on bankruptcy. The European Nations, U.S., China, Japan, Canada, Brazil…and so on are going to be blown out of the water by this. I’m not saying it is desirable and won’t create problems, but topple the global economy? Really?
Since 1973 there have been 15 major financial crises that affected the markets. What follows leaves out a number of political, currency, commodity, wartime, and other crises:
1973: OPEC strangles energy supply. Oil prices surged out of sight leading to the worst bear markets since the depression.
1980’s: The Latin America Debt Crisis. This crisis threatened to bankrupt many major US banks.
1984: Continental Illinois and National Bank became insolvent. This threatened to create a run on U.S. banks.
1987: The DOW dropped almost 25% in a single day. The largest one-day drop in the history of the market.
1989-1991: The Savings & Loan Crisis. 747 S&L institutions (banks) failed.
1990: The Japan Bubble and Collapse. Japan has still not fully recovered.
1990: The Scandinavian Banking Crisis. Created a dismal impact on Sweden, Norway and Finland.
1992: Black Wednesday. The Bank of England had to withdraw from the European Exchange Rate Mechanism due to speculative attacks on the British pound.
1994: The Mexico Peso Crisis. The US had to lend money to Mexico to prevent the country from going insolvent.
1997: The Asian Contagion. Banking devaluations ran rampant across Asia.
1998: The Russian Stock, Bond and Currency Collapse.
1998: The Long Term Capital Collapse. The Federal Reserve had to step in and provide a bailout to prevent another collapse and contagion.
2000: The DOT COM Bubble Burst.
2001: 9-11. Leading to a wartime market, this began with the literal collapse of the center of the Global Financial Mechanism.
2007: The US Financial Crisis.
The lesson is that crises, volatility, and yes, risk are NORMAL. Stated most simply, the volatility endured from this normalcy is where returns higher than CDs and T-bills come from. Those that realize this “risk adjusted” premium are those that have a clear investment strategy that does not deviate when media speculation paints a dismal picture.
The number of people able to alter their strategies around such events to further profit is so small, there isn’t a single book written about them as a whole. But there are hundreds of books discussing the success of those who look at risk, prudently diversify into it, hold fast, and succeed.
In closing, it is interesting to note that from 1970 to April 2010, the S&P 500 returned 10.0% per year and the EAFE returned 10.1% per year.
I welcome your comments.
Warmly,
Marc Becker
Investment Commentary, Education, & Insight.
Wednesday, June 22, 2011
Wednesday, June 15, 2011
Implicit Costs Maim Investors
When evaluating investment cost, most focus on the obvious rather than the obscure. However, educated investors understand evaluating costs requires more than simply looking at stated (explicit) fees. Today I’m focusing on unstated (implicit) costs that do not show up on a fund screening site or in a prospectus.
Long term investors attempt to structure a diversified portfolio of stocks and bonds. This is most commonly achieved by owning mutual funds. The “expense ratio” (annual fee) of these funds can be found within a prospectus or on most fund screening sites. But the expense ratio itself doesn’t tell the entire story when it comes to total expenses created within these investments.
Funds incur other costs passed to investors when the manager buys and sells underlying securities on behalf of the fund owners. The average fund manager turns over the entire portfolio each year , despite that this flies in the face of a known successful strategy— buy and hold. Every one of these trades incurs additional charges to the fund holder. In cases like this, the implicit costs may be even higher than known fees. When added together, it is not uncommon for fund costs to exceed 3% per year.
Expenses in investing are similar to walking in a swimming pool. The higher the cost incurred, the deeper the pool, and the slower the headway. One of the biggest favors any investor can do him/herself is to stay in the shallow end of the pool.
At Wiser, we actually try to stay in the baby pool. Sure, there is no diving, but how much did you enjoy the last time your portfolio went for a dive?
Prudence dictates minimizing the things that we know are likely to detract from future value. Academically it is long proven that the number one detracting element in investing is cost. That said, looking for ways to avoid all costs isn’t a realistic expectation either.
The point is to be aware of the trade off between cost and value. Funds that trade a lot do so in an effort to add value by achieving higher returns than the market. But these managers, primarily due to the excess costs involved, rarely attain this end. In a way it is like the manager is trying to lift the bucket he is standing in.
The compound affect of this drag is substantial. A recent Government Accountability Office study estimated that 1% in unnecessary cost on a portfolio averaging 8% return can be devastating.
According to this study if you incurred implicit costs of 1% and started with $100,000 you would end with $387,000 twenty years later. Without the added cost the value would be $466,000. Over 30 years— $761,000 vs. $1,000,000. Ouch.
The good news is, once understood, implicit costs can be managed. Minimizing the internal costs of your portfolio by holding low-turnover investments is an important part of being a prudent life-long investor.
We would like to congratulate David R. for correctly answering last week’s trivia question. He even showed the math, impressive.
I appreciate and welcome feedback or comments…warmly,
Marc Becker
Long term investors attempt to structure a diversified portfolio of stocks and bonds. This is most commonly achieved by owning mutual funds. The “expense ratio” (annual fee) of these funds can be found within a prospectus or on most fund screening sites. But the expense ratio itself doesn’t tell the entire story when it comes to total expenses created within these investments.
Funds incur other costs passed to investors when the manager buys and sells underlying securities on behalf of the fund owners. The average fund manager turns over the entire portfolio each year , despite that this flies in the face of a known successful strategy— buy and hold. Every one of these trades incurs additional charges to the fund holder. In cases like this, the implicit costs may be even higher than known fees. When added together, it is not uncommon for fund costs to exceed 3% per year.
Expenses in investing are similar to walking in a swimming pool. The higher the cost incurred, the deeper the pool, and the slower the headway. One of the biggest favors any investor can do him/herself is to stay in the shallow end of the pool.
At Wiser, we actually try to stay in the baby pool. Sure, there is no diving, but how much did you enjoy the last time your portfolio went for a dive?
Prudence dictates minimizing the things that we know are likely to detract from future value. Academically it is long proven that the number one detracting element in investing is cost. That said, looking for ways to avoid all costs isn’t a realistic expectation either.
The point is to be aware of the trade off between cost and value. Funds that trade a lot do so in an effort to add value by achieving higher returns than the market. But these managers, primarily due to the excess costs involved, rarely attain this end. In a way it is like the manager is trying to lift the bucket he is standing in.
The compound affect of this drag is substantial. A recent Government Accountability Office study estimated that 1% in unnecessary cost on a portfolio averaging 8% return can be devastating.
According to this study if you incurred implicit costs of 1% and started with $100,000 you would end with $387,000 twenty years later. Without the added cost the value would be $466,000. Over 30 years— $761,000 vs. $1,000,000. Ouch.
The good news is, once understood, implicit costs can be managed. Minimizing the internal costs of your portfolio by holding low-turnover investments is an important part of being a prudent life-long investor.
We would like to congratulate David R. for correctly answering last week’s trivia question. He even showed the math, impressive.
I appreciate and welcome feedback or comments…warmly,
Marc Becker
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