Kudos to Generation Y

What interest rate are you earning on your savings account? The fact that today’s bank savings accounts generate virtually no yield certainly makes it tougher to convince younger generations to save for retirement. Yet, while you might expect that low interest rates and, therefore, lower compound growth over time, would result in even more young Americans spending rather than saving, a recent TD Ameritrade survey found the reverse to be true. The survey found that Generation Y (teens and twenty-somethings) are more dedicated to saving than their parents and grandparents.

Specifically, the survey reported that 25% of Generation Y and 23% of Generation X who are in their 30s and 40s are saving in their 401(k) plans. This compares to just 16% of Baby Boomers. Generation Y can do better, however, by investing in appropriately diversified portfolios of stock and bonds. Somewhat surprisingly, the survey found that 40% of Generation Y will “never” invest in stocks.

The survey also illuminated another area for improvement. Although the vast majority of Boomers expressed worries about reaching their retirement goals, more than two thirds of those over age 50 (68%) did not take advantage of the catch up contribution provision to their employer-sponsored retirement plan that would have allowed them to sock away another $5,500 last year.

Working with a trusted financial advisor can ensure that you create a fully diversified portfolio that can minimize market volatility and take advantage of all opportunities to save for your short- and long-term goals.

Hedge Funds: A Luxury Nobody Can Afford

I recently read a piece by Jim Parker, a Vice President at Dimensional Fund Advisors, entitled “Hedge of Darkness.” Parker notes, “Big money can be made from hedge funds. If you run one, that is.” Parker goes on to offer some amazingly compelling statistics from The Hedge Fund Mirage: The Illusion of Big Money and Why It's Too Good to be True by Simon Lack, an asset manager who once chose hedge funds for JPMorgan.

For example, Lack begins his book with the statement, “If all the money that’s ever been invested in hedge funds had been put in treasury bills instead, the results would have been twice as good.” Other potential surprises noted by Lack: The 18% return on hedge funds in the nine years to November 2011 was easily beaten by the total 29% gain from the S&P 500 index. The gap was even more pronounced for investment grade corporate bonds, which in the same period gained 77%, as measured by the Dow Jones Corporate bond index.

Of course, I’d emphasize Lack’s point that the underperformance of hedge funds over this period is even greater once the 2% management fee and 20% performance fees charged by hedge fund managers are factored in. In fact, Lack estimates that from 1998 to 2010, the hedge fund industry captured at least 86% of the returns it earned for its customers. So while hedge fund managers amassed great fortunes, their investors earned subpar returns.

In addition to the high fees that eat into returns, poor disclosure, complex legal structures, and the great number of fraud cases contribute to hedge fund’s risk/reward ratio being way out of whack. Pull the lavish curtain aside and what’s advertised like an exclusive five-star resort often turns out to be a dumpy roadside motel.

Are You Wearing Blinders?

You’ve probably heard a family member or a colleague complain about someone who “hears only what he wants to hear.” While being wedded to one’s opinions and ignoring new, relevant information is human nature, this trait can seriously jeopardize investment decisions. In fact, in the world of behavioral finance, ignoring information that could challenge an opinion you already hold has a name--confirmation bias. When we selectively filter information and focus only on data that supports our current opinions, we lose perspective and are prone to make poor investment decisions. In fact, studies show that even professional fund managers are more likely to accept information that supports their original investment thesis than they are to search for information that contradicts their views.

How does confirmation bias affect your decision making? Think of times a stock you purchased fell in value, yet you remained convinced of its long-term viability. How long did you hang on, expecting it to recover, before you cut your losses? Consider, too, how many investors believe they should only invest in dividend paying stocks. When they see a magazine headline promoting the benefits of dividends, they buy the magazine and read the article to support what they believe. Because they don’t consider the fact that many of today’s dividend paying stocks were not dividend payers earlier because of their startup nature is absent from their decision making process. They don’t consider that selecting only dividend paying stocks over the last few decades would have deprived their portfolios of the returns of companies like Cisco, Kohl’s Oracle, St. Jude Medical, and Starbucks in their early days. Take these factors into consideration and it’s likely an investor will embrace a broadly diversified strategy that includes both dividend payers and non-dividend payers and enjoy the potential rewards of both.

As Benjamin Graham said, “The investor's chief problem--and even his worst enemy--is likely to be himself.” So, be mindful of your behavioral tendencies and keep an open mind. Increased self-awareness can lead directly to better investment decisions.

Some Perspective on Living with Market Volatility

“O, woe is me, to have seen what I have seen, see what I see!” This quote from William Shakespeare’s Hamlet has particular relevance today as the prolonged uncertainty of the world’s financial markets has induced a kind of “end of the world” mentality. Many believe they are shouldering difficulties unprecedented in modern history. Yet, without discounting the anxiety generated by the Great Recession and the current Eurozone crisis, a look back on the 20th century puts these seemingly insurmountable current events in perspective.

Reflect on some of the experiences of our grandparents and parents. Nearly 100 years ago, Europe was embroiled in World War I and dealing with widespread rationing, labor shortages, and massive government borrowing. Just over a decade later, the Great Depression cut a swath through the global economy. Yet, these economic challeneges were overcome even though a century ago in the United States the average life expectancy for men was 47 years, only 8 percent of homes had a telephone, and there were only 8,000 cars and only 144 miles of paved roads.

Certainly, the current financial crisis tops off a decade of significant world tragedies -- among them, the attacks of 9/11, the 2004 Asian tsunami, and the 2011 Japanese earthquake, tsunami, and nuclear crisis. Yet, remember that during World War II, more than 50 million died, most of Europe's infrastructure was destroyed, millions of people were homeless, and rationing was prevalent.

As the US and Europe continue to grapple with tough economic conditions, we need to keep in mind that much of the developing world is experiencing rising levels of education, health, and employment. All that -- coupled with the fortitude and resourcefulness that enabled our ancestors to overcome economic difficulties -- bodes well for a stronger global economy.