A Rising Tide Lifts All Boats…(But It Doesn't Mean They Are All Seaworthy!)

We have all heard the saying. There is some truth to the idea that when the economy is doing very well most of the people benefit in some way to some degree. This doesn't mean that all people benefit equally or even proportionately. Even when things are going very well there are bumps in the road or waves on the ocean. We need to remember that if the economy is doing well it indicates that the country as a whole is doing well based on averages. Anytime you average any numbers, you’ll come up with an average for the set but it will also have a median. Averages can be misleading; the median tells you that half the numbers are lower and the other half of the numbers are higher. The median acts as your center point or your balancing point. Why is this important?

It is important because if you only look at averages you will be missing a great deal of the statistical information that is available to you no matter what the subject matter is. You could be researching investments or you could be researching Fantasy Football or Fantasy Baseball players. Let’s say a baseball player had a batting average of .302 the previous season. Most people would say he hit 302 but it is actually .302 which represents the average of all his visits to the plate. If he steps in the batter’s box 1,000 times he’ll get 302 hits. Let’s make this simpler and say for every 10 at-bats he’ll get about 3 hits. Here’s a very important question: Can you deduce from this batting average that this ballplayer will get a hit for each of his next 3-at-bats if he has not had a hit his last 7 trips to the plate? No!

Where are we going with this? If the S&P 500 Index has gone up an average of 14% in the previous 20 years does this mean it will go up about 14% this year or next year? No! We put too much emphasis on the average and we don’t look deeper. There are 500 stocks in the S&P 500 Index. If the Index climbs 14% in one year does this mean that every individual stock in the index climbed exactly 14%? No! One stock might have risen 80%, another 40%, another 10%, and another 1% while several others could have had negative returns yet the index climbed an “average” of 14%. Would you rather invest in the index and take the average of 14% or would you rather invest in the individual stocks that returned 80% and 40%? What about when the index is negative? Does this mean every individual stock had a negative return in that year? No! Would you want to invest in the index knowing it would return a negative average for the year?

The best investments are those which can stand on their own no matter what the overall economy is doing, and no matter if the tide is going in or out. Over time I have slowly shifted my thinking away from indexes and geographical investments. I learned the hard way that just because there were compelling reasons why the Brazilian economy should perform strongly the last few years leading up to the Olympics and World Cup, it doesn’t mean that a Brazilian ETF will realize a great return. China may have a bright future but it doesn’t mean you should invest in an ETF that invests solely in China. It would be wiser to invest in individual solid companies which would benefit from a more successful Chinese economy.

You might believe that a collection might be a wise long-term investment; there are many physical items that you could choose to collect such as cars, coins, stamps, paintings, sculptures, etc. Would a Yugo command the same return over time as a Ferrari? No chance! So you would invest in a “collection” or “index” of cars if you knew they could own Yugos, AMC Pacers and Pontiac Azteks? Research is key to making sound decisions no matter the subject matter. Asking the right questions and seeking the necessary information is critical to success. The next time you hear or read that this is the perfect time to make some investment ask yourself all the prerequisite questions. If investing were so easy we would all own some index funds and there would be no advisers, wealth managers or hedge fund managers.

Loss Leaders Are Not Only Found in Your Supermarket or Big Box Store

I'm sure you have seen all the discount brokerage ads on television, in magazines and journals...heard the radio ads...and read them on the Internet, on your tablet and on your mobile device.

Each one promising a lower cost per trade than the next. Think about it. Can any brokerage company, whether it's exclusively online or if it has physical locations, survive with the revenue from trades that are priced at $3.95, $4.95 or $7.95? Do you think it's possible for any brokerage company to survive and prosper from selling their trading services for a fee that is lower than what Starbucks and your local ice cream shops sells their products for?

Obviously discount brokerage firms need to supplement the very low trading fee with other revenue. It's like a loss leader in a retail store. A supermarket will advertise a popular item at a very low price to get you in the store. It is their hope that you not only buy the sale item but that you buy many other items at full price, since you are there already. We shop this way and we are used to it. The supermarkets know this. They aren't looking at the profit they make on the sale items but the profit they make on all the items being sold each day or week.

I'm sure you have read the fine print. Don't you think the discount brokerage firm, or any trading firm, has a list of charges for anything else that you may need? Don't you think they plan on making money on your cash while it's sitting there waiting to be invested? Of course in this low interest rate environment making money on idle cash isn't as profitable as it used to be. The low trading ticket charge usually applies to buying and selling stocks or ETFs. What about mutual funds? Is there a "preferred" list from which you can trade without any fees? Why would there be a preferred list? Because the brokerage firm must make money on that list of funds in some other way in order not to charge you any trading fees. Otherwise they would not need a preferred list at all. Compare the expenses for each share class...you'll be shocked when you read the numbers.

Cost is always important. What is much more important is the bottom line. In working with our clients, we strive to use the lowest cost share class available. We don't only consider cost. It doesn't matter how low the trading fee is if you lose money on the trade. Then again, if you make money on the trade, you probably aren't as concerned about the trading fee. The trading expenses should always be considered but they shouldn't overshadow the investment goal. The main point here is that costs are important but the main overriding concern should be to invest in the lowest cost share class of whatever fund or security is appropriate for your situation. When dealing with individual stocks, the purchase price and the selling price are much more critical to your overall portfolio success than the ticket charge.