A Different Way to Invest in Our Tumultuous World

Everyone loves a good story. It’s what keeps you hooked watching a movie or reading a book…it’s also what keeps investors committed to poor investment solutions. Investors like a good story that keeps them engaged, and that story usually involves a savvy manager. But there is a different narrative—written by financial scientists.

Now, academic finance isn’t exactly an engaging story. However, it has changed the face of investing and market analysis for every investor. In the 1960’s, University of Chicago romance-language-scholar-turned-economist Eugene Fama and his protégé’s (namely, Michael Jensen of Jensen’s Alpha performance measurement “fame”)  first used the power of advanced computing and the capital asset pricing model (CAPM) to price securities and study what impacts returns. Their breakthroughs in finance led to an understanding that, on average, mutual fund managers don’t outperform the market, as well as the idea that there are other factors in the marketplace that contribute to investment returns.

Enter: evidence-based investing

Evidence-based investing is about identifying the characteristics of stocks that have outperformed in the past, and building portfolio strategies that overweight stocks that have these particular characteristics. It’s about finding companies that have the right factors. Those factors are size, value (the price investors are willing to pay for a dollar of profit), and profitability. The investment industry spends far too much time and money chasing alpha (excess return) and not enough time paying attention to science. Ken French, professor of finance at Dartmouth, estimated in 2008 that over $100 billion is spent chasing returns that can’t be explained by the market. This pursuit is funded by investors in the form of high expense ratios and management fees.

So if financial science tells us what factors contribute to investment returns, and that the pursuit of excess returns through trading and stock picking doesn’t translate to consistent outperformance, how should an investor approach investing during times of tumult? While it is alluring to believe the story of the supposed savvy manager and view world events as if they will precipitate a cataclysmic downfall of the world and market as we know it (or the opposite, depending on the day), this is what we actually do for our clients.

1.   Eliminate Meaningless Questions

· What is the best way to capture market returns? Do professional money managers perform better than the index? Can timing the market improve returns?

2.   Ask Meaningful Questions

· What is the best asset allocation? Is international diversification advantageous? Are small and value stocks preferable to large and growth? Should a diversified portfolio invest in assets other than stocks or bonds? Is there a meaningful and consistent connection between the risk and return of an investment?

3.   Apply the Evidence

· Investment selection of broad-based market funds that are low-cost, transparent and tax-efficient.

· Regular rebalancing as a discipline to control long-term risk and enhance return.

4.   Proactively Monitor

· Robust investment oversight, paying attention to the current state of knowledge in financial economics.

Famed manager Peter Lynch once said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” The evidence-based story can’t explain presidential election outcomes, international geo-political intrigue, or why the Fed isn’t raising interest rates. However, it is a story that keeps an investor grounded and successful over years of daily tumult across the globe. Everyone loves a good story…this one is ours, and we are compelled by the evidence to stick to it.

Sources: Research on Wealth, Spring 2017

Raising Financially Sound Kids

The vast majority of children are destined for a financial future that differs little from that of their parents. Research has found that the financial future of younger generations can sometimes even be worse due to a combination of societal influence and last of intentional “fiscal training”.

You can change that.

An easy way to fiscally train the younger generations in your family is through the use of an allowance. Yes…the old school allowance.

The benefit of an allowance is that it provides an easy way for families to engage in money talk, and teach accountability and personal responsibility at an earlier age. We get questions about when to start and what method to use. As to “When?”, it will differ by family, but many families start when children can understand how the allowance will work. What method you use for allowance should be tailored to your family culture. Here are three systems to consider.

  • Set Dollar System Uses regular monthly amounts with expectations of engagement in the home
  • Reward SystemPay certain amounts for different assigned household jobs
  • Income SystemPay for special jobs outside of regular responsibilities (e.g. mowing the lawn, detailing a car)

Coupled with instruction on how to save, invest, give and spend, an allowance system is a powerful tool to have when raising financially sound kids.

The Boomerang Generation – Planning for the Unplanned

Nearly double the number of 25- to 35- year-old Millennials were living with their parents in 2016 than their Silent Generation counterparts in 1964.1 In fact, the percentage of 18- to 34-year-olds living in their parents’ home grew from 26.0% in 2005 to 34.1% only ten years later. Of this group, 1 in 4 are idle, meaning that they neither go to school nor work.2 These young adults are known as the “Boomerang Generation”. When they boomerang back to their parents’ home, it is often unplanned and can create financial, emotional, and relationship strain. But…with a bit of creative planning, the recipient of the boomerang can help their young adult without sacrificing their financial future.No matter the state of the economy in the United States, the share of young adults moving back home rose over the last several decades. It raises the question why. Some common reasons are:

  • Rising student loan debt (in 2012, 45% of 25 year old college graduates owed $20,000 or more.3)
  • Inability to find a job on graduation from college (or not going to college)
  • Cost of living independently
  • Delaying traditional milestones (e.g. getting a job, marrying, having children)

The Financial Story

What is challenging about the scenario of an adult child coming back to live with you is that it can be taxing emotionally, relationally and financially. Many financial plans are not created to “expect the unexpected”, so when a child boomerangs back…and with them comes increased living expenses for on average three years…it creates strain on the original financial plan.4 In order to address the financial needs of the situation, below are some common mistakes families make that put their long term financial plan in danger.

  • Reducing contributions to retirement savings if still working
  • Withdrawing from investment savings at too high of a rate
  • Not putting a limit on lifestyle spending during the time the adult child is back at home
  • Not communicating expectations with the adult child or asking them to contribute to the household in some way

So what do you do when your adult child announces their intended return to the nest? By being proactive (and a little creative), it is possible to ensure your financial future stays in tact through this transition while you support your family. Here are four important tips to set yourself up for success in a “boomerang” scenario.

  1. Set a “Boomerang Budget”

How much are you willing and able to commit to help your loved one. Every family situation is different, but setting guardrails is very helpful in managing expectations and setting your child (and relationship) up for success

  1. If at all possible, stick to the original plan

This will necessitate a call to your trusted financial advisor. Your greatest ally in an unexpected life event is an expert who can see the situation through a different set of eyes. Most likely, they will see strategies you can’t. If you are still working, don’t reduce retirement savings. Keep paying yourself first and instead, identify areas in the household where the boomeranger can contribute meaningfully. If you are retired, identify your ideal lifestyle and your “acceptable” lifestyle, as well as your willingness to put your ideal lifestyle on hold for a time.

  1. Set the Rules of Engagement

One of the biggest mistakes that can be made is to not address the obvious situation – your adult child is coming back home to live. With that transition comes many changes and opportunities to help your child emerge stronger at the end of their time back in your home. Here are some important issues to address and questions to ask your adult child before they come back to stay.

  • How long will they be staying?
  • What measure will you use to determine it’s time to leave the “nest” (certain amount in savings, level of debt outstanding, time in a job)?
  • How will they contribute to the household (there is no such thing as a free lunch)?
  • What are their personal & professional goals…and how can you help them get there?
  1. Stay Connected

Many parents struggle with what parenting looks like with adult children. The truth is you are more of a coach than a parent at that point in their lives. To be successful, it is critical to stay connected with your adult child. That success is measured by your intentional and focused communication with them. Set regular check-in’s and let them know that you are rooting for them and want to see them succeed when they launch out again. Cultivating your relationship in this way will pay numerous dividends. It manages expectations, builds trust between you, and empowers your child to succeed.

Having a member of the “Boomerang Generation” come to live with you shouldn’t be filled with financial fear or seen as a failure to launch for your child. If handled proactively, it’s filled with opportunity.

(1) Pew Research Center analysis of 1964, 1981, 1990, 2000, and 2016 Current Population Survey, Annual Social and Economic Supplements.
(2) Vespa, Jonathan, “The Changing Economics and Demographics of Young Adulthood: 1975-2016”, U.S. Census Bureau, April 2017.
 (3) Lewin, Tamar, “Some Parents, Shouldering Student Loans, Fall on Tough Times”, New York Times, 2012.
(4) Dettling, Lisa J. And Hsu, Joanne W., Federal Reserve Board, “Returning to the Nest: Debt and Parental Co-residence among Young Adults.”

Savings and Your Mental Health

Savings. Believe it or not, there are certainly many tangible benefits to saving money. In fact, being able to purchase the things that you want or need (now or in the future) is probably the number one reason that we save. But what if the intangible benefits of saving money may actually be more important than the simple act of adding extra zeroes to your bank account? For many, the act of saving itself can have a profound positive impact on their mental health.

1) Forming good habits – In a world filled with endless potential for distraction and instant gratification, regularly denying yourself a portion of your income is a hard habit to form. Starting to save can be a daunting prospect, and continuing to save can be even harder. However, if you “flex” this savings muscle it is an excellent way to develop self-discipline. This discipline can easily spill over and help you develop form good habits in all areas of your life.

2) Security – Running out of money is stressful. Whether you fear living month to month, a big unexpected medical expense, or the possibility of having another set of twins (or triplets!), having a savings cushion does wonders for your sense of security and peace of mind. Everyone might have a different number that makes them comfortable, but simply saving towards an emergency fund or nest-egg gets you a little bit closer to that sense of full fiscal security; reducing stress and allowing you to sleep a little better each night.

3) Generosity – While you certainly don’t need a big savings account to be charitable, having enough money for yourself and your family affords you a greater opportunity to see the needs of your friends and community and lend a helping hand. According to the Cleveland Clinic, not only do you help others when you give, but you experience physical and mental health benefits as well:

  • Lower blood-pressure
  • Increased self-esteem
  • Lower levels of depression
  • Longer life

4) Freedom – An unfortunate reality of modern life is that we sometimes compromise our physical or mental health if we don’t think that we have enough money to make another choice. Saving can allow you the freedom to make important choices unencumbered by financial factors. This financial freedom can extend to choices in your career, where you live, and even your relationships. Feeling trapped in a situation is never good for your mental health, by having the freedom to make your own choices, you can be confident that you are making the best choices for you, whatever they may be.

Now, money can’t solve all of your problems, but it is clear that a diligent savings routine has clear benefits beyond your balance sheet. So while you should certainly do your best to be content wherever you are, spending less and saving more can help more than you know.