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Market Commentary 12/31/2014

The Value of Advice: Managing Assets (and Expectations) amidst the Noise

Each quarter we sift through pages of statistics and reams of economic and investment commentary in preparation for our letter.  The amount of information that we receive and have available is staggering.  This truly is the information age!  Whether you are an investor or investment advisor, you are being inundated with messages that relate to money; some coming from investment firms and investment providers, some coming from our trusted news sources and some from touted experts happily dispensing their financial viewpoint to the masses.  It has reached a point where the everyday smartphone delivers much of the financial information that the highly prized and very pricey Bloomberg terminals delivered just a decade ago to the Wall Street professional.  While we have access like never before, it’s also become more difficult than ever to discern what’s relevant and what is ‘noise’ in making a good investment decision.

A decade or two earlier the stockbroker was a primary resource for most of the investing public.  Brokers provided research to their clients, recommended suitable investments and then brokered the transactions.  It was also a time when the transaction costs were much higher, transparency was limited and access to quality information was through the investment firm.  Since then the world of investing has drastically evolved and continues to evolve toward even more access to information, lower costs of transactions and greater transparency.  These trends should make the investment process simpler and returns to the average investor even greater.  However in this evolved world, there is a surprising find: the average investor has not seen an improvement in their relative returns.  Morningstar, the large investment research firm, has compiled a performance figure for funds called the “Investor Return™.”  What they found overall is that investors suffered from poor timing and poor planning when buying and selling funds.  The barrage of information today compounds the problem for many investors more so than in years past.

With all of the noise that the investor faces, it is difficult to determine what information is relevant.  Certainly investors can’t put their heads in the sand, but it is critical to have a process to sift through the information so that one doesn’t become whipsawed by irrelevant noise.  Just as our old radios required us to adjust the dial to get past the static, our most successful and tenured investment managers have a process that helps them focus on the signals that matter most to the investor.  Benjamin Graham, the great value investor and mentor to Warren Buffett famously reminds us, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”  The broad economic numbers that get reported daily relating to inflation, jobs, the condition of Greece, even energy prices may have a short term impact on the broad market but in the long run the prices will reflect the fundamentals of the individual companies in the portfolio.

Recently we’ve seen a renewed interest by the financial press promoting low cost index investing especially highlighting the S&P 500 index.  It makes sense and it’s not hard to understand if you look at the performance figures for the last year.  The S&P 500 trounced nearly all other major markets and sectors in the US and around the globe.  This past year the S&P 500 returned 13.7% to investors only to be surpassed by the REIT index.  This was a world away from the -4.5% that the developed European markets delivered or the -1.8% generated by the emerging market index.  However all of the attention toward a single benchmark misses a key point:  No one market, sector or stock consistently goes up in a straight line.  Simply looking at the returns of the various asset classes over the past decade or even longer shines a spotlight on the importance of maintaining a diversified portfolio.  The S&P 500 has had two solid years, but it spent most of the past decade in the middle of the pack.  Over the past ten years, average returns for emerging market stocks, real estate and small company US stocks all posted better annualized returns than the S&P 500.  No one knows what will be the next leading sector, stock or geographic market to invest in.  As Warren Buffet said, “Investing is simple, but not easy.”  Unfortunately, promoting one asset class or low cost indexing strategy as the best way to invest because it did well this time is misleading to investors.  Investors have fallen into this trap over and over again.

The importance of asset allocation and diversification was highlighted by Vanguard earlier this year.  They published research quantifying the value financial advisors bring to their clients.  They broke the components of what we do as investment advisors into modules each with an annualized benefit to the client’s return.  Vanguard confirmed previous research stating that portfolio allocation is the greatest determinant of long term performance.  For Legacy Financial Advisors clients, the allocations are uniquely designed with the client’s individual financial objectives and level of risk tolerance in mind.  While each of the modules researched had a positive impact on overall investor return, after asset allocation the largest contributor to client’s return was what they coined “behavioral coaching.”  Their research reinforced findings by Morningstar saying that individual investors often buy or sell at the wrong time with decisions influenced by noise that has little to do with the long term prospects for the investment or the investor’s objectives.  Vanguard found that helping clients resist the urge to react to the noise and stick to the plan adds significant value.  Their research suggested that this alone added one and a half percent per year to the client’s bottom line return.

Market performance and headlines change far more often than our clients’ objectives.  Investors have to filter through the noise that often makes them feel that they will be penalized if they do not make changes based on the constant flow of information they receive.  We know that what moves markets on any given day, week or quarter has little to do with determining whether a client will reach their financial goals.  We have prepared our clients’ portfolios in advance of sudden volatility through the use of diversification.  This allows our clients the ability to withstand those most difficult times when the market declines.  Understanding the balance between how much is exposed to market volatility and how much is protected has attributed to our clients success over the past 30 years.  As your advisor we will continue to guide you through the noise and help you to attain or maintain your goals.

As always, we appreciate the trust you have in us and welcome any thoughts or questions

Thomas L. Menzel, CFP®                                             Shawn J. Jacobson, CFP®, ChFC, MBA
Asset Manager                                                            Asset Manager
JP Morgan 1Q 2015 Guide to the Markets; Rick Ferri, “Investment Noise and How to Deal with It” September 19, 2013; ASX “Don’t be Seduced by ‘Market Noise’” April 2014; Vanguard Pressroom “Vanguard Research Quantifies the Value of Advice” March 10, 2014; Fact Sheet: Morningstar Investor Return July 2006; Star Tribune “Home is Where the Best Investments Are” December 28, 2014

IMPORTANT DISCLOSURES: The opinions presented in this communication are subject to change without notice and no representation is made concerning actual future performance of the markets or economy. Information obtained from sources is considered reliable but is not verified. The research and other information provided herein speak only as of it date. We have not undertaken, and will not undertake any duty to update the research or information or otherwise advise you of changes in the research or information. Performance information presented is not an indication of future results and index data is provided for market reference purposes only. This is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. This document is the property of Legacy Financial Advisors and is intended solely for the use of the Legacy client, individual, or entity to which is addressed. This document may not be reproduced in any manner or re-distributed by any means to any person without the express consent of Legacy. This material is for educational purposes only. Mis-transmission is not intended to waive confidentiality or privilege.