Archive for January, 2018

An Exploration of Timing the Market, and What You Can Do Instead

Posted by Daniel J. Greenblatt, CFA®

Economist John Kenneth Galbraith famously said, “We have two classes of forecasters: Those who don’t know – and those who don’t know they don’t know.”

His words underscore a popular issue in investing–timing the market.

As the current bull market nears its ninth year, clients commonly ask us “what should I do about it?” Since the bull market began on 3/9/2009, the S&P 500’s total return has exceeded 370%, small cap equities (S&P Small Cap 600) have returned more than 470%, and international equities (MSCI EAFE) have “only” returned 190% as of 12/31/171. Following the investing adage “buy low, sell high”, your gut tells you it’s time to get out of the market. Exacerbating these fears, industry pundits are constantly predicting major corrections in the stock market.

Market Timing: The Problem with Forecasting

Investor obsession with market forecasts is understandable. Successfully timing the market can be enormously profitable and has launched many investment managers into stardom. The problem with forecasts is that even the experts are not very good at them!

According to billionaire investor Howard Marks from Oaktree Capital Management, successful investment forecasting requires the following2:

1. The forecasts have to be sufficiently different from the market consensus.

2. The forecasts must be consistently accurate.

3. The forecasts must be timely.

Achieving these three objectives can be difficult, and the task is made more complex after you consider external pressures with which forecasters are typically faced. For example, if a mutual fund manager makes a contrarian prediction that ends up being incorrect, performance will suffer on a relative basis to that manager’s peers. Investors will likely withdraw funds, which will lower the fund manager’s compensation, and may eventually lead to him losing his job. Alternatively, the manager could make a consensus forecast and maintain his lifestyle with relatively little worry. These types of dynamics create a strong incentive for forecasters to not stray very far from their peers, even though these are the types of predictions that provide the least value.

The Track Record of Forecasters

There have been numerous academic studies that test whether the experts can successfully time the market. On average, it has been found that the following groups have failed to time the market3:

For individual investors who often trust their “gut”, the results are even worse. According to Dalbar, the average annualized investor return in equity funds was 3.66% vs. 10.35% for the S&P 500 from 1986-2016. While there were other factors that led to their underperformance, Dalbar concluded market timing was the primary reason4.

So, What Should You Do? – Marketing Timing Alternatives

Instead of trying to time the market, we tell our clients that they should focus on other aspects where they have more control and where their probability of success is potentially higher. These other opportunities include:

While we do not believe that markets are perfectly efficient, timing the market is difficult at best. At Lake Street, we focus on the aspects of investing that we can control and plan accordingly for those that we cannot.

Sources:

1. FactSet

2. https://www.oaktreecapital.com/docs/default-source/memos/1996-07-22-the-value-of-predictions-ii-or-give-that-man-a-cigar.pdf?sfvrsn=2

3. https://www.vanguard.com/pdf/s700.pdf

4. https://www.forbes.com/sites/johnbuckingham/2017/04/03/the-cost-of-market-timing/#491f5b2932ab

Would Your Insurance Have You Covered When You Need It?

Posted by Brian J. Thompson, CFA®

5 Elements of Property and Casualty Insurance High Net Worth Individuals Shouldn’t Overlook

While you’re working on sticking to your New Year’s resolutions, here’s a good one to add to the list that will benefit you in 2018 and beyond: double-check that your property and casualty insurance policies have you covered.

Natural disasters and other unexpected events happen all the time. It’s always a good idea to review your insurance policies with your agent at least once each year. Doing so ensures you and your agent fully understand what is covered and what you’re self-insuring. A thorough review also brings to light some often-overlooked areas of property and casualty insurance coverage.

Check Your Property and Casualty Insurance Policy for These 5 Things

  1. Excess Liability Coverage

Excess liability insurance covers personal losses over and above the primary policy. For example, if you experienced a car accident and were sued by the other driver, your auto policy would cover up to a certain amount of liability (usually $250,000 per person, $500,000 per accident), at which point your excess liability policy would kick in.

You should always know the level of excess liability coverage you have. Data suggests that claims/settlements for lawsuits has increased over time, so a $5M or $10M policy may not be enough in today’s litigious environment. Additionally, keep your exposure in mind when determining the amount of coverage needed. Here are some key questions to ask:

There are certain exclusions to what a typical excess liability policy will cover, such as business risks, directors and officers, and employment practices. It’s important to review the exclusions with your agent to be sure you understand what is and is not covered, and to determine whether any excluded coverage can be added via an endorsement or separate policy.

  1. All-Risks Policies and Exclusions

Most high net worth carriers typically write their homeowners policies as “all-risks” or “all-perils” coverage, which means all risks are covered unless they are specifically excluded. Typical exclusions are floods, earthquakes, and occasionally wind if your property is in a coastal area.

You should know which perils are excluded so you can determine what you are self-insuring. There may be options to add coverage for the excluded perils­–simply ask your agent for a quote. However, there are often limitations on how quickly you can add coverage if there is a known risk–for example, it can take 30-60 days to put a flood policy in place in a coastal area, and it could be longer if an elevation certificate is needed. In short, don’t wait until you need the insurance to try and implement it.

  1. Flood Insurance–National Flood Insurance Program (NFIP) vs. Traditional Private Carrier Coverage

When possible, it’s generally better to obtain flood insurance through a private carrier than through NFIP. The most glaring shortfalls of NFIP are that a loss is not covered unless your neighbors have also sustained damages to their home, and NFIP does not cover any damages to basements. Both of these stipulations usually come as a surprise to the insured, and since private carrier insurance is more in line with what one would expect be covered, it’s usually the better option.

However, some homeowners are unable to obtain private carrier insurance due to their level of risk, so NFIP is the only option. If this situation is true for you, be sure to regularly inquire with your insurance agent if private insurance has come available for your home.

  1. Documentation of Belongings and Valuables Coverage

In the event of a loss, it’s important to have a record of your belongings and quality of workmanship of your home or homes. How long has it been since your last insurance appraisal? It is generally recommended that you have an appraisal following any significant changes to your home, or every 3-5 years. Failing to do so could mean your insurance policy isn’t covering the total value of your home.

You should also consider the following:

 

  1. Deductibles

In determining any policy’s deductible, the first question you should ask is how much are you willing to self-insure? High net worth families typically have a higher self-insurance threshold, which can translate to material premium savings over time. When onboarding new clients, we often see deductibles for homeowners’ policies somewhere between $1,000 and $10,000. However, when we discuss these numbers with clients, we learn that many have paid more than their deductible for a loss to avoid the hassle of filing an insurance claim, and to avoid seeing higher premiums in the years to come. Increasing the deductible to $25,000, or even to $50,000, makes sense in cases when there is a significant premium savings. Also, most high-net-worth insurance carriers include a waiver of deductible clause if there’s a loss greater than $50,000, meaning the insured would not have to go out of pocket at all.

Another item to consider are special deductibles on policies for losses caused by specifically-listed perils such as winds, floods, or earthquakes. Oftentimes, these special deductibles are based on a percentage of the dwelling coverage. This amount is important as even 1% can make a big difference in how much you’re self-insuring for a high-value home. For example, in the case of a $10,000,000 home in Key West that was destroyed by Hurricane Irma, if the wind deductible was 2%, the owner would have been out-of-pocket $200,000. If the wind deductible were 3% instead, the owner would be out $300,000. Make sure to ask your agent to compare the special deductibles of different carriers.

Don’t Get Caught Without Proper Insurance Coverage

Insurance coverage can easily fall to the backs of our minds–until we need it. Make sure if that time does come, you are covered with policies that will keep you and your family’s assets protected.

Review your insurance plan at least annually to limit surprises and provide financial peace of mind in the case of a loss. Adding a discussion with your insurance agent to your 2018 resolutions will pay off this year and the years to come.