Tim Maurer

Why Busyness Isn’t Good Business

Re-posted from

It’s old news that we’re busy and that we wear our busyness as a badge of honor. But a new study found that Americans, in particular, are actually buying it. Specifically, the study concluded that Americans who always say they’re “busy” are actually seen as more important. Unfortunately, it’s all a charade.

Numerous studies have shown that busyness isn’t actually good business, and here’s the big reason why: It makes us less productive. We’re all susceptible to it, but If I’m saying to myself (and I have), “Woo, I’m busy; really busy,” I’m likely being distracted from the most important, most productive work that I could be doing. I may feel like I’m doing more, but the net result is actually less. And it often feels like it.

Glasses on newspaper

Can Your 401(k) Impact Your SS Benefits?

By Claire Boyte-White | Updated June 26, 2017 — 6:00 AM EDT

Reposted from Investopedia

While income you receive from your 401(k) or other qualified retirement plan does not affect the amount of Social Security retirement benefits you receive each month, you may be required to pay taxes on some or all of your benefits if your annual income exceeds a certain threshold.

Why Doesn’t 401(k) Income Affect Social Security?

Your Social Security benefits are determined by the amount of money you earned during your working years for which you paid Social Security taxes. Since contributions to your 401(k) are made with compensation received from employment by a U.S. company, you have already paid Social Security taxes on those dollars.

This holds true even for traditional 401(k) accounts. Contributions to traditional accounts are made with pretax dollars, but this tax shelter only applies to income taxes, not Social Security. While you don’t pay income tax on traditional 401(k) funds until you withdraw them, you still pay Social Security taxes on the full amount of your compensation in the year you earned it.

“Contributions to a 401(k) are subject to Social Security and Medicare taxes, but are not subject to income taxes, unless you are making a Roth (after-tax) contribution,” notes Mark Hebner, founder and president of Index Fund Advisors, Inc., Irvine, Calif., and author of “Index Funds: The 12-Step Recovery Program for Active Investors.”

The Tax Impact of 401(k) Savings

Though the amount of your benefit is not affected by your 401(k) savings, you may have to pay income taxes on some of your benefits if your combined annual income exceeds a certain amount. In fact, about one-third of benefit recipients must pay taxes on a portion of their benefits.

The income thresholds are based on your combined income, which is equal to the sum of your adjusted gross income (AGI) – which includes withdrawals from any retirement savings accounts – any non-taxable interest earned and one-half of your Social Security benefits. If you take large distributions from your 401(k) in any given year that you receive benefits, you are more likely to exceed the income threshold and increase your tax liability for the year.

In 2017, if your total income for the year is less than $25,000 and you file as an individual, you won’t be required to pay taxes on any portion of your Social Security benefits. If you file jointly as a married couple, this limit is raised to $32,000. You may be required to pay taxes on up to 50% of your benefits if you are an individual with income between $25,000 and $34,000, or if you file jointly and have income between $32,000 and $44,000. Up to 85% of your benefits may be taxable if you are single and earn more than $34,000 or if you are married and earn more than $44,000. If you are married but file a separate return, you are likely to be liable to for income tax on the total amount of your benefits, regardless of your income level.

Other Types of Retirement Income

In some cases, other types of retirement income may affect your benefit amount, even if you collect benefits on your spouse’s account. Your benefits may be reduced to account for income you receive from a pension based on earnings from a government job or from another job for which your earnings were not subject to Social Security taxes. This primarily affects people working in state or local government positions, the federal civil service or those who have worked for a foreign company.

If you work in a government position and receive a pension for work not subject to Social Security taxes, your Social Security benefits received as a spouse or widow or widower are reduced by two-thirds of the amount of the pension. This rule is called the government pension offset (GPO). For example, if you are eligible to receive $1,200 in Social Security but also receive $900 per month from a government pension, your Social Security benefits are reduced by $600 to account for your pension income. This means your Social Security benefit amount is reduced to $600, but your total monthly income is still $1,500.

The windfall elimination provision (WEP) reduces the unfair advantage given to those who receive benefits on their own account and receive income from a pension based on earnings for which they did not pay Social Security taxes. In these cases, the WEP simply reduces Social Security benefits by a certain factor, depending on the age and birth date of the applicant.

How Your Is Benefit Determined?

Your Social Security benefit amount is largely determined by how much you earned during your working years, your age when you retire and your expected life span.

The first factor that influences your benefit amount is the average amount that you earned while working. Essentially, the more you earned, the higher your benefits will be, up to the maximum benefit amount of $3,538. The Social Security Administration (SSA) calculates an average monthly benefit amount based on your average income and the number of years you are expected to live.

In addition to these factors, your age when you retire also plays a crucial role in determining your benefit amount. While you can begin receiving Social Security benefits as early as age 62, your benefit amount is reduced for each month that you begin collecting before your full retirement age. Full retirement age varies between 65 and 67, depending on your year of birth. Conversely, your benefit amount may be increased if you continue to work and delay receiving benefits beyond full retirement age. For example, in 2017, the maximum monthly benefit amount for those retiring at full retirement age is $2,687. For those retiring early, at age 62, the maximum drops to $2,153, while those who defer collection until age 70 – the latest age at which collection can commence – can collect a benefit of $3,538 per month.

“Delaying Social Security until age 70 can be beneficial since you will receive an 8% gain every year after reaching your full retirement age,” says Carlos Dias Jr., wealth manager, Excel Tax & Wealth Group, Lake Mary, Fla.

Eligibility Requirements

To receive Social Security benefits, you must have accrued 40 credits, which you earn by working and paying into the Social Security system. Each year of work is worth a maximum of four credits, so you must work a minimum of 10 years to be eligible. However, each credit is equivalent to $1,300 of taxable earnings in 2017. Once you’ve earned $5,200 in any given year, you have already earned the maximum four credits. This means you could elect to stop working for the rest of year without endangering your eligibility, though this is not a very sustainable strategy. For one thing, a lower income will mean your benefits will be lower.


Larry Swedro at Computer Monitors

Aging No Guarantee Of Financial Wisdom

Re-posted from

May 10, 2017

There’s an adage that with age comes wisdom. But do we tend to become better investors as we age? This is an increasingly important question as the U.S. investor population is both aging and living longer. Unfortunately, research has found that in general the answer is no, although it’s not all one-sided.

On the positive side, as we age, we tend to have more diversified portfolios, own more asset classes and have higher allocations to international equities. And older investors tend to trade less frequently (that’s a good thing, as the evidence shows a negative correlation between individual investors’ trading activity and their returns). They tend to be less affected by behavioral errors, such as selling winners too soon (the disposition effect) and local bias (the familiarity effect). They also tend to own mutual funds with lower expense ratios—another good thing. These choices reflect greater investment knowledge.

Older Investors Less Effective

However, George Korniotis and Alok Kumar, authors of the study, “Do Older Investors Make Better Investment Decisions?”, found that “older investors are less effective in applying their investment knowledge and exhibit worse investment skill.”

Korniotis and Kumar also found that, while older and experienced investors are more likely to follow rules of thumb that reflect greater investment knowledge, the adverse effects of cognitive aging dominate the positive effects of experience. For example, they found that stock picks tend to lag the market by ever-increasing amounts as we grow older, and they exhibit poor diversification skill.

They noted: “The age-skill relation has an inverted U-shape and, furthermore, the skill deteriorates sharply around the age of 70.” They found that “on average, investors with stronger aging effects earn about 3% lower risk-adjusted annual returns, and the performance differential is over 5% among older investors with large portfolios.”

As further evidence of this negative relationship, Michael Finke, John Howe and Sandra Huston, authors of the study “Old Age and the Decline in Financial Literacy,” found that while financial literacy scores decline by about 1 percentage point each year after age 60, confidence in financial decision-making abilities does not decline with age.

Thus, they concluded that increasing confidence and reduced abilities explain poor investment (and credit) choices by older investors—age is positively related to financial overconfidence. And overconfidence can be a deadly sin when it comes to investing. Adding to the problem is the tendency for older people to reject evidence of declining cognitive abilities.

Experienced financial advisors know that it is common for clients to experience an increase in behavioral issues when they reach an advanced age, issues that can negatively impact the odds of achieving their financial goals.

If nothing else, as we age and our investment horizon shortens, investors exhibit an increasing preference for more conservative assets—our tolerance and capacity for risk tends to fall. We want more certainty. This argues for an increasing exposure to safer bonds and other assets with low correlation to equities. Yet that can be taken to an extreme when an insufficient allocation to equities can increase the odds of running out of money.


Risks For Retirees

In his March 2017 paper, “Risks in Advanced Age,” Michael Guillemette discusses the risks that retirees face and possible solutions to help them overcome behavioral hurdles. He points out that “if financial planners make clients aware of their declining cognitive and financial literacy abilities, they may be more willing to make simplified and satisfactory financial decisions.”

Guillemette highlighted an important issue related to longevity risk: “Wealthy people are living significantly longer than their less wealthy counterparts, creating the need for retirement assets to last for an extended period. Life expectancy for the 10th percentile of household income is 76 years for men and 82 years for women. In comparison, for the 90th percentile of income (which is similar to the clientele of fee-only advisors) life expectancy is 85 years for men and 87 years for women.”

This knowledge can help in the decision to buy longevity annuities as a hedge against outliving your assets, increasing the level of certainty and reducing anxiety.

Guillemette concluded with this important insight: “It is important for financial planners to have plans in place before behavioral biases hinder older clients from reaching their goals.”

Another interesting point I’ve heard from CPAs and financial advisors who work with elderly clients is that, as people age, they tend to feel more strongly about paying less or no income tax. One example is that of an elderly person in the 15% tax bracket buying municipal bonds so he doesn’t have to pay income taxes, despite the fact that taxable bonds could provide a higher after-tax return. Older people tend not even to do the analysis because of the bias against paying taxes.

A second example involves doing Roth conversions between retirement and the start of required minimum distributions (RMDs). This necessitates paying income tax but at a low tax rate, thus avoiding paying higher income taxes once RMDs start. Educating investors about the benefits of tax-centric planning in advance of implementing them can help overcome cognitive biases and show that paying some taxes early can actually reduce taxes over the long term.


The bottom line is that it’s important for investors and advisors alike to take into account the likelihood that financial decision-making skills will eventually decline, creating the potential for poor decisions.

Thus, plans that address this issue should be put in place before that stage is reached. Plans should include granting powers of attorney for financial and health care matters to trusted family members or professionals. And these documents should be reviewed on a regular basis to make sure they are up to date.

It’s important to recognize that there are many important decisions to make as we enter the period when our cognitive skills start to decline—decisions that can have major impacts on the success of a financial plan. Among them are:

  • When to begin taking social security. This is a very complicated issue, and filing at the right time can mean tens of thousands of dollars’ difference over a lifetime. Far too many people fail to consider the longevity insurance benefit of delaying social security payments as long as possible.
  • The ability to take advantage of a lower tax bracket between retirement and when RMDs start to reduce the size of IRAs. Taking income at a low bracket early can lead to avoiding paying tax at a higher bracket later.
  • Proper asset location, holding lower-returning assets (such as bonds) in a traditional IRA while holding higher-returning assets (such as stocks) in a Roth IRA to keep future RMDs as low as possible.
  • Evaluating existing life insurance policies. Is there still a reason to keep an old life insurance policy that was necessary with a young family? That policy still has costs, even when the cash value is paying the premium. The cash value could be redeployed, for example, to fund a long-term care insurance policy.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

Every Millennial Should Fund A Roth IRA

Reposted from

Personal finance is more personal than it is finance.

Much—too much—has been said and written about the relative superiority of Roth IRAs versus Traditional IRAs. The debate over which is better too often involves the technical numerical merits. In truth, the Roth wins in almost every situation because of its massive behavioral advantage: a dollar in a Roth IRA is (almost) always worth more than a dollar in a Traditional IRA. This is true regardless of one’s age, but the Roth IRA is even more advantageous for Millennials.

I must first disclaim that you can disregard any discussion of Roth or Traditional IRA if you’re not taking full advantage of a corporate match in your employer’s 401(k)—free money is still better than tax-free money. But after you’ve “maxed out” the match in your corporate retirement account, here are the top three reasons Millennials should consider putting their next dollar of savings in a Roth IRA:

1) Life is liquid, but most retirement savings isn’t.

Yes, of course, in a perfect, linear world, every dollar we put in a retirement account would forevermore remain earmarked for our financial futures. But hyperbolic discounting—and the penalties and tax punishments associated with early withdrawal from most retirement savings vehicles—can scare us away from saving today for the distant future. The further the future, the more we fear.

The Roth IRA, however, allows you to remove whatever contributions you’ve made—your principal—without any taxes or penalties at any time for any reason. Therefore, even though I’d prefer you to generally employ a set-it-and-forget-it rule with your Roth and not touch it, if the privilege of liquidity in a Roth helps you save for retirement, I’m all for it.

2) There are too many competing priorities.

Millennials are dropped into the middle of a financial should-fest. You should pay down school loans, save up for a home down-payment, drive a cheap ride, purchase the proper level of insurance, enhance your credit and save three months’ worth of cash in emergency reserves. All while having a life? No chance.

Most personal finance instruction tells you what your priorities should be, and if you’re looking for that kind of direction, I’m happy to help in that regard as well. But it’s also not a mortal money sin to employ some Solomonic wisdom and compromise between, say, two worthy savings initiatives—like short-term emergency reserves and long-term retirement savings. Therefore, while I can’t go so far as to suggest that you bag the idea of building up cash savings in lieu of a Roth, I’m comfortable with you splitting your forces and dipping into your Roth IRA in the case of a true emergency. The challenge we all face is to define “true emergency” without self-deception.  (And no, splurging on concert tickets or a last minute vacation with friends don’t qualify.)

3) Roth contributions cost you less today than they will in the future.

Despite my sincerest attempt, I couldn’t avoid the more technical topic of taxes—and nor should I, in this case. That’s because it only stands to reason that you’re making less money—and therefore paying less in taxes—at the front end of your career than you will be in the future.

Therefore, in addition to beginning tax-free compounding sooner, Roth IRA contributions—which are not tax-deductible—will likely “cost you” less as a career newbie than they will as a seasoned executive. At SpaceX. On the first Mars colony. Furthermore, you can also make too much to contribute to a Roth IRA, progressively phasing out of eligibility at income of $118,000 for an individual and $186,000 for a household.

Like Coachella tickets, the opportunity to invest in a Roth IRA may not be around forever. Tax laws and retirement regulations are constantly evolving, and who knows what the future may hold. This increases their value for everyone, but especially for those who could benefit from them the most—Millennials.

I’m a speaker, author of “Simple Money” and director of personal finance for Buckingham and the BAM Alliance. Connect with me on Twitter, Google+, and click HERE to receive my weekly email.

Larry Swedro

Swedroe: Prospecting For Returns

Reposted from February 15, 2017

Behavioral finance is the study of human behavior and how that behavior leads to investment errors, including the mispricing of assets. The field has provided many important insights that we can use to improve investor behavior and produce better investment results. If investors are made aware of their biases and the negative impact those are likely to have on their returns, they are more likely to change their behavior.

The field of behavioral finance has gained an increasing amount of attention in academia over the past 15 years or so as more pricing anomalies have been discovered. Pricing anomalies present a problem for believers in the efficient markets hypothesis. Among the many anomalies uncovered is that individual investors have a preference (or taste) for gambling when buying individual stocks.

Prospect Theory

For example, research has found that individuals prefer stocks with low nominal prices, high volatility (and high beta) and high positive skewness (returns to the right of the mean are fewer but further from it than returns to the left of the mean, like a lottery ticket).

This preference for gambling can be explained by prospect theory, which is a behavioral model describing how people decide between alternatives that involve risk and uncertainty (e.g., the likelihood, expressed as a percentage, of a gain or a loss). Prospect theory is about how our attitudes toward risks concerning gains may be quite different from our attitudes toward risks concerning losses, indicating that people are loss-averse.

Because people dislike losses more than they derive joy from an equivalent gain, they are more willing to take risks to avoid a loss. This preference leads individuals to overweight the tails of a return distribution, explaining the widespread preference for lotterylike gambles.

Prospect theory helps explain findings in the research showing poor average returns to IPO stocks, distressed stocks, high-volatility equities and “penny stocks” sold in over-the-counter markets and out-of-the-money options. These assets all have positively skewed returns. It can also explain the well-documented lack of diversification in many household portfolios.

An Empirical Study
Nicholas Barberis, Abhiroop Mukherjee and Baolian Wang contribute to the literature on investor behavior and pricing anomalies with their paper, “Prospect Theory and Stock Returns: An Empirical Test,” which appears in the November 2016 issue of The Review of Financial Studies.

They hypothesized: “For many investors, their mental representation of a stock is given by the distribution of the stock’s past returns. The most obvious reason why people might adopt this representation is because they believe the past return distribution to be a good and easily accessible proxy for the object they are truly interested in, namely the distribution of the stock’s future returns.” More sophisticated (institutional) investors would consider the potential future distribution of returns.

Prospect theory suggests that investors would prefer securities with a high-prospect-theory value (meaning they exhibit positive skewness, like a lottery ticket) and thus tilt their portfolios to such assets and away from stocks with low-prospect-theory value. Based on this hypothesis, Barberis, Mukherjee and Wang predicted that “stocks with high prospect theory values (exhibiting positive skewness) will have low subsequent returns, on average, while stocks with low prospect theory values will have high subsequent returns.”


The intuition is that “stocks with high prospect theory values are appealing to some investors; these investors tilt toward these stocks in their portfolios, causing them to become overvalued and to earn low subsequent returns.” The authors also noted we should expect the prediction about returns to hold more strongly among stocks that are more heavily traded by less sophisticated individual (versus institutional) investors, for example, among small-cap stocks.

To test their premise, the authors’ metric was the distribution of monthly returns over the past five years in excess of the market’s return. Their U.S. database consisted of all equities for which 60 months of data was available and covered the period 1926 through 2010. The results were consistent with their hypothesis.

They write: “We find that the coefficient on the stock’s prospect theory value, averaged across all the monthly regressions, is significantly negative: stocks with higher prospect theory values have lower subsequent returns. We also find, again consistent with our framework, that this result is particularly strong among small-cap stocks.”

Furthermore, the alphas on the portfolios they constructed decline in a near-monotonic fashion as they moved from portfolios with the lowest prospect theory value to the highest. In addition, consistent with prior research on limits to arbitrage and the role they play in allowing anomalies to persist, the authors also found that the “predictive power of prospect theory value for subsequent stock returns is stronger among stocks that are less subject to arbitrage—for example, among illiquid stocks and stocks with high idiosyncratic volatility.”

Their findings were consistent across 46 international markets they tested. And the results were robust over the two subperiods studied. They were also robust after controlling for exposure to well-known factors such as size, value, momentum, illiquidity and idiosyncratic volatility.

For investors, the implications of findings from studies into behavioral finance are striking. The combination of investor preference for skewness and limits to arbitrage can result in an equilibrium that leads to overpriced, positively skewed stocks. And price premiums caused by skewness preferences will underperform stocks that are not positively skewed.

These findings have implications for portfolio construction as well. First, investors buying individual stocks should avoid those with lotterylike characteristics. Second, mutual funds can improve performance by screening out stocks with these negative characteristics.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


2016 Market Review

Re-posted from 2016 Market Review January 10, 2016 Market Review

by Bryan Harris, Advisor BylineSenior Editor

In 2016, the US market reached new highs and stocks in a majority of developed and emerging market countries delivered positive returns. The year began with anxiety over China’s stock market and economy, falling oil prices, a potential US recession, and negative interest rates in Japan. US equity markets were in steep decline and had the worst start of any year on record. The markets began improving in mid-February through midyear. Investors also faced uncertainty from the Brexit vote in June and the US election in November.

Many investors may not have expected global stocks and bonds to deliver positive returns in such a tumultuous year. This turnaround story highlights the importance of diversifying across asset groups and regional markets, as well as staying disciplined despite uncertainty. Although not all asset classes had positive returns, a globally diversified, cap-weighted portfolio logged attractive returns in 2016.

Consider that global markets are incredible information-processing machines that incorporate news and expectations into prices. Investors are well served by staying the course with an asset allocation that reflects their needs, risk preferences, and objectives. This can help investors weather uncertainty in all of its forms. The following quote by Eugene Fama describes this view.

“If three or five years of returns are going to change your mind [on an investment], you shouldn’t have been there to begin with.” ―Eugene Fama

The chart above highlights some of the year’s prominent headlines in context of broad US market performance, measured by the Russell 3000 Index. These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a long-term perspective and avoid making investment decisions based solely on the news.

The chart below offers a snapshot of non-US stock market performance (developed and emerging markets), measured by the MSCI All Country World ex USA Index (in USD, net dividends). The headlines should not be viewed as determinants of the market’s direction but as examples of events that may have tested investor discipline during the year.

World Economy

2016 Year in Review Major World Indices

2016 Market Perspective

Equity Market Highlights

After a rocky start, the US stock market had a strong year. The S&P 500 Index logged an 11.96% total return and small cap stocks, as measured by the Russell 2000 Index, returned 21.31%.

Overall, performance among non-US markets was also positive: The MSCI World ex USA Index, which reflects non-US developed markets, logged a 2.75% return and the MSCI Emerging Markets Index an 11.19% return.1

Global Diversification Impact

Overall, US equities outperformed equities in the developed ex US markets and emerging markets. As a result, a market cap-weighted global equity portfolio would have underperformed a US equity portfolio. Investors generally benefited from emphasizing value stocks around the world, as well as US small cap stocks.

Returns at the country level were dispersed. In developed markets, returns ranged from –24.87% in Israel to +24.56% in Canada. In emerging markets, returns ranged from –12.13% in Greece to +66.24% in Brazil.

Strong performance in the US placed it as the 17th best performing country out of the 46 countries in the MSCI All Country World Index (ACWI), which represents both developed and emerging markets. Although the S&P 500 Index had a positive return in 2016, the year was not in the top half of the index’s historical annual returns.

Brazil offers a noteworthy example of market prices at work and the difficulty of trying to forecast and time markets. Despite a severe recession, Brazil was the top performing emerging market country in 2016. Brazil’s GDP was projected to shrink 3.4% in 2016, according to the OECD in November, yet its equity market logged strong performance. The lesson is that prices incorporate a rich set of information, including expectations about the future. One must beat the aggregate wisdom of market participants in order to identify mispricing. The evidence suggests that this is a very difficult task to do consistently.


In 2016, equity market volatility, as measured by the CBOE Volatility Index (VIX),2 was below average. There were, however, several spikes—as you might expect—as new information was incorporated into prices. The high was reached in early February, and spikes occurred following the Brexit vote in June and again in November preceding the US election.

Premium Performance

In 2016, the small cap and value premiums3 were mostly positive across US, developed ex US, and emerging markets, while the profitability premium varied by market segment.4 Though 2016 marked a generally positive year, investors may still be wary following several years of underperformance for value and small cap stocks. Taking a longer-term perspective, the premiums remain persistent over decades and around the globe despite recent years’ headwinds. The small cap and value premiums are well-grounded in financial economics and verified using market data spanning decades, but pursuing those premiums requires a consistent, long-term approach.

US Market

In the US market, small cap stocks outperformed large cap stocks and value stocks outperformed growth stocks. High profitability stocks outperformed low profitability stocks in most market segments.5 Over 2016, the US small cap premium marked the seventh highest annual return difference since 1979 when measured by the Russell 2000 Index minus Russell 1000 Index. Most of the performance for small caps came in the last two months of the year, after the US election on November 8. This illustrates the difficulty of trying to time premiums and the benefit of maintaining consistent exposure. Through October, US small cap stocks had outpaced large company stocks for the year by only 0.35%. By year-end, the small cap premium had increased to 9.25%, as shown below.

US value stocks outperformed growth stocks by 11.01% following an extended period of underperformance. Over the five-year rolling period, the value premium, as measured by the Russell 3000 Value Index minus Russell 3000 Growth Index, moved from negative in 2015 to positive in 2016.

2016 Year in Review Major World Indices

Developed ex US Markets In developed ex US markets, small cap stocks outperformed large cap stocks and value stocks outperformed growth stocks. Over both the five- and 10-year rolling periods, the small cap premium, measured as the MSCI World ex USA Small Cap Index minus the MSCI World ex USA Index, continued to be positive. The five- and 10-year rolling periods for the small cap premium have been positive for the better part of the past decade.

Value stocks outperformed growth stocks by 9.26%, as measured by the MSCI World ex USA Value Index minus the MSCI World ex USA Growth Index. Similarly to US small caps, most of the outperformance occurred in the fourth quarter, reinforcing the importance of consistency in pursuing premiums. Despite a positive year, the value premium remains negative over the five- and 10-year rolling periods.

Emerging Markets In emerging markets, small cap stocks underperformed large cap stocks and value stocks outperformed growth stocks. Despite the underperformance of small cap stocks, small cap value stocks fared better than small cap growth stocks and performed similarly to large cap value stocks. Investors who emphasized small cap value stocks over small cap growth stocks benefited.

Fixed Income

Both US and non-US fixed income markets posted positive returns. The Bloomberg Barclays US Aggregate Bond Index gained 2.65%. The Bloomberg Barclays Global Aggregate Bond Index (hedged to USD) gained 3.95%.

Yield curves6 were generally upwardly sloped in many developed markets, indicating positive expected term premiums. Indeed, realized term premiums were positive in the US and globally as longer-term maturities outperformed their shorter-term counterparts.

Corporate bonds were the best performing sector, returning 6.11% in the US and 6.22% globally, as reflected in the Bloomberg Barclays Global Aggregate Bond Index (hedged to USD). Credit premiums were also positive in the US and globally as lower quality investment grade corporates outperformed their higher quality investment grade counterparts.

While interest rates increased in the US, they generally decreased globally. Major markets such as Japan, Germany, and the United Kingdom all experienced decreases in interest rates. In fact, yields on Japanese and German government bonds with maturities as long as eight years finished the year in negative territory.

In the US, interest rates increased the most on the short end of the yield curve and were relatively unchanged on the long end. The yield on the 3-month US Treasury bill increased 0.35% to end the year at 0.51%. The yield on the 2-year US Treasury note increased 0.14% to 1.20%. The yield on the 10-year US Treasury note closed at a record low of 1.37% in July yet increased 0.18% for the year to end at 2.45%. The yield on the 30-year US Treasury bond increased 0.05% to end the year at 3.06%.


The British pound, euro, and Australian dollar declined relative to the US dollar, while the Canadian dollar and Japanese yen appreciated relative to the US dollar. The impact of regional currency differences on returns in the developed equity markets was minor in most cases. US investors in both developed and emerging markets generally benefited from exposure to certain currencies.

“There’s no information in past returns of three to five years. That’s just noise. It really takes very long periods of time, and it takes a lot of stick-to-it-iveness. You have to really decide what your strategy is based on long period of returns, and then stick to it.” ―Eugene Fama

1. All non-US returns are in USD, net dividends.
2. The VIX is a measure of implied volatility using S&P 500 option prices. Source: Bloomberg.
3. The small cap premium is the return difference between small capitalization stocks and large capitalization stocks. The value premium is the return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).
4. Profitability is measured as a company’s operating income before depreciation and amortization minus interest expense scaled by book equity. The profitability premium is the return difference between stocks of companies with high profitability over those with low profitability.
5. Profitability performance is measured as the top half of stocks based on profitability minus the bottom half in the Russell 3000 Index.
6. A yield curve is a graph that plots the interest rates at a specific point in time of bonds with similar credit quality but different maturity dates.

Year-in-review features major headlines, performance data for world indices, and a market perspective for 2016. The text and graphics may be downloaded and adapted for client communication.

Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Dow Jones data provided by Dow Jones Indices. MSCI data © MSCI 2017, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. The BofA Merrill Lynch Indices are used with permission; © 2017 Merrill Lynch, Pierce, Fenner & Smith Inc.; all rights reserved. Bloomberg Barclays data provided by Bloomberg. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio.

Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities.

Investing risks include loss of principal and fluctuating value. Small cap securities are subject to greater volatility than those in other asset categories. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Sector-specific investments can also increase these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, liquidity, prepayments, and other factors. REIT risks include changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer.

Eugene Fama is a member of the Board of Directors for and provides consulting services to Dimensional Fund Advisors LP.

Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

Identity Theft

InFocus November 2016—Protecting Your Identity

Intro: your guide to navigating safely in a cyber world

Holiday lovers aren’t the only ones who think this is the most wonderful time of the year. From Black Friday to Cyber Monday to every other day through the end of 2016, millions of shoppers will not only be hitting the mall but also their laptops, tablets and smartphones as they click, click, click items off their lists. This is music to the ears of cybercriminals. Last year, online orders on Cyber Monday alone exceeded $3 billion, an increase in e-commerce activity of nearly 18 percent from 2014.

Cybercrime — which is any criminal activity that involves the Internet, a computer or computer technology — has become an unwieldy epidemic that comes in many shapes and forms. And though it is hardly a seasonal problem, cybercrime is heightened during this time of year when an incomprehensible flurry of personal information is being transmitted electronically every second.

The following offers a primer of cybercrime activity and an array of tips for helping you protect yourself — and your identity — from the bad guys.

Section 1: LOOK, LEARN

Don’t Get Hooked: How to Recognize and Avoid Phishing Attacks | Digital Guardian

Phishing attacks are when cybercriminals try to con users into revealing sensitive information or downloading viruses by means of electronic communication. Phishing can take many forms — be it spear phishing or whaling, smishing or vishing. This visual playbook breaks down various phishing attacks and offers tips to put you on your best defense (Rule #1: Be suspicious, always).

Section 2: READ

 How Best to Stay Safe Online | NBC News

With hacking reaching epic proportions, “white hat” cybersecurity experts are struggling to keep pace with “black hat” hackers. This article shares practical steps you can take to strengthen your digital security

7 Bad Password Habits to Break Now | IT Pro Portal

One of the best defenses to protect your private information is a strong password. Avoid these common password habits that put you at risk. | MORE: How secure is your password?

Beware iPhone Users of Fake Retail Apps | The New York Times

Fake retail and product apps are swarming Apple’s App Store. Some apps are designed to look like the real thing, while others are for companies that don’t have official iPhone apps. Either way, the goal is to trick consumers so they give up information that allows fraudsters to access credit cards.

Scammers Targeting PayPal Users on Twitter ValueWalk

Fraudsters are flocking to social media to try and lure users into giving up their login information to PayPal and gain access to funds.

section 3: WATCH

 Raise Your Shield

Did you know anyone with an email account is a potential victim to an online attack? Or that there are more than 100,000,000 attempted email attacks by cybercriminals every day? The Office of the Director of National Intelligence shows common tricks fraudsters use to try and get you to give up your personal info.

Could You Be Hooked by a Phishing Scam?

Follow some simple do’s and don’ts to help you distinguish fake websites and emails from legitimate ones.

Glasses on Retirement Summary

Choosing Between Roth and Traditional IRA’s

Among the most important decisions investors make is their choice of location for assets within the various alternatives available for retirement (tax-advantaged) accounts. Allocating between a traditional IRA (a pretax, tax-deferred account) and a Roth IRA (a post-tax, tax-free account) can have a pronounced impact on retirement outcomes, given the $14 trillion in tax-advantaged retirement account assets at the end of 2015.

David Brown, Scott Cederburg and Michael O’Doherty contribute to the literature on retirement asset location with their June 2016 paper, “Tax Uncertainty and Retirement Savings Diversification.”

The modeling approach they adopt accounted for investor age, current income and taxable income from outside sources in retirement, as well as the highly progressive income tax regime now in place. The authors point out that “the marginal rate for a single taxpayer with inflation-adjusted income of $100,000, for example, has changed 39 times since the introduction of income taxes in 1913 and has ranged from 1% to 43%.” This creates considerable uncertainty.

Because risk-averse investors (and most investors are risk averse; it’s generally only a matter of degree) dislike uncertainty, this should create a preference for Roth accounts, as they “lock in” the current rate, eliminating the uncertainty associated with future changes.

On the other hand, a traditional account, which offers retirement savers the benefit of deducting current contributions, allows investors to “manage their current taxable income around tax-bracket cutoffs, which is valuable under a progressive structure.”

Another benefit of traditional accounts, the authors write, is that “the progressive tax rates faced in retirement provide a natural hedge against investment performance. Investors with poor investment results and little wealth in retirement will pay a relatively low marginal tax rate, whereas larger tax burdens are borne by investors who become wealthy as a result of good investment performance.” This creates tension between the traditional and Roth options.

Who Should Use The Roth Structure?

The authors state: “Roth accounts are primarily useful for low-income investors who can lock in a low marginal rate by paying taxes in the current period.” They add that because “future tax rates are more uncertain over longer retirement horizons” and their analysis of historical tax changes suggests “that the rates associated with higher incomes are more variable,” eliminating “exposure to tax risk is particularly attractive for younger investors with relatively high incomes and correspondingly high savings.”

The authors continue: “Despite high current marginal tax rates, and contrary to conventional financial advice, these investors benefit the most from the tax-strategy diversification offered by Roth accounts.”

Brown, Cederburg and O’Doherty concluded: “Whereas conventional wisdom largely supports choosing between traditional and Roth accounts by comparing current tax rates to expected future tax rates, the hedging benefits of traditional accounts and the usefulness of Roth accounts in managing tax-schedule uncertainty are important considerations in the optimal savings decision.” They note that, for wealthy investors, their analysis shows “tax-strategy diversification is particularly attractive, despite their high current marginal tax rates.”

The authors also examined their findings’ economic implications: “Our results are of practical importance to employers and regulators who determine the retirement savings options available to employees. In particular, broadening access to Roth versions of workplace accounts would provide investors with important tools for managing their exposures to tax risk. Given that these accounts are available under current regulations, encouraging the widespread adoption of, and education about, employer-sponsored Roth plans could substantially improve investors’ welfare.”

What the authors found provides investors with the proper framework to make informed decisions regarding the asset location of their retirement savings and the diversification of tax risk.

This commentary originally appeared July 27 on

By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.

The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2016, The BAM ALLIANCE

Larry Swedro at Computer Monitors

Swedroe: Irrelevance Of Dividends

Swedroe: Irrelevance Of Dividends |

Research has established that dividend policy should be irrelevant to stock returns, yet investors have long demonstrated an irrational preference for them. Mutual fund providers are well-aware of this fact.

Earlier this week, we reviewed a pair of studies showing that mutual fund managers exploit investors’ well-documented preference for cash dividends to attract assets by artificially “juicing” the dividend yield, and that they use dividend-chasing behavior strategically to benefit themselves at the expense of fund investors. Today we’ll tackle some possible explanations for investors’ anomalous behavior.

Attempting To Explain The Preference For Dividends

Hersh Shefrin and Meir Statman, two leaders in the field of behavioral finance, attempted to explain the preference for the cash dividends anomaly in their 1984 paper, “Explaining Investor Preference for Cash Dividends.” They offered the following explanations.

First, in terms of their ability to control spending, investors may recognize they have problems with the inability to delay gratification. To address this problem, they adapt a “cash flow” approach to spending, meaning they limit their spending only to the interest and dividends from their investment portfolio.

A “total return” approach that used self-created dividends would not address the conflict created by the individual who wishes to deny himself or herself a present indulgence, yet is unable to resist the temptation. While the preference for dividends might not be optimal (for tax reasons), by addressing the behavioral issue, it could be said to be rational. In other words, the investor has a desire to defer spending, but knows he doesn’t have the will, so he creates a situation that limits his opportunities and, thus, reduces the temptations.

The second explanation is based on “prospect theory” (also referred to as loss aversion), which states that investors value gains and losses differently. As such, they will base decisions on perceived gains rather than on perceived losses.

So, if someone were given two equal choices, one expressed in terms of possible gains and the other in terms of possible losses, people would choose the former. Because taking dividends doesn’t involve the sale of stock, it’s preferred to a total-return approach that may require self-created dividends through sales. Sales might involve the realization of losses, which are too painful for people to accept (they exhibit loss aversion).

What they fail to realize is that a cash dividend is the perfect substitute for the sale of an equal amount of stock, whether the market is up or down, or whether the stock is sold at a gain or a loss. It makes absolutely no difference. It’s just a matter of how the problem is framed. It’s essentially form over substance.

Whether you take the cash dividend or sell the equivalent dollar amount of the company’s stock, you’ll end up with the same amount invested in the stock. With the dividend, you own more shares but at a lower price (by the amount of the dividend), while with the self-dividend, you own fewer shares but at a higher price (because no dividend was paid).

Consolation Prizes
Shefrin and Statman write: “By purchasing shares that pay good dividends, most investors persuade themselves of their prudence, based on the expected income. They feel the gain potential is a super added benefit. Should the stock fall in value from their purchase level, they console themselves that the dividend provides a return on their cost.”

They point out that if the sale involves a gain, the investor frames it as “super added benefit.” However, if the investor incurs a loss, he frames it as a silver lining with which he can “console himself.” Because losses loom much larger in investors’ minds, and because they wish to avoid them, they prefer to take the cash dividend, avoiding the realization of a loss.

Shefrin and Statman offer yet a third explanation: regret avoidance. They ask you to consider two cases:

1) You take $600 received as dividends and use it to buy a television set.

2) You sell $600 worth of stock and use it to buy a television set.

After the purchase, the price of the stock increases significantly. Would you feel more regret in case one or in case two? Since cash dividends and self-dividends are substitutes for each other, you should feel no more regret in the second case than in the first case. However, evidence from studies on behavior demonstrates that, for many people, the sale of stock causes more regret. Thus, investors who exhibit aversion to regret have a preference for cash dividends.

Shefrin and Statman go on to explain that people suffer more regret when behaviors are taken than when behaviors are avoided. When selling stock to create the homemade dividend, a decision must be made to raise the cash. When spending comes from the dividend, no action is taken; thus, less regret is felt. Again, this helps explain the preference for cash dividends.

The authors also explain how a preference for dividends might change over an investor’s life cycle. As mentioned previously, a theory incorporating self-control is used to justify spending only from a portfolio’s cash flow, never touching the principal.

Younger investors, who generate income from their labor capital, might prefer a portfolio with low dividends, as a high-dividend strategy might encourage dis-savings (spending from capital). On the other hand, retired investors with no labor income would prefer a high-dividend strategy for the same reasons, to discourage dis-savings. A study of brokerage accounts found that a strong and positive relationship between age and the preference for dividends did in fact exist.

While the preference for cash dividends is an anomaly that cannot be explained by classical economic theory (which is based on investors making “rational” decisions), investors who face self-control issues (such as a weakness for impulse buying) may find that, while there are some costs involved, the benefits provided by avoiding behavioral problems may make a cash dividend strategy a rational one.

Before summarizing, we have one more important point to cover. It involves how popularity drives down returns.

The Curse Of Popularity

The Federal Reserve’s zero-rate policy has led many investors to search for incremental yield, replacing safe bonds with riskier assets. Dividend-paying stocks are among the beneficiaries of these cash flows. That increased demand has impacted valuations, which are the best predictors of future returns. Higher valuations predict lower future returns. Until recently, dividend-paying strategies—specifically high-dividend strategies—called for the purchase of value stocks. Increased demand, however, has changed that.

The table below shows three value metrics—price-to-earnings (P/E), price-to-book value (P/B) and price-to-cash flow (P/CF)—for two of the market’s most popular dividend strategies: the SPDR S&P Dividend ETF (SDY), with more than $14 billion in assets under management (AUM), and the Vanguard Dividend Appreciation ETF (VIG), with more than $22 billion in AUM. Data is as of July 13, 2016. VIG buys the stocks of companies with rapid growth in their dividends.

The table also shows the two large-cap value ETFs with the most AUM, the iShares Russell 1000 Value ETF (IWD) and the Vanguard Value ETF (VTV). Finally, I’ll compare the value metrics of these funds with that of the SPDR S&P 500 ETF (SPY). As you review the data, remember that the lower the price metric, the higher the expected return. Data is from Morningstar.


The above data makes clear that the popularity of the two dividend strategies (SDY and VIG) has led to a rise in the prices of these stocks and reduced their expected returns. No matter which value metric we look at, the expected returns for both SDY and VIG are now well below the expected returns of the two large value strategies, and also below that of the S&P 500 ETF. It’s an example of the curse of popularity, and what happens when a trade gets “crowded.” Forewarned is forearmed.


It seems that investors all over the world are prone to the same behavioral mistakes, mistakes that lead them into a preference for dividends. While Shefrin and Statman showed that at least some investors may derive some benefit (such as help in controlling spending), the preference is irrational from a financial economist’s perspective. It can lead to reduced diversification benefits and higher tax costs. And it can lead at least some investors to fall prey to mutual funds seeking to exploit the typical retail investor’s lack of financial knowledge.

For the past 20 years, the workhorse model in finance has been the Fama-French four-factor model—the four factors being beta, size, value and momentum. The model explains the vast majority (about 95%) of the differences in returns of diversified portfolios.

Newer asset pricing models, which include the profitability, quality and investment factors, have added further explanatory power. Yet none of them include dividends as a factor. If dividends played an important role in determining returns, these models wouldn’t work as well as they do.

In other words, if dividends added explanatory power beyond that of the factors I just mentioned, we would have a model that included dividends as one of the factors. But we don’t. The reason is that stocks with the same “loading,” or exposure, to these common factors have the same expected return regardless of the dividend policy. This has important implications, because about 60% of U.S. stocks and about 40% of international stocks don’t pay dividends.

Any screen for dividend stocks results in portfolios that are far less diversified than they could be if dividends were not included in the portfolio design. Less diversified portfolios are less efficient, as they have a higher potential dispersion of returns without any compensation in the form of higher expected returns (assuming exposures to the factors are the same).

Additionally, you have seen how the preference for dividend stocks has driven dividend strategy valuations to levels well above the valuations of value strategies and the overall market. This should raise concerns about future returns.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

Market Volatility

Learning to Ignore Short-Term Fund Performance Relative to Indexes

Our clients generally understand that focusing on the short-term performance of a fund relative to another fund or an index is a waste of time. These differences rarely tell you anything important about long-term performance and, in fact, can lead to counterproductive behavior if you are prone to selling funds that underperform to move into funds that have outperformed. These performance differences, after all, tend to reverse more often than not. We call this “returns-chasing behavior” and it is one of the surest paths to poor long-term performance. Jared Kizer, chief investment officer for the BAM ALLIANCE, frequently receives questions about performance differences — from clients and advisors alike. He shares his insights below.

I have spent years thinking about this issue and analyzing hundreds of performance cases and performance attribution analyses. I find that there are two areas that drive a lot of these questions, and I hope to clarify both:

  • What do you mean by “short term”?
  • How big can performance differences be over short-term periods of time?

Before digging in, let’s talk about the structure of the funds we use in client portfolios relative to index funds.

Evidence-Based Funds Vs. Index Funds

The funds we use are rarely index funds, meaning by definition they will not precisely track well-known indexes. In fact, most of the funds we use have significantly different compositions from the indexes they are most frequently compared to. This is not an accident. We purposefully use funds that do not explicitly track indexes.

Going into all the details behind this is beyond the scope of this piece. In short, we want to maximize the benefits of indexing — low costs, generally low turnover of holdings, broad diversification and tax efficiency — and minimize the negatives. As great as index funds are, published research has shown they can have negatives. For example, some indexes rebalance in a way where other managers know the stocks (or bonds) that are likely to enter and leave the index on the rebalancing date. This degree of transparency can allow these managers to take advantage of index funds, which reduces long-term performance. This effect is most frequently documented in Russell’s indexes and some of the larger indexes like the S&P 500. Indexes also frequently do not target specific styles like size, value and momentum in ways we think make the most sense given what academic research shows.

Evidence-based funds can alleviate these problems, but that does not guarantee these funds will always outperform an index strategy or outperform similarly constructed evidence-based funds. In fact, they can underperform for long periods of time without offering an indication that the fund is designed poorly or managed poorly. Investors in these funds must remain disciplined during these periods to realize the expected benefits.

What Is “Short Term” and How Big Can Differences Be?

Investors are not always happy with my answer to the time horizon question. In truth, anything is possible for periods of less than five years — and by no means does even five years guarantee the expected result. I want to illustrate this point using performance comparisons over months, quarters and years. In the first figure on the next page, I take the month-by-month differences in return between the stock funds that compose our Risk Target 3 model and the indexes they are most frequently compared to. I then find the pair with the largest amount of underperformance (meaning underperformance of the fund relative to the index) for that particular month and plot that result over time. My analysis starts in October 2005 since that was the first full quarter where five of the seven stock funds in our Risk Target 3 strategy had live returns data.

Figure 1: Differences in Monthly Performance

Figure 1 Differences in Monthly Performance

This analysis shows that in virtually every month at least one of the funds in our model portfolio has underperformed the index by 1 percent or more. In fact, there are multiple months where one of the funds underperformed the index by 2 percent or more. We also see that there are very few months where all the funds outperform their indexes. Let’s now move to quarterly returns.

 Figure 2: Differences in Quarterly Performance

Figure 2 Differences in Quarterly Performance

Here we see that the differences generally get larger, not smaller. There are now a decent number of periods where at least one of the funds underperformed the index by 4 percent or more. Keep in mind, this same concept holds true if we were comparing a particular fund to another fund (e.g., comparing DFA Small Value to DFA Targeted Value). We now move to annual returns.

Figure 3: Differences in Annual Performance

Figure 3 Differences in Annual Performance

The first full year of annual returns data is 2006. While we have limited data to analyze, we generally see again that the differences get larger, not smaller. In fact, in 2008 one of the funds we use underperformed the index by about 13 percent. That does not mean the fund is bad and should be replaced. This is just the nature of shorter-term performance comparisons. We also now see that at least one fund underperformed its index over the full year in every period.

So, this analysis tells us that in periods going out to one year we can expect to see that some funds have underperformed their index by 4 percent or more. It also tells us there will be periods where a fund underperforms its index by even more. We expect and know this will happen with the funds we use.

If this degree of underperformance continues over even longer periods, our Investment Policy Committee has processes to evaluate results and determine whether anything is materially wrong with the fund’s strategy. Most frequently, we find that even longer periods of performance are completely explainable and not a reason to replace the fund. For example, for periods ending in 2015, many of the funds we use had underperformed indexes over longer periods of time because value stocks had done poorly relative to growth stocks. Many of our funds are deeply tilted toward value stocks when compared with indexes, so this was the main explanatory factor behind the performance result. In these cases, the funds did exactly what they were intended to do. It just happened to be a bad period for value stocks.

In summary, acting on short-term performance results is usually detrimental to long-term performance. By the nature of financial markets, the funds we use will periodically underperform indexes and other funds over longer periods of time. The key to seeing the expected benefits — as with many areas of evidence-based investing — is realizing this, not reacting to it, and having the discipline to stick with your strategy and the funds within it over the very long-term.

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 Copyright © 2016, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.
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