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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

Many investors who have looked at their investment account recently are stunned by both the size of the losses they have experienced and how quickly those losses happened.

In late February, stock markets around the world descended into bear market territory (losses greater that 20%) in the shortest period in history. That is right, our markets declined to bear market territory faster than during the Great Depression!

Worst of all, conventional diversification techniques of holding stocks, bonds, and precious metals has not helped lessen the pain. The chart below shows the returns of different asset classes from their highs through March 23, 2020.

Asset Class Losses from Highs Through March 23, 2020

Chart Data: Source – Morningstar Direct. U.S. Bonds (AGG) from high 3/6/20. U.S. Stocks (SPY) from high 2/19/20. International Stocks (ACWX) from high 1/16/20. Gold (GC00) from high 2/24/20.

The only true safe haven in this market route has been cash. Investors often do not realize that conventional diversification usually fails during severe bear markets until they look at their investment account balances during times like these.

Lowering the Risk of Large Losses

If conventional diversification fails, what can an investor do to protect their portfolio against large losses in bear markets? The best solution is to add additional sources of diversification not found in conventional portfolios but actively used in modern portfolio design.

Investment strategies like trend following are designed to protect portfolios against rare events like we face today. Trend following strategies reduce the amount of stocks in a portfolio when markets begin generating large losses and start to trend down. Trend following strategies are a time-tested method to help avoid large portfolio losses, and they have been successful once again in this bear market.

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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

The large stock market losses over the last few weeks are a great opportunity to better understand the impact losses have on your investment portfolio and your long-term wealth.

Improving your knowledge of how investment losses work can help you safely navigate the dangerous and uncertain markets we are facing with greater confidence.

When investors are asked why they choose to invest their money, a common answer is they want their money to work for them and grow over time by benefiting from the powers of compounding. Regrettably, most investors fail to realize that compounding works in both directions and compounded losses can permanently reduce the wealth you accumulate from investing.

Being successful at anything in life usually comes down to the fine details, profitable investing is no different. As you watch the markets from day-to-day it is easy to make critical miscalculations. For example, if your portfolio losses 1% today, thanks to compounding you must earn more than 1% tomorrow to recover from your loss. Simply stated, whenever your portfolio takes a step back, it must take more than a step forward to get back to where it started.

Unfortunately, the news about compounded losses gets worse. The larger the loss your portfolio suffers, the exponentially larger your gains must be in the future to recover and get back to even. This means that the returns you need to earn to recover from losses grow faster than the losses themselves. The table below shows the returns you must generate (right column) to recover from different size investment losses (left column).

Returns Required to Recover from Investment Losses

Source: 3Summit Investment Management

The impact losses have on a portfolio is a detail commonly ignored because of a misunderstanding of the math behind how investment returns work. Sometimes a short video is worth a thousand words. View the quick video below to learn why you must earn higher returns than what you lost to get your portfolio back to even.

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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

The financial services industry suffers from significant ethical challenges, but most people do not realize the extent to which their interests directly conflict with the interests of their financial advisor or how those conflicts impact their wealth.

For example, only 9% of financial advisors are both obligated to provide investment advice that is in their client’s best interest and are not permitted to be compensated through commissions or sales charges.

Why should you care if your financial advisor is obligated to act in your best interest or how your advisor gets paid? The U.S. Department of Labor estimated in 2016 that conflicted investment advice may cost Americans as much at $17 Billion a year! One way to avoid paying the potentially high costs of receiving conflicted investment advice from a trusted financial advisor is to only work with an advisor bound by a fiduciary duty to you and works on a fee-only basis.

What is a Fiduciary?

A fiduciary financial advisor is bound by an ethical obligation to act only in their client’s best interest. A fiduciary must avoid conflicts of interest and clearly disclose any possible conflicts to their clients.

Common Conflicts of Interest

Financial advisors can have many conflicts of interest that are likely to harm your financial success and cost you a fortune in fees. Here are two examples of common conflicts you should be aware of when working with a financial advisor:

  • Fee-Sharing Agreements — Many financial advisors enter into fee-sharing agreements with mutual fund providers. A mutual fund provider can charge investors in their mutual funds an annual sales fee that may then be given to a financial advisor as a kickback for investing their clients in the providers funds. Fee-sharing is a huge conflict of interest because financial advisors are incentivized to only invest their clients in mutual funds that kickback fees to them, instead of investing in funds with the best management and lowest fees or better yet, not buy mutual funds at all for their clients.
  • Commissions on the Sale or Trading of Financial Products — Many advisors receive large commissions for investing their clients in mutual funds, insurance policies and annuity products. It is common for advisors to recommend expensive annuities and other insurance products because they earn very large commissions by selling them to their clients.

Also, earning commissions on the trading of mutual funds through up-front fees can incentivize an advisor to “churn” investment accounts. Churning occurs when an advisor trades excessively in order to extract additional commissions from their clients. Upfront fees on a mutual fund (called front-end loads) can be as high as 5% of the value of the trade.

If you have a half a million-dollar account and an advisor invests the entire account in several 5% front-end load mutual funds, you just paid $25,000 dollars in fees out of your retirement savings and your financial advisor receives a portion of those fees as sales commissions. When the advisor decides to switch funds in the future you are likely to pay front-end load fees again!

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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

In 2019, the S&P 500 returned 31.49%!

Performance this good is rare, the S&P 500 has only generated annual returns this high 11 out of the past 83 years. Given these spectacular returns investors should beware, the most common and often damaging investing mistake after blockbuster years like last year, is to give into the temptation to chase performance.

A traditional diversified investor with a portfolio of around 60% in stocks and 40% in bonds, most likely generated returns around half the S&P 500 in 2019. Returns of around 14% for diversified portfolios, while excellent, do not usually make investors happy compared to what the broader S&P 500 returned.

Following periods of abnormally high returns, investors naturally compare their portfolio to widely publicized index returns, like the S&P 500, despite the irrelevance of the comparison. This comparison can trigger investor greed as the fear of missing out on a continuation of unusually high returns drives investors to chase those potential returns by increasing their allocation to stocks.

Missing out on unusually high returns, like we saw last year, can be as psychologically tormenting to investors as watching their portfolio suffer very large losses. Often the urge to chase performance hoping to earn higher returns can prove to be too much for investors leading to a cascade of mistakes.

The temptation of a diversified investor to chase performance can result in two distinct, but equally damaging investing mistakes. The first mistake is dramatically increasing the risk of a diversified portfolio by buying more stocks at already high prices, in hopes of increasing returns. Investors who make this mistake usually plan to return to a diversified strategy in the future when the stock market begins to encounter challenges and negative returns, which is the definition of a market timing strategy.

The second mistake happens when the very risky portfolio takes large losses, which then can cause a panic, pushing the investor to reduce their allocation to stocks at lower prices in order to de-risk the portfolio to slow or stop losses. What should be clear from this all too common scenario is that the urge to chase performance pushes investors to change investment strategies and become market timers. Sadly, market timing almost always results in buying high and selling low, which is the opposite of a good investment strategy.

To succeed at a market timing strategy, an investor must be right about both the future direction of the stock market and the timing of when the stock market direction will change. They must be right about direction and timing when both increasing and decreasing their allocation to stocks. If you are counting, market timing success requires four correct predictions in a row!

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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

The S&P 500 had a banner year in 2019, returning over 31%!

While you might believe most investors would be happy by their investment portfolio returns, they often are not. Diversified investment portfolios are a common source of investor disappoint during years of unusually high returns and likewise losses.

When stock markets make strong advances up, investors become completely focused on returns. If investors compared their diversified portfolios to the S&P 500 after last year’s 31% return, many noticed they produced returns often less than half the returns of the S&P 500, which made them very unhappy.

During times of economic turbulence like in 2008 and 2009, investors no longer focused on returns and became completely focused on risk as they watched in dismay as their diversified portfolio, believed to be moderate to low risk, lost potentially more than 35%, which also made them very unhappy.

Investors are not entirely to blame for being discontent with the performance of their diversified investment portfolios. The investment management industry carries much of the blame for investor dissatisfaction by leading investors to have unrealistic expectations of their portfolio’s return potential and ability to protect against large losses, especially during market extremes. However, there are ways to reduce the disappointment you may feel about your diversified portfolio by improving performance and mitigating large losses during extreme market environments.

The Jack of All Trades and Master of None

When investors are asked what their primary investment objectives are, most say they want both high returns and to protect their portfolio from large losses. The problem is that these two objectives are in opposition to one another and both objectives cannot be effectively achieved with a single investment strategy.

Everyone loves a solution that gives them everything they want and nothing they don’t, therefore the investment management industry is skilled at selling diversified portfolios that are represented as being capable of producing both high returns while also protecting investors from large losses. I call these “swiss army” portfolios because they are sold as no-compromise investment solutions. These portfolios often are sold as growth or aggressive portfolios.

The problem with swiss army portfolios is they cannot possibly deliver on their promise because the primary impediment to generating outsized returns is too much diversification and the primary impediment to preventing large losses is too little diversification. 

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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

The new year is always a good time to take another look at your investment strategy, which is why I am going to explain the best kept secret in investing and how this secret can help you dramatically increase the wealth you accumulate from your investments and at the same time lower the risk of your investment portfolio.

Every investor has almost certainly heard the common investing wisdom that says, the more risk you take in investing, the higher the returns you are likely to earn. In fact, nearly the entire investment industry designs and manages investment portfolios with the common investing wisdom as their core investment philosophy.

For example, if you have ever talked to an investment advisor, you likely spent significant time talking about your risk tolerance. Because the common investing wisdom says you must increase your risk to increase your potential returns; investment advisors look to invest your assets in the highest risk portfolio they believe you can tolerate with the well intentioned goal of trying to earn you higher returns over time.

Contrary to the common investing wisdom, the best kept investing secret is that minimizing the risk instead of maximizing the risk of your investment portfolio can lead to accumulating much greater wealth over the long-term from your investments.

Let’s look at a hypothetical portfolio example that illustrates the significant gains in wealth that can be achieved by simply reducing the risk of an industry standard 60/40 portfolio. The industry standard portfolio invests around 60% in stocks and 40% in bonds (often called a 60/40 portfolio).

The average investor considers a 60/40 portfolio to be a low or moderate risk investment approach. In the chart below, the light blue line shows the growth of a $10,000 investment made in March of 2004 in a portfolio that represents an industry standard 60/40 portfolio. The dark blue line represents the growth of another $10,000 investment over the same time period in a modern low-risk 60/40 portfolio that utilizes modern portfolio design and risk management techniques to lower the total risk of the portfolio.

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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

Deciding what age to begin claiming your Social Security benefits is one of the most important retirement decisions you will need to make. Your decision can change the amount you receive in your monthly benefits check by as much as 76%!

You reach full retirement age for your Social Security benefits when you turn 66 and 6 months. However, you are eligible to begin claiming your Social Security benefits beginning at the age of 62 in exchange for lower monthly benefit checks for the rest of your life. You may also choose to defer claiming your benefits beyond full retirement age until the age of 70 and receive higher monthly benefit checks for the rest of your life.

Every year after the age of 62 that you defer claiming your benefits; the monthly benefit check you will receive until death increases by an average of 7.4%. The important takeaway is that if you defer claiming benefits from the time you are eligible at 62 to the date you turn 70 years old, your monthly check will be 76% higher each month for the rest of your life.

Of course, like most things in life, to get larger benefit checks you must forgo the smaller benefit checks you would have otherwise received if you claimed earlier. To really understand the decision of when to claim benefits, we need to calculate the age at which you would break-even in total benefits collected if you chose to defer receiving your Social Security benefits until you are 70 versus claiming at 62 when you become eligible.

The table below presents these calculations and the analysis assumes you would be turning 62 in 2020 and eligible to begin claiming your Social Security. Of course, your total monthly benefit will vary depending on your income history, however the math would still work the same regardless of the monthly benefit you are entitled to receive.

Social Security Deferral Break-Even Analysis (Assumes a $1,000 benefit at full retirement age of 66 and 6 months)

The last column of the chart shows the age at which you would break-even in total benefits received as a result of forgoing monthly benefit checks by deferring your claim for an additional year. To receive the maximum benefit by waiting until age 70 to claim, you would have to live to 80 years old to break-even in total benefits collected to make up for the eight years you did not receive smaller benefit checks.

The average life expectancy is just under 80 years old in the United States, but you should take your health, family history, marital status and the importance of your Social Security benefits to fund your retirement into account before making your final claim decision. There is a 50/50 chance at least one spouse will live to 90, so do not make the mistake of underestimating your potential lifespan.

If you live to 90 and claimed Social Security benefits at 70 you would receive 26% more in total benefits than if you had claimed at 62.

Total Benefits Collected at Age 90 (Assumes a $1,000 benefit at full retirement age of 66 and 6 months)

You should always plan to live longer than you expect because running out of money at the end of life is not a desirable outcome. Think of deferring Social Security to age 70 as longevity insurance that you can “buy” from the federal government by paying for retirement out of your retirement savings until you begin receiving Social Security at age 70.

The check you receive will be much larger when you begin collecting Social Security and it is inflation adjusted! If you plan to work past the full retirement age of 66 and 6 months, the decision to defer is obviously much easier and would be the best option.

Costs can skyrocket towards the end of life, deferring Social Security is a high-quality insurance policy that may help cover higher than expected costs and ensure you continue to live comfortably regardless of how long you live. If you have the financial ability to defer Social Security until the age of 70, the Social Security deferral option is the best longevity insurance you can buy and you should have little concern about not living past the break-even age of 80 years old.

Not maximizing your benefits in the event you should pass away before 80 years old is a small price to pay for the extra financial stability  you will enjoy should you have the good fortune to live much longer than you expect.

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If you would like professional assistance in evaluating your investment strategy and portfolio or would like help planning for retirement, please call (571) 565-2161 or email us, we are always happy to help. Also, consider learning more about this topic and gaining unique investing insights by listening to our popular podcast or viewing our investing video series.

3Summit Investment Management is a fiduciary investment advisor providing clients with an alternative to outdated, conventional investment portfolios. We design custom, modern portfolios capable of delivering greater wealth accumulation with much lower levels of risk. To learn more about how we can help you improve your long-term investing results call (571) 565-2161, email ([email protected]) or visit 3Summit.com.

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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

Most people would jump at the opportunity to improve the long-term performance of their investment portfolio by 20%, 30% and maybe even more than 50%.

The good news is this type of performance improvement from your investment portfolio is possible and does not require picking the best mutual funds or finding the next hot stock. To achieve significant performance enhancements, you must master the one skill that separates the very few GREAT investors from the masses of simply ordinary investors… the art of patience. All great investors have one behavioral trait in common, they focus more energy on patience than they do looking for the next great investment idea.

While the quality of your investment portfolio certainly has an impact on your investing success, once you have a good investment strategy, great results can only be achieved by having the patience to stick with your investment strategy for the long-term. Total conviction in your investment strategy and a willingness to wait a decade or more to find out if your patience will pay off is required.

We can look at a hypothetical portfolio to see how profitable patience can be. The chart below shows how a portfolio that invested $10,000 in January of 1995 in the lowest risk stocks in the market (dark blue line) compares to a portfolio that invests $10,000 in an S&P 500 index fund (light blue line) over the same time period.

The low-risk stock portfolio turned the $10,000 initial investment into $136,939 compared to the S&P 500 index fund portfolio, which turned the $10,000 investment into only $90,545 over the same time period. The low-risk portfolio generated 464% higher compounded returns, which resulted in 66% more wealth for the low-risk portfolio investor compared to the S&P 500 index fund investor!

The low-risk investment portfolio clearly was a good investment strategy (learn more about low-risk investment portfolios). However, just looking at the chart and the returns of both portfolios understates how difficult it is to actually realize results like the low-risk portfolio achieved and why only the most patient investors will ever have a chance to attain this level of investing success.

Investing, at its core, is the art of navigating uncertainty. No investor has any idea how financial markets will perform in the future, which is what makes investing so hard. A fundamental truth about being human is that uncertainty makes us all uncomfortable and therefore we all have adapted some illogical behaviors that make us bad investors by default.

The behavioral tendency most responsible for preventing investors from being patient is called anchoring. When confronted with uncertainty, investors consciously and unconsciously, tend to look for reference points (“anchors”) to help them make decisions, regardless of the anchor’s relevance to their investment portfolio.

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This is a sponsored column by 3Summit Investment Management, LLC based in Vienna, VA. 3Summit designs custom, modern investment portfolios and has unique expertise in managing investment risk.

By Dan Irvine | Principal, 3Summit Investment Management

Nearly half of American households invest in mutual funds.

However, popularity doesn’t equate to quality — investing in mutual funds can be a poor investment strategy. If you own mutual funds, you may be surprised to hear our reasons why mutual funds are not a good investment.

“Stock picking” rarely works

Mutual fund managers attempt to outperform the markets by using stock analysts to pick individual stocks to produce higher returns than the market as a whole. The theory behind the strategy of stock picking is that if you can buy only the best stocks in the market and avoid the worst, your mutual fund should easily outperform the market it seeks to beat.

Unfortunately, the evidence shows that stock picking rarely works and the majority of mutual funds underperform simple market indices that invest in all or most of the stocks in any given market.

No investor can predict the markets. Your chances of picking a mutual fund that outperforms a specific stock market index looks more like Vegas odds than an investment strategy. In 2018, only 38% of the 4,600 active mutual funds beat their comparative market index during that year. If we extend that view over the last 10 years, it gets worse. Only 24% of active mutual funds beat their target market index.

Prudent investors that invested in index funds instead of mutual funds over the last 10 years had a 76% greater likelihood of achieving better performance (Morningstar Active Passive Barometer 2018).

The longer you hold a mutual fund the lower your long-term returns are likely to be

Many professional investment advisors weigh past returns heavily when selecting mutual funds for their clients. Mutual funds with the best recent performance usually attract the most new investors. Research shows that picking mutual funds based on past performance is a poor choice because mutual funds that have performed well in the past, usually do not continue to outperform.

Of the top performing 25% of actively managed mutual funds at the end of 2016, only 7% of those funds remained in the top 25% after three consecutive years. Even worse, only 1.4% of the top performing mutual funds remained in the top 25% performance ranking after five consecutive years (S&P Dow Jones SPIVA Research, September 2018).

Mutual fund performance appears to be a function of luck instead of stock picking skill by the mutual fund manager. The bottom line is that you face uncomfortably high odds of accumulating less wealth by investing in mutual funds instead of index funds.

Mutual funds are structured with inherent disadvantages

In addition to the likelihood of lower long-term performance, mutual funds erode an investor’s potential returns through high fee structures and tax inefficiencies. The commissions for trading mutual funds can be very high as well, depending on the fund and broker used for trading. Furthermore, mutual funds can only be traded at the end of the day, unlike a stock or index fund that can be traded anytime throughout the day at the current market price.

Perhaps the biggest disadvantage of mutual funds is also the reason that mutual funds remain such a popular investment. Many mutual funds have built-in conflicts of interest because many non-fiduciary investment advisors receive minimally disclosed fees through fee-sharing agreements with the mutual fund manager. Investment advisors can receive a fee kickback when they invest their clients’ money in those mutual funds, regardless of the fund’s quality.

Take another look at your investment portfolio

If you own mutual funds, the new year is a good time to re-evaluate your investment strategy and improve your chances of generating higher returns and more wealth over your investing time horizon.

If you would like professional assistance in evaluating your investment strategy and portfolio please call 571-565-2161 or email us, we are always happy to help. Also consider learning more about this topic and gaining unique investing insights by listening to our popular podcast or viewing our investing video series.

3Summit Investment Management is a fiduciary investment advisor providing clients with an alternative to outdated, conventional investment portfolios. We design custom, modern portfolios capable of delivering greater wealth accumulation with much lower levels of risk. To learn more about how we can help you improve your long-term investing results call (571) 565-2161, email ([email protected]) or visit 3Summit.com.

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