Kara Smith has worked in human resources for seventeen years. She’s currently HR director for a government contractor in Alexandria, Va., operating in what she says “isn’t the most stable of industries.” Whatever financial stability she’s to have in life she needs to provide for herself.
This could be why she’s obsessed with the performance of her investment portfolio. She told me, “I check the markets regularly throughout the day via the TradeKing app and reading Yahoo Finance over lunch. I also check my net worth on the Mint app a few times a day. I work in corporate America where I have my phone with me all the time. I am regularly checking the markets throughout the day when my attention should be focused on my job.”
She feels overwhelmed by experts and ideas. “I’ve had years where I’ve done well and years where I haven’t — I’d really like some peace of mind. I belong to an investment club where we meet weekly. There’s about thirty of us, and every week thirty different stock picks and way more opinions. Basically, it wears me out listening to all the tips and making adjustments all the time to my accounts.”
She remembers visiting her family in Atlanta four years ago for Christmas, and buying shares of Apple on that trip. The stock rose from a split-adjusted $46 on December 20, 2010 to $100 on September 17, 2012. During Apple’s strong phase, Kara was so excited to see it growing that she moved her entire TradeKing account balance into it. Then, it crashed to $73 by Christmas Eve 2012. She remembers, “I was in a very foul mood and totally distracted during the holiday. I isolated myself from the family so that I could research and come up with an idea of what to do when the markets re-opened.”
She thinks her panic that Christmas is what ramped up her market involvement to a level she describes as “almost day trading.” She didn’t want to hold anything and see it go down again. “Since then, I’ve been selling as soon as there is a profit.”
The problem with that approach is that it keeps her sidelined during big recoveries that often follow big crashes. For example, after falling 44 percent from $100 in September 2012 to $56 in April 2013, Apple stock embarked on a 132 percent recovery to a recent high of $130. Most investing plans that advise selling to avoid price weakness end up leaving too much capital on the sidelines, missing out on what is the stock market’s historical tendency to go up. Once a person is harmed by a crash, they become overly cautious and end up crimping future gains, and find themselves obsessed with the need to control their portfolio, as Kara discovered.
Ironically, “taking control” of one’s portfolio generally spins it out of control because we’re bad at knowing what moves to make based on the headlines of the moment. In Apple’s strong recovery over the past two years, for instance, there were reasons to feel cautious along the path higher. The stock fell 10 percent in the month following Christmas 2013, and Societe Generale downgraded it. The stock fell 11 percent from last Thanksgiving to the middle of January, and Mizuho Securities downgraded it. Beyond Apple itself were general market concerns: interest rates poised to rise, trouble in the eurozone, and worries by some analysts that stocks were overvalued because of the Federal Reserve’s easy money policies.
This is always the backdrop in markets, and it’s caused stress in Kara’s life. “I enjoy researching and investing,” she says, “but never really intended to trade so frequently. It seems I always read or hear something that makes me want to sell what I have and buy something else.”
Kara is looking to reduce the frenetic pace and stress of the current way she’s managing her portfolio. She told me she would never pay fees to someone when it comes to managing her money. “I want to be in control and educated about where my money goes,” she says. Finally, she wants to consolidate what she feels has become “quite a hodgepodge” of holdings across various accounts, including a 401(k), a traditional rollover IRA, a Roth IRA, and two taxable accounts. In addition to several individual stock holdings including Allstate, Disney, and Microsoft, she owns the following mutual funds, all highly rated by Morningstar: Hodges Small Cap (HDPSX), Lazard Global Listed Infrastructure (GLFOX), and Villere Balanced (VILLX).
She’s hoping The 3% Signal can accomplish her goals, and it can. For starters, its use of just two funds will simplify Kara’s portfolio. The two funds used by the plan should be the cheapest small-cap stock index fund and cheapest general market bond index fund available in her accounts, for example, iShares Core S&P Small-Cap (IJR) and Vanguard Total Bond Market (BND). Compare their expense ratios (%) with the three mutual funds from Kara’s portfolio:
The average expense ratio of Kara’s three funds is 1.18%. Right off the bat, she’s saving a considerable amount of money in reducing expenses by 88% to IJR’s low ratio and 94% to BND’s. Next, consider performance. Here’s how the four non-bond funds performed (%) in the past one, two, and five years , not counting dividends:
5.9 | 33.0 | 95.9 IJR
-4.5 | 7.9 | 65.1 VILLX
6.4 | 25.1 | 48.7 GLFOX
5.3 | 31.5 | 118.4 HDPSX
Two of the three funds have not been competitive with IJR. HDPSX has been, which is impressive. Most actively managed funds fare worse against the index, so hats off to the Hodges team. However, history suggests the fund is unlikely to maintain its current five-year outperformance against the small-cap index, even in raw terms but certainly in expense-adjusted terms. If Kara wants to continue paying handsomely to bet that Hodges Small Cap will overcome what dooms most active management in the long run, she could run her 3Sig plan with HDPSX in place of IJR, but I would recommend switching entirely to IJR and BND.
The 3Sig plan will shield Kara from the stress of investing indecision and free up her time to focus on work and her personal life. I suggest that she also disconnect apps and other tools that introduce market noise into her days. The 3Sig plan is built to thrive on market fluctuation, so there’s no need to monitor her portfolio for the right times to buy and sell. There will be no emergency moves to make. The plan shows what to do at the end of every quarter with clear buy and sell signals between the only two funds it needs.
“This is going to be a big relief,” she says. “I’m going to let the markets wander wherever they want to go and just make profitable moves once a quarter. No more obsessing!”
Look insideThe Kelly Letter
“Strong job growth and falling unemployment, despite still-slow GDP, suggest that Fed hikes are on the horizon and likely strengthen the dollar further. We see risk of a near-term 5 to 9 percent dip.”
— Excerpt contributed by Jason Kelly
Z-val definition and more forecasts in The Z-val Zone.
“Valuations are reasonable now. They’re not low anymore. We’re at a level where we’ll still make new highs, but there will be a lot more volatility on the path higher.”
– Excerpt contributed by Chad Berger
“The reason I’m not bearish is that interest rates are so low and even with the Fed maybe tightening in June, maybe September, they are going to remain well below their average for many, many years, and that’s a very, very important consideration — valuation of the market. …
“I would not just look at the historical P/E and say, ‘Oh, wow, the market is overvalued.’ You must value stocks, in fact all assets, relative to interest rates and what else is available in the financial markets. …
“I would not advocate to start tilting away from stocks and moving into alternative assets. I don’t see any there that I find more attractive than stocks at the current time. …
“I mentioned at the end of last year that, although I thought 2015 was going to be good, I certainly wouldn’t be surprised to see a correction … it’s almost impossible to be certain about when a correction is going to happen and I’m still bullish long-run.”
“We’re within 10 percent of what I consider ‘fair market value’ … Could there be a correction? We haven’t had a correction in so many years. Most certainly. … I certainly would not be surprised to see a correction in the next three months that brings the market down maybe 5 percent to 10 percent.”