by: Mary Elizabeth Guidry

The end of summer generally signals the hottest time of year, so what better way to beat the heat than with a good book and a cold drink? A genuine thirst for knowledge is part of RGT’s culture, and members of our Investment Team would like to share some of their favorite books with you. We’ve included books for those that love a good narrative, books for the analytically minded, and even something for the sports fans. Please enjoy.

 

The Most Important Thing, by Howard Marks is comprised of various letters Marks has written over the years. The letters provide insight into the famous investor’s strategy, as well as his views on markets and the overall economy. Value investor Warren Buffett has said of Marks, “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book.”

 

The Intelligent Investor: The Definitive Book on Value Investing, by Benjamin Graham has been a must-read book since it was first published in 1949.  As evident by its title, this book introduces value investing in a manner that transcends time.

 

Bulls, Bears, & Basketball: Financial Planning for College Hoops Fans, by Chuck Thoele is an RGT staple, and a must-read for college basketball fans. Published by one of our founders, the book presents financial planning in a relatable, easy to read manner.

 

Thinking, Fast and Slow, by Daniel Kahneman is an overview of Economist Daniel Kahneman and Psychologist Amos Tversky’s findings over their careers, based on behavioral science. The book provides several examples and explanations of their experiments and findings, along with more recent studies on happiness. This book is essential to an understanding of the science behind behavioral investing.

 

The Undoing Project, by Michael Lewis was published last winter and is about Kahneman and Tversky’s lives and careers. It touches on their history and explains their research and conclusions. While not as detailed as ‘Thinking, Fast and Slow,’ it is written in narrative form by a best-selling author.

 

Red Notice, by Bill Browder has elements of suspense, intrigue, finance, and Russian politics. Bill Browder is the co-founder and CEO of an investment firm that was once the largest foreign portfolio investor in Russia. The book is an unbelievable true story written like a crime thriller. You won’t want to put this one down.

 

Against the Gods, by Peter Bernstein describes the history of probability and risk management, from the early games of chance and probability theory to modern applications of risk management. While the book was written in the mid-90s and is dated to a certain extent, it still touches on the rise of derivatives in modern finance.

Devil Take the Hindmost: A History of Financial Speculation, by Edward Chancellor, paints a historical picture of how economic and psychological forces drive the desire to speculate. From the Tulip mania of the 1600’s to Long-Term Capital Management’s collapse in the late 1990’s, readers will see how bubbles are made, manipulated, and who wins when they pop.  

This list is not exhaustive, but ideally it gives readers some insight into what drives our thinking, and lets you know what we like to read. Please enjoy the remaining “dog days” and let us know if we can serve you in any way.

by: RGT Wealth Advisors

Approximately 77 percent of retirees now prefer to give money to loved ones throughout their retirement rather than leave inheritances in estates after they pass away according to a recent study.[i]

 

This post will explore the potential benefits and risks of gifting inheritances early, and help you determine if this could be the right strategy for you.

 

What are Some Benefits of Gifting Inheritances Early?

 

• Avoiding inheritance and death taxes. When it comes to estate planning, the tax code can be complicated. Currently, twenty-one states and the District of Columbia have a death tax, inheritance tax, or both.[ii] These taxes can greatly reduce any remaining assets loved ones inherit. The IRS currently allows gifts of up to $14,000 per person each year[iii] that are not taxable for either party. Because of these taxes and the ability to annually distribute monetary gifts, many are looking to distribute their wealth to loved ones early rather than leave inheritances in wills.
• Providing financial assistance when loved ones need it. Gifting to loved ones now allows you to help them when they need the money the most, as opposed to waiting until after a death. This often includes assisting with the purchase a new home, unexpected medical expenses or paying off school loans. The flexibility to assist loved ones financially often makes sense for some when compared to willing assets at a later date.

 

What are Some Risks of Gifting Inheritances Early?

 

• Ensuring enough money is left for retirement and unexpected expenses. People are living longer; thus, retirement savings are being stretched further. It is important to determine your retirement lifestyle goals and financial needs first, and then look at remaining resources for loved ones. You don’t want to put yourself in a situation where you are not able to cover your living expenses or unexpected medical costs because you gifted loved ones too much, too soon.
• Not gifting all loved ones equally. Some people may feel pressure regarding how to gift inheritances early rather than leave gifts in their wills, especially if gifted amounts vary. Distributing gifts of varying amounts to family members and loved ones has the potential to create unintended consequences and strain relationships. It will be important to consider your loved ones’ financial needs, and determine when monies will best benefit them.

 

Next Steps to Consider

 

Now that we’ve explored some of the benefits and risks to gifting inheritances early, here are some next steps to help in your decision making:

 

• Consult with an estate planner and tax expert before you determine if the benefits outweigh the risks for you. Relying on experts can help you explore other gifting options that still reap tax benefits, including trusts.
• Work with your RGT wealth advisor to determine how much you can afford to give loved ones now and how much you should allocate into your estate planning.

 

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[i] “Giving in Retirement: America’s Longevity Bonus.” Merrill Lynch and Age Wave. 2016. https://mlaem.fs.ml.com/content/dam/ML/Articles/pdf/ML_AgeWave_Giving_in_Retirement_Report.pdf.

[ii] Drenkard, Scott. “Does Your State Have an Estate or Inheritance Tax?” Tax Foundation. May 2015. https://taxfoundation.org/does-your-state-have-estate-or-inheritance-tax/.

[iii] “Frequently Asked Questions on Gift Taxes.” Internal Revenue Service. https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes.

by: Chris Rachfal, CFA, RGT Wealth Advisors

What are factors?

 

Over the last several years, investors have been inundated with attempts to re-brand factor investing – “smart beta,” “strategic beta,” “engineered equity,” “beta plus,” etc. While the list of marketing-driven buzzwords continues to expand, they are all largely synonymous with factor investing. They each refer to investment strategies focused on systematically gaining exposure to stocks (or bonds, currencies, commodities, etc.) with one or more characteristics that have been empirically shown to drive positive active returns – that is, returns over and above the cap-weighted market index.

 

The first, and most well-known factor discussed in academic literature is the market factor, which is generally defined as the excess return of the market over the risk-free rate. By increasing exposure to the market factor relative to Treasury bills, (i.e. taking additional, undiversifiable market risk), an investor is compensated with a higher expected return over an extended time horizon. Investors accept the risk of underperforming in the short run for the expectation of outperforming over the long run.

 

Unfortunately, in practice, exposure to the market factor alone does not fully explain the differences in returns between portfolios. To better understand what characteristics drive performance differentials between portfolios, academics began searching for and finding “pricing anomalies,” otherwise known as factors.

 

In addition to the market factor, the primary equity factors we focus on are:

 

• Size – small companies have tended to outperform large companies;
• Value – cheaper companies (in terms of a high book value or earnings relative to market value) have tended to outperform expensive companies;
• Momentum – companies that have recently performed well have tended to outperform companies that have recently performed poorly; and
• Quality – companies with high profit margins and strong balance sheets have tended to outperform companies with lower profits and weaker balance sheets.

 

Why do these factors add value? If they are widely known, why should we expect them to continue to add value?

 

The answer to these questions can typically be described as either “risk-based” or “behavioral” in nature. Risk-based explanations assert that factors have rewarded investors with excess returns because stocks that exhibit these characteristics are inherently riskier. Therefore, investors require a risk premium in return for owning them. For example, small companies tend to have smaller capital bases, higher leverage, increased default risk, etc. Value companies, on average, tend to be more exposed to the business cycle, carry more fixed assets, be more highly levered and tend to have a higher risk of distress than growth companies. Given these increased risks, it makes sense that investors would demand, on average, a risk premium (higher expected return) to invest in smaller companies over larger companies or value stocks over growth stocks.

 

Behavioral explanations assert that factor risk premiums do not exist solely due to increased risk, but rather due to a combination of risk factors and investor biases that hinder the market from correctly pricing these anomalies. For example, the momentum effect is typically supported by behavioral explanations. One version, put forth by Toby Moskowitz, asserts that information travels slowly into prices¹. He argues that prices do not immediately adjust to news but tend to drift upwards (or downwards) as the market processes the good (or bad) news – this is underreaction. Somewhat counterintuitively, Moskowitz also finds that overreaction also plays a part as investors chase the newly created trend and can push prices farther from equilibrium, introducing a short to intermediate term momentum effect. Quality is also likely a behavioral anomaly; after all, who would rationally require high quality stocks to generate a risk premium over low quality stocks? Research by Ryan Liu suggests it is related to investor expectations². Investors are willing to make contrarian bets on low quality companies at the expense of high quality companies. This behavior has the effect of increasing the prices (and therefore driving down expected returns) of low quality firms at the expense of high quality firms, while also increasing expected returns of high quality companies.

 

All five factors mentioned have risk-based or behavioral explanations that support each factor’s existence, and often more than one of each. What is important to know and remember is that no one can be certain which, if any, hypothesis is correct about why a certain factor works or has worked. We cannot prove why a factor works, but by utilizing a rigorous and analytical framework we may be able to assess whether a factor is real and whether it can be expected to continue to exist in the future.

 

Researchers and practitioners Larry Swedroe and Andrew Berkin propose such a framework below, requiring that any factor pass the following five-part test³. They stipulate that for an anomaly to be considered a true factor and not just noise, it must be:

 

• Persistent – it must generate excess returns over long periods of time and across market regimes
• Pervasive – it must be present across different asset classes and geographies
• Robust – it must continue to “work” despite tweaking the definition of the factor
• Investable – the excess returns must be large enough to still add value after frictions such as trading costs are accounted for
• Intuitive – it must have a logical underpinning (risk-based or behavioral) that supports a risk premium being associated with it and that also supports its efficacy in the future

 

So, is Factor Investing Easy?

 

Unfortunately, no. Even the factors with the strongest historical returns have the potential to significantly trail the market over long stretches – think Value stocks during the tech boom in the late 1990’s. Even more recently, Value stocks were trounced by the broad market in 2015 and early 2016.  Experiencing a massive drawdown or trailing an index by double digits is painful – but potential for such short-term pain is also why factors tend to add value over long time horizons. If something works all the time, there would be no risk premium associated with it. Thus, patience is a prerequisite for harvesting a factor’s excess returns.  It is also why diversifying across factors is an important component of a sensible factor strategy. Value and Momentum, for example, have historically displayed a low correlation to each other. When Value tends to be out of favor, Momentum tends to be in favor and can offset losses in the Value portfolio, and vice versa. Similarly, Quality can augment Value and Size, helping to screen out the lowest quality companies most likely to be “value traps.” By diversifying across factors, we can dampen the volatility of the portfolio while reducing the risk of any one factor having an outsized impact on the portfolio.

 

Factor investing is no free lunch. It requires conviction, patience, discipline, the willingness to be out of step with the broad market, and a long-time horizon. Note that these are many of the same characteristics required to be successful in virtually every other area of investing, as well.

 

Summary

 

• Factors are characteristics of stocks or stock portfolios that have been shown to drive positive excess returns over time
• Factor investing seeks to harvest excess returns by owning stocks that display these characteristics and by avoiding stocks that display the opposite characteristics
  • Size
  • Value
  • Momentum
  • Quality
• Factor risk premiums exist due to some combination of increased risk, behavioral biases, or structural inefficiencies in the market
• We can avoid mistaking randomness for a factor that deserves a risk premium by making sure the factors we utilize are persistent, pervasive, robust, investable, and intuitive
• Factor investing is hard; it does not work all the time and individual factors can sometimes trail the broad market significantly. It requires conviction and patience.
• Factor diversification can reduce volatility but not eliminate it.

 

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1. Moskowitz, Tobias J., “Explanations for the Momentum Premium,” AQR Capital Management White Paper, 2010
2. Liu, Ryan, “Profitability Premium: Risk or Mispricing?” November 2015. https://pdfs.semanticscholar.org/94f3/bb0d05a8fe349d3ca378bbe52e1f9ac72831.pdf
3. Berkin, Andrew L. and Larry E. Swedroe. Your Complete Guide to Factor-Based Investing. Saint Louis: BAM Alliance Press, 2016. Print.

by: RGT Wealth Advisors

Wealth management firm makes list for third year

 

DALLAS – The Dallas-based financial planning and investment advisory firm, RGT Wealth Advisors (“RGT”), has been named to the Dallas Business Journal’s Best Places to Work list for the third consecutive year.

 

“Our primary focus is to be champions of our clients’ financial goals and futures, and that all starts internally with our employees and our culture,” said RGT Managing Director Mark Griege. “We work hard to ensure that we are advocates for our employees, and are very pleased to see that they and others in the community recognize that.”

 

RGT was one of the companies selected from among more than 500 North Texas businesses by a third-party research firm that reviewed applications. Finalists were chosen based on employee survey feedback. RGT was ranked in the medium category for organizations with 50-249 employees.

 

The firm was recently recognized among the top 10 registered investment advisory firms in the nation by Financial Planning Magazine and has repeatedly been ranked among the top wealth managers in Dallas by D Magazine.

 

 

Founded in 1985, RGT is an independent, fee-only firm that provides wealth advisory services, portfolio management and family offices services. Clients partner with RGT to manage their financial life and keep them on track to achieve their goals. To learn more about RGT Wealth Advisors and the firm’s approach, please visit their website at: https://rgtadvisors.com/.

by: Greg Bone, Managing Director, RGT Wealth Advisors

For Investors it’s Important to Know the Difference Between Scary and Dangerous

 

An annual rite of late spring/early summer is the outpouring of articles written by someone with “life experience” (i.e., someone, like me, whose youth is solidly in their rear view mirror) aimed at recent graduates and young adults. These articles, often transcripts of commencement speeches, are a noble attempt to impart a bit of hard-earned wisdom to those just starting out on their life’s journey.  Last May, the Wall Street Journal published an article titled “A Dad’s-Eye View of Scary vs. Dangerous” written by Jim Koch, the founder of the Boston Beer Co. (brewer of Samuel Adams), which fit neatly into this mold. In the article Mr. Koch wrote that it is important for both parents and children to learn the difference between taking risks that are scary, but worthwhile, and risks that are dangerous. While this article is focused more on making big life decisions, it struck me while reading it that this way of looking at the world has some real application for investors as well.

 

It seems worthwhile to spend some time pondering issues that often make investors anxious or concerned and asking the question; is this simply scary or is it truly dangerous?

 

Rebalancing

 

The idea of selling an investment that has gone up in value and using the proceeds to buy an investment that has gone down in value is often a scary one for investors. Investors often state that they want to buy more of the mutual fund or invest more in the asset class that has gone up. And it’s often difficult to get them to invest in mutual funds or asset classes that have suffered from recent poor performance. However, if there is a sound and well thought out investment plan in place, this sort of rebalancing enforces the discipline of buying when prices are low (after poor performance) and selling when prices are high (after strong performance). Over time a disciplined approach to rebalancing a portfolio will provide a better result for investors. So disciplined rebalancing is sometimes scary, but definitely worthwhile. Failure to rebalance effectively can actually be dangerous, as it may result in a portfolio that is inappropriate relative to the investors’ long-term goals, objectives and risk tolerance.

 

Investment Selection

 

Selecting the appropriate investment vehicles with which to execute an investment plan is an important part of effective asset management. Oftentimes these decisions are difficult to make. If a manager or fund has performed well recently will it continue to be a good selection in the future? If it has a recent record of poor performance does that imply that it is a poor choice? Even though relying on an investment manager’s track record may provide a sense of comfort, overreliance on performance, particularly recent and short-term performance, in making investment decisions can be very dangerous for investors (hence the well-known disclaimer that past performance is not an indicator of future results). However, utilizing a more comprehensive approach to due diligence which focuses on an investment manager’s process, their people, operational effectiveness, compliance history, investment merits of their approach, and the consistent application of all of these variables over time should lead to better decisions.  And sometimes these decisions may be scary, such as the decision to stick with an underperforming manager or investment when recent performance has been bad due to adverse market conditions despite the manager’s continued adherence to their investment mandate. The decision to sell an investment despite strong recent performance due to personnel changes at the manager level or asset bloat inside a mutual fund may cause fear of regret and compromise the decision making process. Having a disciplined investment selection process with a long-term perspective can be quite scary, but it is the appropriate approach to making investment decisions.

 

Transparency

 

It should be apparent that a lack of transparency is not just scary, but also dangerous. The idea of transparency should apply to many facets of the portfolio. Investors should know what they own and they should understand the risks of their investments. They should also know what fees they are being charged and have a full understanding of how their advisors and portfolio managers are compensated. All potential conflicts of interest should be disclosed upfront by investment advisors. There should be transparency around the liquidity provisions of all investments. And investment performance should be reported in a clear and timely manner. The investment industry, like all industries, is rife with insider language and jargon. This can often be confusing, and scary, and will sometimes require an explanation. But if your investment advisor is not willing to take the time to answer your questions, clarify confusing terms, and provide clear and concise answers to your questions, then you should begin to question their commitment to providing adequate transparency.

 

Leverage

 

Most of us know that a modest amount of debt, artfully applied, can be a useful financial tool.  Using an appropriately sized mortgage with manageable payments make the home buying process much better for everyone. The same can be true for the use of debt on a company’s balance sheet. A thoughtful approach to capital structure can help companies grow and help them manage the uneven cash flows that most businesses face as they move through the business cycle. However, an improper use of leverage can become dangerous and scary for investors. Sometimes this leverage is apparent, as when margin is used on investment or brokerage accounts. Other times excessive levels of leverage can sneak into portfolios in more subtle ways. This can occur within investments that have inadequate levels of transparency, such as with hedge funds that use excessive leverage to boost returns on “hedged” arbitrage trades. It can also occur with real estate investments that use aggressive amounts of leverage, particularly if that leverage is based on inflated property values.

 

The News

 

In today’s oversaturated world of the 24-hour news cycle being beamed to us constantly across multiple media platforms, the “News” is probably the scariest thing investors face today. This is only compounded when investment markets react quickly and violently to a news event. There are many examples of this overreaction every year. A great example from 2016 would be Brexit, Great Britain’s unexpected decision to leave the European Union. Markets across the world reacted negatively to the news. While Brexit may indeed have long long-term economic consequences, the long-term implications of Brexit will have far more of an impact on UK citizens than US investors. Given that well diversified portfolios are not dominated by investments that will be directly and adversely impacted by Brexit, these events seem to fall more into the scary category than the dangerous category.

 

We can think back to events like the “Taper Tantrum” or the “Flash Crash” to see markets that react violently and quickly but ultimately rebound in fairly short order. We should acknowledge that when big events lead to market corrections it is definitely scary. Anytime there are wild swings in markets over short periods of time investors should take the time to assess exactly how dangerous these swings are to the long term health of their portfolio.

 

The ability to distinguish the dangerous from the merely scary is a valuable skill for investors to have. Developing a well thought out investment plan will help will help provide perspective and hopefully lend some perspective to help you determine if something is truly dangerous, or merely scary. And having a trusted financial advisor with whom you can discuss these issues will provide even more help working through difficult market environments. Using these steps to distinguish between the scary and the dangerous should help you make more informed decisions and will hopefully will lead to better long-term financial results.