Paul Meloan – Vested Interest

A long time ago a famous hockey coach said “Last year we couldn’t win at home.  This year, we can’t win on the road. My problem as coach is that I can’t think of any place else to play.”  And thus the problem of limited opportunities.
A hockey team can only play two places: home or away.  As an investor, it may seem like the opportunity set of assets in which to invest is not much larger.  Most people are aware of the biggest three: cash, stocks and bonds.  In dealing with most clients these three asset classes comprise the bulk (if not all) of their investable assets.  Of course, other assets exist (real estate, private equity, commodities, etc) but these three are hard to match in terms of high liquidity, low cost of ownership, and highest expected returns.  Those are three good things!
So what do most people see in these assets? The flaws, of course.  Cash assets like CDs and money market funds are yielding barely positive returns. Bond yields are now near 35 year lows.  If interest rates ever rise (which I believe has been predicted now for the past 12 consecutive years……) bond values will drop.  U.S. stocks returned 11% compounded annually from 1926 to the end of the 20th century, yet have only returned 4.8% annualized from 2000 through the end of 2014. (I got the stock numbers from the Center for Research in Security Pricing (CRSP) data set for the total return of all US stocks 1926-2014).
You as an investor have little control over this opportunity set.  What you can control is how you feel about it and how you react to it.  Some examples:

1.  For planning purposes it is healthy to assume a somewhat lower investment return than historic averages.  A good chunk of all periods have yielded lower than average returns (eg, 1965-1982, 2000 to today).  The net effect of this is that it means your savings rate may need to be a bit higher, especially early in life when time is your biggest advantage.

2. Stop kidding yourself into thinking you’re so much smarter than the market or have some angle on when things will change.  You don’t.  No one else does either.

3. Make regressing to the mean your friend, not your enemy.  Staying diversified among all the major asset classes and re-balancing periodically can help you make this happen.  If you don’t know what this means or how to do it, you need to learn because it matters and will make a difference.

4. Cash has a very important role in your portfolio, regardless of what it yields.  Everyone needs a certain amount of cash (a non-volatile, totally liquid asset) every month to pay the bills and put food on the table.  Thinking about zero percent interest rates does not help you here, so let it go.

Finally, costs always matter.  In a low-return environment the cost of ownership appears in returns more starkly than it does in bull markets.  A stock market rising 15% year over year applies a nice coat of paint to dangerously designed and expensive investments.  If you do not know the total cost of ownership of your investments, you need to learn it.

Invariably the most productive thing you can do as an investor is accept the limits of investing opportunities and focus energy on things you can actually affect.

Paul Meloan is the co-founder and co-managing member of Aegis Wealth Management, LLC, in Bethesda, Maryland USA. Before Aegis Paul was a practicing attorney as well as working in the tax practice of Ernst & Young, LLP.

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