Value Investing Is Alive and More Appealing Than Typical

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Quiz!

Which of the following are true about US stocks (multiple answers may be correct)?

  1. Value stocks outperformed growth stocks in the past 90 years.
  2. Value stocks have become more expensive than growth stocks.
  3. Growth stocks grow faster than value stocks.

Value Investing Is Alive and More Appealing Than Typical

I’ve seen a number of articles declaring US value investing dead.

What is Value Investing? Value investing refers to buying companies with low stock prices relative to their intrinsic value, or book value (i.e. low Price/Book or P/B). Over the past 90 years, the collective of US value stocks outperformed growth (high Price/Book) stocks.

Why would people question value investing now? US Value stocks have underperformed US Growth (high Price/Book) stocks for the past 10 years – long enough for people to believe that maybe there is a new normal and value stocks will underperform growth stocks moving forward.

What is the theory for the new normal? The theory is that value investing became more commonplace, and the extra investing in value stocks led to bidding up their prices and eliminating the excess-return benefit compared to growth stocks.

Let’s test the theory. If the theory is right, the prices of value stocks increased all the way to match the prices of growth stocks (by definition, they cannot be any higher), eliminating the pricing benefit. It turns out that the opposite is true: the discount in Price/Book of value stocks increased significantly in the past 10 years.

Conclusion. The theory that value investing is dead due to overcrowding fails a simple math test. Based on the test, the opposite seems true, supporting the notion that the underperformance is part of a cycle, and value investing may enjoy greater excess returns than typical in upcoming years.

Implications for other investments. There are 2 other investment categories that show potential promise thanks to a similar simple mathematical test: US Small stocks & Emerging Markets stocks.

Quiz Answer:

Which of the following are true (multiple answers may be correct)?

  1. Value stocks outperformed growth stocks in the past 90 years. [The Correct Answer]
  2. Value stocks have become more expensive than growth stocks.
  3. Growth stocks grow faster than value stocks.

Explanations:

  1. This has been correct in the US for the past 90 years, and in other countries for decades.
  2. The opposite is true: value stocks are enjoying lower valuations (Price/Book, or price relative to the intrinsic value) today than in recent years.
  3. This has been true in the past 10 years in the US, but not in the long run.
Disclosures Including Backtested Performance Data

What Determines Investment Returns?

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Quiz!

Which of the following are factors that determine investment returns (may be multiple answers)?

  1. Past known world events.
  2. Central bank actions.
  3. Future unknown world events.
  4. Valuations

What Determines Investment Returns?

Most investors focus on one factor when trying to predict investment performance: past world events. In reality, investments are impacted by different factors, including: future world events, central bank actions (the Fed in the US), momentum, valuations and the natural growth of companies. Here are a few scenarios that tend to surprise investors and lead to unexpected results:

  1. Recently there was a negative event that led to declines. The next day brought a positive event along with gains. The reverse also happens.
  2. Recently there was a negative event that led to declines. A central bank (the Fed in the US) took actions to support the economy, leading to optimism and gains. Even as little as indication for future support can lead to gains.
  3. An investment is more likely to continue its trend of recent months. A high investment can keep going higher and a low investment can keep going lower.
  4. An investment with low valuations is likely to enjoy greater than average gains in the upcoming 5-10 years. In addition, it is more likely to revert from negative momentum to positive momentum.
  5. Beyond all factors above, you can expect diversified stocks to grow on average, thanks to the productivity of the underlying companies. It doesn’t happen in every specific day, month or year, but it happens on average, supporting long-term investors. And it happens more (on average) for certain groups of stocks including: small companies, cheap stocks (low valuations), and emerging markets.

Quiz Answer:

Which of the following are factors that determine investment returns (may be multiple answers)?

  1. Past known world events.
  2. Central bank actions. [Correct Answer]
  3. Future unknown world events. [Correct Answer]
  4. Valuations [Correct Answer]

Explanations: Past known events are already reflected in stock prices. Read this month’s article for further explanations.

Disclosures Including Backtested Performance Data

Is Your Growing Income Making You Less Financially Independent?

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Quiz!

Say you earn $100k per year ($80k net) and save 10% of your gross salary. After a number of years, you built an investment portfolio of $120k. You recently got a big raise from $100k/year to $200k/year ($150k net). You double your saving rate from 10% per year to 20% per year. What is the impact on your financial security soon after the raise:

  1. Increased by 20%
  2. Increased by 10%
  3. Did not change
  4. Declined by 36%
  5. Declined by 54%

Is Your Growing Income Making You Less Financially Independent?

Say you earn $100k per year and save 10% of your gross salary. After a number of years, you built an investment portfolio of $120k. You recently got a big raise from $100k/year to $200k/year. You double your saving rate from 10% per year to 20% per year. The table below shows the impact on your finances (all amounts are in dollars):

Increase Spending Based on Income: Financial Security Drops
Before raise After raise Change
Gross income 100k 200k
Net income (an example) 80k 150k
Saving rate 10% 20% x2
Saving amount 10k 40k x4
Spending (net income – saving amount) 70k 110k +57%
Spending rate = annual spending / total saved. Lower = higher financial security. 70k / 120k = 58% 110k / 120k = 92% +59%

The paradox. You just doubled your saving rate, quadrupled the amount saved each year, have 57% extra to spend, yet you quickly become more stressed about money than before the raise! What happened? Your spending increased by 59% relative to your total savings, making you less financially secure and more dependent on your job. The stakes are higher, making work a lot more stressful. I believe that this is a big reason for rising stress and declining happiness along with rising incomes.

Is there a Solution? Yes. Instead of counting on potential earnings, increase your spending only (1) based on new money that you already saved, and (2) in a sustainable way. In the example above, you keep your spending at $70k right after the raise, and increase it only using 3% of the money that you already saved and invested. 3% is an example of a likely sustainable withdrawal rate from a diversified stock portfolio. The table below shows the progression over 3 years (all amounts are in dollars):

Sustainable Increase of Spending (3% of New Money Saved): Total Spending & Financial Security Keep Going Up
Calculation Formula Before raise Year 1 Year 2 Year 3
Savings
Year-start savings Last year’s Year-end savings 120k 120k 212k 269k
Investment growth [Made up returns, with 10% average] 10% -10% 34%
Investment dollar growth Year-start savings x Investment growth 120k*10% = 12k -21k 91k
New savings Net income – last year’s Total spending 150k–70k = 80k 78k 76k
Year-end savings Year-start savings + Investment dollar growth + New savings 120k 120k+12k +80k = 212k 269k 436k
Spending
Added sustainable income New savings x 3%, rounded 80k x 3% = 2k 2k 2k
Total spending Last year’s Total spending + Added sustainable income 70k 70k + 2k = 72k 74k 76k
Financial security (annual spending / total saved), lower is better Year-end savings / Total spending 58% 34% 28% 17%

Key points:

  1. Higher income never hurts financial security. This plan eliminates the big dip in financial security after the raise. Instead, it provides growing financial security. Note: Your overall financial security could decline during big enough down years for your investments, but this is not related to your increased spending. It is the result of owning volatile investments. Volatility is the price of high long-term expected returns. It can hurt you when between jobs, but should help while you are in saving mode (see: How to Use Volatility to Make Money http://www.qualityasset.com/2018/07/31/how-to-use-volatility-to-make-money/).
  2. Sustainable new spending. By increasing your spending by a small percent of new savings, the new spending is expected to be sustainable even in the face of severe investment declines.
  3. Plan not reactive to investment volatility. The plan does not change spending along with the investment’s ups and downs. Declines don’t hurt spending, while gains are left to compound until you reach financial independence (retirement). When independent (spending/investments <= 3%), you can further increase your spending to 3% of your investments, whether you are working or not.
  4. Relatively simple calculation. By tying your spending only to money you save from your income, the calculation stays relatively simple: Once a year, you can total your additions (minus withdrawals, if any) to your investment portfolio, and you can raise your annual spending by 3% of that amount. Your investment advisor should have this information, and do the calculation for you.
  5. Reward for rising income. By tying your spending only to money you save from your income, you reward yourself for increases in income, instead of investments that you cannot control.
  6. Spending, total savings, and financial security all set for growth. Thanks to compounded investment growth, the available money to spend, the total savings, and financial security, all should grow exponentially over time (beyond the dips during down periods in the cycle).
  7. Baseline spending. The first step is setting your baseline spending. To find that, go over every item in your spending, and ask if you are willing to trade it with a more relaxed life. Once you completed all the trades (spending reductions), you maximized your financial relaxation. The lower the baseline, the higher your financial security, the faster it will grow, and the sooner you will reach retirement – the point from which you can keep growing your spending, independently of income.
  8. Resolving the paradox of: higher income = more stress. Many people have strong desires for increased spending immediately as their income goes up, making this plan seem too extreme. If you feel that way, think about something even more extreme: the prospects of becoming more stressed and less happy “thanks” to your higher income. Keep this paradox in mind before rushing to add to your spending based on growing income and not actual savings.

Quiz Answer:

Say you earn $100k per year ($80k net) and save 10% of your gross salary. After a number of years, you built an investment portfolio of $120k. You recently got a big raise from $100k/year to $200k/year ($150k net). You double your saving rate from 10% per year to 20% per year. What is the impact on your financial security soon after the raise:

  1. Increased by 20%
  2. Increased by 10%
  3. Did not change
  4. Declined by 36% [The Correct Answer]
  5. Declined by 54%

Explanations: Read this months’ article for an explanation.  Technical note:  The 59% increase in spending rate mentioned in the article is equivalent to a 36% decline in financial security: 1/(1+59%)-1 = -36%.

Disclosures Including Backtested Performance Data

Do Stocks Decline after Yield Curve Inversions?

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In late March the yield on short-term bonds (3-month) was higher than longer-term bonds (10-year) for a week. Normally you would expect higher returns for offering a 10-year loan than for offering a 3-month loan, leading to an upward sloping curve of yields of bonds of different maturities. What we saw in late march is called a “yield curve inversion” – longer-dated bonds providing lower yields than shorter ones. This often occurs when the Fed raises short-term rates fast relative to current conditions, and can be a precursor to a recession. It was true in both 2000 & 2008. Should you expect a decline to start soon? No. There is usually a significant lag between the inversion and stock declines. Here are the returns between the inversion and the stock decline for the S&P 500 and Extended-Term Component (ET) in the 2 prior cases of 2000 and 2008:

Inversion 1 Peak 1 Duration S&P 500 Return ET Return
9/30/1998 1/31/2000 16 months +39% +165%
01/31/2006 10/31/2007 21 months +18% +95%

1 I used month-end dates, given better access to historic return data on a monthly basis. The missing/extra partial-month impact on the results should be minimal.

These ET surges that are typical leading to peaks are a reason for you not to be concerned, and even be optimistic. Additional thoughts:

  1. Leading to peaks, ET tends to significantly outperform the S&P 500. It is great for your risk plan to be in a much stronger position in the face of future declines.
  2. The recent inversion was very short-lived, and current interest rates are still very low historically. It is possible that a recession is even further away than typical after inversions.
  3. While the statistics above provide a reason for optimism, I continue to be prepared for declines at any point – there are no guarantees on timing and results in investing.
Disclosures Including Backtested Performance Data

Should Higher Earners have Higher or Lower Saving Rates?

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Quiz!

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. What should your new saving rate be? Please select the best answer.

  1. Increase your savings nicely to $13k/year (but lower your saving rate to 13k/160k = 8%).
  2. Keep your saving rate at 10%, increasing your savings to $16k/year.
  3. Increase you saving rate to 20%, increasing your savings to $32k/year.

Should Higher Earners have Higher or Lower Saving Rates?

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. Should you keep your saving rate of 10%, increasing your savings to $16k/year? Should you increase your savings by less than that or even more? For many reasons, you should increase your saving rate, leading to new savings greater than $16k/year. Here are a few reasons:

  1. Usually, the higher your income, the lower your job security. Many more people compete for CEO or VP roles, than a fast food restaurant employee. You need to build security through savings faster to make up for your declining job security.
  2. If you lose your job, there are fewer jobs to choose from, the higher the income.
  3. The excess happiness obtained by increased spending goes down quickly as the amount goes up. Reducing financial stress typically brings much greater happiness.
  4. Social security covers a smaller portion of high incomes. If you earn $30,000 per year, social security will give you a retirement greater than half of your earnings. But, at $300,000 per year, social security income covers a small portion of the income you got used to. It is up to you to make up the difference. To get income of $300,000 from a portfolio that can generate 3% per year, you would need to build savings of $10,000,000. If you want to enjoy anywhere near the standard of living you got used to, you need a very high saving rate combined with investing for high growth compounded over many years.

The good news is that even at 20% = $32k saving rate, your income available to spending grows by a substantial: (160k – 32k) – (100k – 10k) = 38k minus income taxes. You get the double benefit of higher spending along with a big increase in your saving rate.

Quiz Answer:

Say that you earn $100k/year, and you save $10k/year, or 10% of your income. You got a big promotion, and your income jumped to $160k/year. What should your new saving rate be? Please select the best answer.

  1. Increase your saving nicely to $13k/year (but lower your saving rate to 13k/160k = 8%).
  2. Keep your saving rate at 10%, increasing your savings to $16k/year.
  3. Increase you saving rate to 20%, increasing your savings to $32k/year. [The Correct Answer]

Explanations: Read this months’ article for an explanation.

Disclosures Including Backtested Performance Data

How Much Should You Spend? A Rule of Thumb for All!

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Quiz!

Which rule of thumb for spending can be useful for all personality types?

  1. Save 10% of your income and spend the rest.
  2. Save 10% of your income for incomes up to $200k, and 20% for incomes above that. You can spend the rest.
  3. Keep your spending as low as needed to avoid chronic financial stress.
  4. Save as much as needed to allow you to retire by a reasonable age such as 65 or 70. You can spend the rest.

How Much Should You Spend? A Rule of Thumb for All!

This article offers a rule of thumb for a healthy spending level for all personality types.

Full sustainability: No matter your preferences, you can feel comfortable to spend an amount that is likely to be sustainable for as long as you live, whether you work or not. This is: your current social security payments, pensions and other guaranteed income, plus a sustainable withdrawal from your investments (e.g. 3%-4% for many globally diversified stock portfolios, reduced enough to account for surprise expenses).

Rule of thumb for all: Early in your career, full sustainability is rarely possible. A rule of thumb is to keep your spending as low as needed to avoid chronic financial stress. The benefit of this rule is that it can apply equally to different personalities. Here are a few examples:

  1. Risk averse: If you are risk averse, you may become stressed by any income instability or large surprise expenses. It may be worth keeping your spending as close as you can to 3%-4% of your portfolio. It may involve a large initial adjustment, but in return you will get many rewards. You will take the fastest road out of financial stress. You will enjoy the extra savings, plus the compounded growth of the extra savings. This will lead to a positive snowball effect of fast growing sustainable income along with relaxation.
  2. Time-sensitive spending: Some expenses lead to benefits that may not be available if delayed. Examples include children’s education & healthy eating. If you are risk averse, a compromise may be delaying most expenses, but still retaining your time-sensitive expenses.
  3. Instant gratification: If you are averse to delaying gratification, and don’t get too stressed without much of a safety net, you may choose to spend the bulk of your income, no matter how limited your investments are. Any loss of job, and many surprise expenses will require quick adjustments and potential stress. With low total savings to enjoy compounded growth, you will likely have a lot less money to spend in your lifetime, and your dependency on work will stay consistently high. But if immediate gratification is your top desire, and the consequences don’t stress you, it may be worth the tradeoff.

Important notes:

  1. Be realistic about upcoming expenses. Many types of non-recurring expenses are bound to happen. Examples include medical costs, house repairs, car repairs, new cars, loss of job and business downturns. I’ve heard people refer to these as bad luck. Switching your mindset, and seeing them as expected non-recurring expenses, can significantly increase your happiness and success in life.
  2. The benefit: The rule of thumb of avoiding chronic financial stress can be helpful regardless of your priorities. If your spending creates ongoing stress, you are probably not living an authentic life, and the price could be greater than any benefit you are getting by the spending. This is true whether you think you are spending very little or a lot.
  3. Stable jobs with guaranteed pensions. Because most jobs are far from guaranteed, the ultimate way to avoid chronic financial stress is to depend on sustainable withdrawals from actual money in the bank (investments). If you are lucky enough to have a very stable job that has a guaranteed pension, the pressure to reduce the dependency on work is lower. Please remember, though, that such jobs are rare, and pensions may not be as guaranteed as they used to be.
  4. If you are married, it is worth discussing spending, with a clear goal of resolving and preventing chronic financial stress. To motivate the talks, realize that one person’s stress typically hurts both members of the couple – even the person who is less risk averse and eager to spend more.
  5. Perspective: You can maximize your happiness by comparing yourself to people living in a basic structure with no running water and no electricity, and realize how fortunate you are. No matter how much you lower your spending, you are very fortunate in life.

Quiz Answer:

Which rule of thumb for spending can be useful for all personality types?

  1. Save 10% of your income and spend the rest.
  2. Save 10% of your income for incomes up to $200k, and 20% for incomes above that. You can spend the rest.
  3. Keep your spending as low as needed to avoid chronic financial stress. [The Correct Answer]
  4. Save as much as needed to allow you to retire by a reasonable age such as 65 or 70. You can spend the rest.

Explanations:

  1. Your saving rate depends on how much you have saved, how soon you desire to retire, your spending rate, your income level, your job stability, and a number of other factors. There isn’t one percentage that applies to everyone.
  2. All else being equal, you should save a greater percentage of your income, the higher it is, since it is tougher to replace higher incomes, and your basics are more likely to be covered already. But, spending and saving rates depend on many other factors, some of which are mentioned in #1 above.
  3. Stress is a protection mechanism that tells you that you are not acting in an authentic way. If you are chronically financially stressed, you are acting against your internal beliefs. This rule of thumb can help everyone.
  4. There are many problems with this advice. A few of them: You cannot count on a specific growth rate on your investments to know when you can retire, you cannot anticipate health problems, loss of job, volatile business income, and the list goes on.
Disclosures Including Backtested Performance Data

Your Neighbor’s Grass is Brown!

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Quiz!

Your friend told you about a business-class flight he took for a trip. Which of the following are most likely to be true.

  1. He values the pleasure of a business-class flight, and decided to spend on that.
  2. He is wealthy.
  3. He lives in a fancy house.

Your Neighbor’s Grass is Brown!

Have you ever seen a friend’s or neighbor’s fancy car, or heard about her fancy trip, and thought how lucky she is? After nearly 1.5 decades in this business, I’ve heard many people’s stories, and learned that things are rarely what they seem. Specifically:

  1. Each person emphasizes certain expenses, while often keeping other expenses much lower. A person can fly business class, while living an otherwise modest life. Another may lease a fancy car, while renting a modest home. A third may live a simple life in a fancy home. A fourth may pay for a very expensive private school for her children while living a modest life. These are all examples based on people I personally know. I believe that only a small fraction of people who spend big in a few categories, can afford to spend big in all categories. It makes sense to choose the most important things in your life and focus your spending on them, rather than spending evenly across all categories, whether important to you or not, leaving less money to your top priorities.
  2. Many big spenders are chronically stressed. It fits with a recent study showing that income above $105,000 in North America paradoxically leads to diminished happiness. Anyone with high income faces the temptation to spend a big portion of their income. Say you gross $1M and net $600k per year. You save what feels like a respectable 20% of your net income: $120k, and spend $480k. After a number of years, you built a nice investment portfolio of $1M. You are still highly dependent on your income, and replacing such high income can be a big challenge. This can lead to unusually big stress. In addition, high income often comes with big responsibilities (CEO, business owner), putting extra pressure. To sustain $480k of spending from a stock portfolio that can handle sustainable 3% withdrawals, you would need to reach savings of $16M. Such a level of savings is not common, and probably a lot less common than spending of $480k per year.

If you are able to satisfy your basic needs (food, a place to sleep, basic clothes, etc.), and spend modestly relative to your savings, you are under a fraction of the financial pressures of many big spenders. You may think that their grass is greener, but it is brown compared to yours. Peace of mind, lesser dependency on work, and appreciation for the little things in life are worth a lot more than what big expenses can buy along with the stress involved. You are the source of envy of some very big spenders who realize that your grass is greener. Next time you see a big spender, you may replace feelings of envy with some compassion.

Quiz Answer:

Your friend told you about a business-class flight he took for a trip. Which of the following are most likely to be true.

  1. He values the pleasure of a business-class flight, and decided to spend on that. [The Correct Answer]
  2. He is wealthy.
  3. He lives in a fancy house.

Explanations:

  1. People often spend money on things they value.
  2. People usually spend money based on their income, even if their total wealth (savings/investments) is low.
  3. People usually spend big money on several categories, but not all.
Disclosures Including Backtested Performance Data

Do Rising U.S. Interest Rates Hurt Emerging Markets?

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Quiz!

Would you expect emerging markets investments to go up or down when interest rates go up in the US?

  1. Up.
  2. Down.

Do Rising U.S. Interest Rates Hurt Emerging Markets?

There is a widely held belief that when the US Fed (Federal Reserve) raises interest rates, emerging markets investments should decline.

Why do people expect emerging markets to get hurt when US rates go up?

  1. Stronger dollar: When US rates go up relative to rates in other countries, people can earn a higher rate on savings in the US. This would lead to money flowing from other countries to the US, which would strengthen the dollar.
  2. Higher borrowing costs for emerging markets: Many emerging markets companies borrow in dollars. If a Chinese company earns money in yuans and borrows in dollars, a stronger dollar would make the loan more expensive in yuans, hurting the company.

Reality is the opposite!

While the logic seems sound, reality in the past 20 years has been the opposite. The table below tracks the returns of ET (Extended-Term Component), a portfolio focused on emerging markets, in periods of rising and declining rates in the US:

Period Start

Period End

Change in US rates

ET Returns

12/31/1998

5/16/2000

+1.75%

+58%

5/16/2000

6/25/2003

-5.50%

-11%

6/25/2003

6/29/2006

+4.25%

+169%

6/29/2006

12/15/2015

-5.25%

+20%

12/15/2015

9/28/2018

+2.00%

+50%

Observations & notes:

  1. In all rising-rate periods, ET gained substantially.
  2. In declining-rate periods, ET had much worse results, with negative to low-positive returns.
  3. Market tops and bottoms didn’t coincide perfectly with the borders between the periods. Measured from the turning points in the portfolio, the results are substantially stronger.

Why do emerging markets go up when US interest rates go up, and vice versa?

The Fed reacts to the world economies when setting the interest rates. It focuses on the US, but considers the rest of the world as well. Specifically:

  1. When the economy shows signs of weakness after a period of expansion, the Fed lowers rates, to support the economy.
  2. When the economy turns around after a period of contraction, the Fed raises rates to moderate the expansion.

While I wouldn’t count on emerging markets to go up perfectly whenever US rates go up, the data is useful in avoiding expecting the opposite.

Quiz Answer:

Would you expect emerging markets investments to go up or down when interest rates go up in the US?

  1. Up. [The Correct Answer]
  2. Down.

Explanations: Read this month’s article for an explanation.

Disclosures Including Backtested Performance Data

How to Use Volatility to Make Money

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Quiz!

If you add annually to a portfolio that drops 50% in one year and recovers the next year, what penalty or benefit do you get when compared to a portfolio with the same returns (0%) and no volatility?

  1. -50%
  2. No impact.
  3. +50%

How to Use Volatility to Make Money

Investment volatility is the investment’s movements up and down away from its average growth. It is commonly viewed as a negative, but for a disciplined long-term saver, it is typically a positive. A hypothetical example can demonstrate it. Let’s compare 2 portfolios with identical returns, and different volatility:

Portfolio 1

Portfolio 2

Year 1

0%

-50%

Year 2

0%

100%

Average

0%

0%

If you start with $100, both portfolios will be worth $100 after 2 years. Specifically, Portfolio 2 will go through the following values: (Year 1) $100 – 50% = $50. (Year 2) $50 + 100% = $100. The portfolios have identical average growth, but Portfolio 2 is far more volatile.

Let’s see the final balance if you add $100 in the beginning of each year:

Portfolio 1

Portfolio 2

Year 1

($100 + 0%) = $100

($100 – 50%) = $50

Year 2

($100 + $100) + 0% = $200

($50 + $100) + 100% = $300

Even though both portfolios have the same average growth, when adding to both portfolios identical amounts each year, the more volatile portfolio ended up 50% higher ($300 vs. $200).

How is this possible? The percentage going back up is greater than the original percentage going down. When a portfolio recovers from a 50% decline it goes up 100%. This is because the percentage going up is relative to a lower starting amount. While old money simply recovers, new money that was invested low goes up $100 – double the -$50 impact of the decline.

Notes:

  1. Some investors lose faith in their portfolio after declines, and hold off on investing (or even sell). If you do that, you can negate the entire benefit of volatility and even hurt your returns.
  2. Even with discipline, there is a special case that can lead to a negative effect. The case involves no up period after a down period, for example, only up years followed by only down years. This is not a concern for disciplined lifelong investors, because such a sequence is limited to one cycle or less.

Quiz Answer:

If you add annually to a portfolio that drops 50% in one year and recovers the next year, what penalty or benefit do you get when compared to a portfolio with the same returns (0%) and no volatility?

  1. -50%
  2. No impact.
  3. +50% [The Correct Answer]

Explanation: See this month’s article for an analysis of this scenario.

Disclosures Including Backtested Performance Data

The Winners and Losers of Tariffs

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Quiz!

Who are the winners when a country increases taxes on imports (tariffs) from another country?

  1. The country taxing imports.
  2. The other county (the exporter).
  3. Neither country.
  4. Both countries.

The Winners and Losers of Tariffs

Tariffs hurt specialization across borders, limit global trade, and increase the costs to consumers – it’s a losing proposition for everyone involved. So, why would the US seek to increase tariffs? I believe that it is a negotiation tactic by the US, to try to reduce the trade imbalance with other countries (the US imports more than it exports). If I am correct, this can go on while each country involved figures out the extent of its power. I believe that once all the information is available and the negotiations are complete, any buildup in bilateral tariffs would be removed to everyone’s benefit.

Supporting my opinion is the fact that the world is very interconnected economically. Let’s view two big players in these negotiations: the US and China. I will point out several mutually beneficial connections in the table below.

Action

Benefit to the US

Benefit to China

The US imports from China a lot more than it exports

US consumers get cheaper products, thanks to cheaper labor in China.

China gets more buyers for their products

China loosely pegs the yuan (its currency) to the dollar. They get dollars from exports to the US, and buy US treasuries to keep the dollar’s value high enough relative to the yuan.

The US government gets cheap loans from China, to support its huge budget deficit. China is the largest lender to the US government.

By buying dollars, China keeps its currency low, to make its exports cheaper in dollars, and be more competitive.

Quiz Answer:

Who are the winners when a country increases taxes on imports (tariffs) from another country?

  1. The country taxing imports.
  2. The other county (the exporter).
  3. Neither country. [The Correct Answer]
  4. Both countries.
Disclosures Including Backtested Performance Data