Finance 101: September 2024
In September the financial advisors at Ruedi Wealth Management wrote four more columns for The News-Gazette’s Business Extra section. Make sure to look for them every Saturday in the weekend edition of the paper, but in case you missed any in September all four are below.
You Still Can’t Time the Market
Paul Ruedi
One of the topics I have been completely consistent on in these columns and our radio show is that you cannot time the market. At times I feel like a broken record any time I bring it up, and I think to myself, “surely everyone knows that by now, right?” But this is such an important investing lesson to understand because it is still the number one way people cause destruction to their own portfolios.
By this point, most people should know they can’t time the market. The studies are out there, and there are enough people like me out there constantly reminding them what a mistake market timing can be. But it is just so attractive to people on a human level. Who wouldn’t want to own stocks at just the right time to experience the rewards of investing without the pain?
Though the logical side of our brain has been told we can’t successfully time the market, at least not consistently over time, the human, emotional side of us simply wants the pleasure of investing without the pain. Lately I have found it interesting that even people who “know” they can’t time the market will do mental gymnastics to basically do the same thing. For example, a person with a lump sum to invest might see a market that has increased by double digits this year and think they should wait for a pullback before investing their money.
But this year was a perfect example of why this thought process can be very costly. After 2023 saw a large increase in the stock market, it would have been very tempting to wait for a pullback sometime this year before investing. But that pullback never came and a person waiting to invest would have missed out on this year’s substantial gains. Of course I must mention, past performance is not an indication of future results.
So I suppose this is my 1,000th reminder that you can’t time the market. Any attempts to time the market are considerably more likely to cost you dearly, than they are to benefit you. And those cute ways your brain is finding to try to time the market without actually doing something radical like selling everything - those are market timing too. If you simply cannot resist the temptation to time the market in some form or another, you may want to outsource your investment management to a professional.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
Asset Location
Ryan Repko, CFP®
People preparing for retirement often end up with their savings in three different types of accounts that are treated differently for tax purposes. Regular “taxable” brokerage accounts require all taxes be paid on any portfolio income in the year it was received. Traditional retirement accounts, like 401(k)s and IRAs only incur taxes when a distribution from the account is taken. The last type of accounts are Roth retirement accounts, where both portfolio income and distributions from the account are tax-free, provided some basic holding period rules are met.
Asset location is the process of selecting which investments you hold in each type of account, to minimize taxes, and thereby increase your return. Like many financial decisions, there is no one-size-fits-all solution that could be given with respect to asset location. But there are a couple of factors that can guide what type of account an investment could end up in.
The first consideration is the tax efficiency of an investment. A low-turnover index fund, or a fund that pays mostly qualified dividends would be tax efficient, as an investor will owe very little in taxes each year for simply owning that fund. Tax efficient investments would be good candidates for a taxable brokerage account.
A high-paying divided stock that kicks out a lot of income, or bonds that pay out interest, or a fund that has high turnover, would be considered less tax efficient. As a result, an investor would owe a relatively higher amount of taxes each year for owning these type of investments if they were held in a taxable account. Thus if an investment is more tax inefficient, it is a higher priority to place it in a tax-deferred 401(k) or tax-free Roth account to decrease that ongoing tax burden.
The second consideration for asset location is the expected return of an investment. If the expected return on an investment is very low, it doesn’t really matter where it ends up, as the difference in the taxes on a small amount of growth will be minimal. But if the expected return on an investment is very high, it would be a higher priority to hold in a Roth account, where all the growth would be tax-free.
In rare cases these priorities converge and make tax location choices somewhat easy, but more often than not, it takes some careful planning to orchestrate an optimal asset location. Each person’s balance within each account type will be different and thus can crowd out truly optimal placement decisions. If you need help with asset location decisions, you may want to talk to a financial advisor.
Ryan Repko is a Certified Financial Planner™ professional with Ruedi Wealth Management in Champaign, Illinois.
The Flaw of Averages
Paul Ruedi
As a financial advisor who has to correctly use statistics when creating financial plans, one of my favorite books covers how seemingly simple statistics can be completely misunderstood. The book was written by a Stanford University professor named Sam L. Savage and is cleverly titled The Flaw of Averages. As the title hints, even a statistical concept like an average can be misunderstood and result in flawed decision-marking.
Any time you reduce an entire data set to a single number, it hides the reality of that data set. Take for example the averages of two series of numbers. The first series is 4, 4, 4, and 4. The average of those numbers is obviously 4. The second series is 20, 0, 8, and - 12. The average of those number is also 4. Though the average of the two groups of numbers is the same, the underlying data set is radically different in a way an average simply doesn’t capture.
As humans we often use averages to set our expectations when making decisions under uncertainty. But averages can be misleading and get people into trouble. Savage uses the example of a statistician who drowns in a river that is three feet deep on average. He uses a cartoon to illustrate the river with shallow sides and a deep middle section. The river truly is 3 feet deep on average, but lurking within that average is a section deep enough to cause trouble.
As you can see, having an incomplete understanding of statistics can lead to serious consequences. Anticipating stock returns for financial planning purposes is a prime example of this. The average annual return of the S&P 500 going back to 1928 is just above 10%.* But that data set includes extreme returns well above and well below 10%. Though the long-term average return is around 10%, investors should not expect to receive that number in any given year, much less several years in a row.
For this reason, you simply can’t make financial planning decisions using assumptions of average stock returns. You must incorporate the entirety of a much larger data set to understand all the different potential outcomes investors could experience. If you are concerned your financial plans may be based on average assumptions, you may want to revisit those assumptions. If that all sounds way too complicated to do yourself, you may want to seek the help of an expert.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
Advice that Doesn’t Change
Paul Ruedi
Writing compelling financial content every week is hard. If we stooped to the level of peddling “expert stock picks” or market forecasts, our job would be much easier. But our investment advice doesn’t change. After reading hundreds of these columns, I am sure our regular readers are starting to recognize some themes that tend to come up over and over.
The primary determinant of success or failure as an investor is behavior, no matter what you choose to invest in. If a person gets swept up in the emotions of a temporary decline, and panic-sells their investments, it doesn’t matter how good the investments themselves performed over time, that person will have failed as an investor.
Alternatively, people often get swept up in the euphoria of market highs and over-extend themselves. Moral of the story, the discipline of the investor is more important than the investments.
You aren’t likely to beat the market, other than just by random luck. Whether it be through stock picking or market timing, even the vast majority of professional investors who set out to beat the market fail to do so. On top of that, active management costs more and tends to result in less diversified investment portfolios.
A much better solution is a disciplined buy and hold strategy paired with a low-cost and highly diversified investment portfolio. Harness the returns of the market that are there for the taking and don’t overcomplicate it.
As far as your investment portfolio is concerned, the biggest determinant of your return is your ratio of stocks to bonds. Stocks represent ownership of the great companies of America and the world. Stock returns are unpredictable year-to-year, but over decades, investors are compensated with wealth-creating compound growth.
Bonds on the other hand are much more predictable and offer much lower returns as a result. Naturally, the amount of higher returning stocks or lower returning bonds has a major impact on your expected return as an investor. It is a simple risk and return story.
These are just a few of the key themes I am sure our column readers and radio listeners have noticed over the years. Consistency is key when investing and something as critical as your core investment philosophy shouldn’t change based on current events or the investing fad of the day. So you’ll have to forgive us if we sound a bit repetitive, but we just can’t help it. Good advice doesn’t change.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
*Disclaimer: Past performance is no indication of future results.
You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.