Keep Your Eyes on the Prize

Why are you investing? What do you want?

Someday....someday I'm going to buy a BIG sailboat.

Someday....someday I'm going to buy a BIG sailboat.

When I was 12 years old my Dad taught me a very important life lesson while he was teaching me how to mow the lawn. "Keep your eyes locked on where you want to end up and that's where you'll go." he said. And while he was teaching me how to make nice straight lines as I mowed the lawn the lesson translates to many other areas of life.

So where do you want to end up?

When I first started Course Pilot Financial I was really surprised by how many new clients would shrug their shoulders and say something like "I don't know, I haven't really thought much about retirement" during our first meeting. Retirement is a big deal! It's likely the single biggest financial goal category you have and yet my experience shows that many people are just meandering toward it with very little vision or passion about the life they will have during the 20 to 30 years they will live after work. 

Most people have a general idea of when they would like to retire (usually 65ish) but beyond that it gets cloudy real quick. Having a clear vision of what you want is incredibly important to your investment plan. How can we know if you are on the right track if we have no idea what you are aiming for?

Asking the right questions.

When do you want to retire is only the beginning. Let's explore that in a little more depth:

  • What type of lifestyle would you like to live in retirement?
  • Where would you like to live?
  • Are you planning to travel a lot? Where would you like to go?
  • Are you going to buy a sports car? How about a boat?
  • Will you be more active with your charitable endeavors?
  • What about the grandkids?

Can you see how the answers to questions like these might help us paint a better picture and construct a better plan?  

Develop your vision and focus

Every year I go to the Newport Boat Show with my family. I love boating and look forward to the day when our kids are old enough for sailing. So, even though I am not in the market for a boat yet, and won't be for another few years, I find going to the boat show helps me keep my dream at the top of my mind.

It's one thing to dream about "someday owning a boat" and another to go out and experience it. Doing so allows you to gain a deeper insight into why you want the things you want or experiences you want to have. You can research how much things cost, what options are available and put a plan together for achieving it.

Sure, our job as your advisory firm is to manage your assets and offer you relevant guidance but you play a big part too. It's your vision, your passion and your desire to experience life to the fullest that drives everything we do. That's not just marketing speak, that's a fundamental truth.

Stay on target.

Unlike mowing the lawn, life is not a straight line. As we have seen over the past decade markets can be extremely volatile. You yourself have most likely changed over the past 10 years as well. Can you think of things that interest you now that weren't even on your radar years ago?

Every review I have with a client starts the same way "Here is the likelihood that you will successfully achieve the goals stated in your plan. Are these still your most important goals?" There may be several quarters in a row where nothing changes but by keeping your goals front and center we can make sure we don't stray too far off target.

How do you stay on target? Have you developed techniques for making sure your plan reflects what you value most? 


Real Inflation vs Personal Inflation

Do you remember when a gallon of gas cost about a dollar?

What's the lowest price you remember paying for gas?

What's the lowest price you remember paying for gas?


Or when a family of four could go to a Red Sox game for less than hundred dollars? Ah! Those were the days.

Prices going up over time is a simple fact of life that we have all come to accept. We grow up hearing our grandparents regaling us with tales of their youth when a loaf of bread only cost a nickel. And of course I expect we will be wowing our grandkids in 2040 with stories of how cheap stuff was in the olden days too. 

When we find ourselves waxing nostalgically about the low prices of yesteryear we are thinking about real inflation. The most common statistic used to track real inflation is the Consumer Price Index (CPI) which tracks the price of a "representative basket of goods and services" over time. This is the number you hear on the news. It is also the number we use in our financial plans to ensure we adjust your future spending needs appropriately.

When the CPI goes up from one period to the next it is called inflation and when it goes down it is called deflation.

Why do prices go up?

Prices go up over time for a few reasons: 

  • The good or service becomes more scarce. If the supply dwindles but demand stays high prices go up. Oil is a great example of a scarce resource. 
  • Demand increases but supply doesn't. There are only so many seats at Fenway Park and more people want to buy tickets than there are seats available. Expect the Red Sox to keep raising prices.
  • The cost of providing the good or service becomes more expensive. Raw materials and labor are themselves scarce resources. Workers need to buy gas to drive to work and they want to take their kids to the Red Sox game on the weekend, both of those things are more expensive than they used to be. Cost of living increases in normal economic environments are fairly commonplace and almost always passed on to the consumer.

Do you remember when most households had only one television?


Do you remember life before cell phones, iPods and WiFi networks in the home? I remember when we got our microwave, dishwasher, VCR, cable TV, and I even remember when we got our first push button phone. Life was different then wasn't it?

I still remember my Great Grandmother telling me the story of the first time she saw an automobile. Can you even imagine how amazing it must have been for her to see how the lifestyles of average people improved over the course of her lifetime? The minimum standard of living in the poorest of homes in America today is likely well beyond her wildest girlhood dreams.

This phenomenon is called personal inflation.

Most of us lived for years without many of the things we now see as necessities in our lives. My children for example will never know a world without air conditioning, yet I didn't have A/C until I got married. And this expectation of an air conditioned world will require them to consume more electricity in their lifetime than I will in mine.

Technological advancements and increased comfort are wonderful things. You won't see me going back to window fans anytime soon. But understanding the controllable nature of personal inflation is just as important to your financial future as the realization that real inflation will eat away at your purchasing power if you fail to account for it.

It is also important to recognize that personal inflation and real inflation are linked. As our minimum standard of living increases so will our required wage to support that living increase. The higher wage requirement will drive up the costs of the standard basket of goods and services we produce which will in turn increase the cost of the goods we consume.

One way to tilt the odds in your favor in this cycle is to be more cognizant of both your personal inflation and your consumption of scarce resources. In this way you can take advantage of the increased wages that will come with time while avoiding potential cost expansion for items that may not provide you with true value in your life.

What do you think? Are you paying more attention to personal inflation these days? What are some products or services that fall into the personal inflation category that you simply can't live without? 

Index Investing is Upwardly Biased

The odds are always stacked in the house's favor. Luckily, you own the house.

If the last decade hasn't tested your belief in the old axiom that "the stock market is a great long-term investment" I am not sure what will. It seems like every time the markets get any momentum behind them something comes along and yanks the rug out from under them and down they go. However, believe it or not this is a good thing for the future. Let me explain why.

S&P Chart.png

S&P 500 Closing Values

Stock market indices like the S&P 500, exhibited above, almost by definition must go up over time.

Why? Because they are structured with a bias to do so. Actually, there two biases at work here that make an upward trend over time a virtual certainty:

  1. Selection Bias - The S&P 500 and the Dow Jones Industrial Average both are selective indexes. This means that they track only a select number of companies. For the S&P it is the "500 leading companies in leading industries of the U.S. economy" whereas the Dow tracks 30 companies that Dow Jones believes "to provide a clear, straightforward view of the stock market and, by extension, the U.S. economy." So what happens when one of the companies included in either of these indexes starts to perform poorly? Or what happens when a company like Google bursts on the scene? You got it, out with the junk and in with the good stuff. As you might imagine investors prefer to put their money in the stocks of companies whom they believe will do well in the future. The more people buy a certain stock the more that stock's price goes up and the better the company performs the more people who own the stock will require in return to part with their shares. If the component company stocks go up in price so will the index at large.
  2. Survivor Bias - A few short years ago General Motors was a component company in both the S&P 500 and the Dow 30. Now, GM is not listed on any index because it is not currently a public company. You won't find Merrill Lynch or Bear Stearns shares weighing down any index either. These companies all died as far as the stock markets are concerned. It's a rather Darwinian survival of the fittest type of environment. Even non-selective indexes like the Wilshire 5,000, which strives to capture a complete picture of the equity market, is biased to track strong performing companies over time. 

Does this mean that stocks are not risky in the long run? No. As Professor Zvi Bodie (I was student of Dr. Bodie's at Boston University) reminds us, the long-term is made up of a series of short-terms. The market can have several bad years in a row, it can stay flat for a decade or more and it can go on phenomenal bull runs as we saw during the 80s and 90s. 

The take away is that index investing does have an upward bias even if that upward movement is not predictable over any one particular time period. However, we can model likely outcomes with different degrees of confidence as a result of what we learn from these biases of the indexes in which we invest.

What are you thoughts? How are you feeling about the future of the markets? How much of your current portfolio is invested in stocks index vehicles?

Active Investment Management with Passive Investment Products

Active is Attractive but Passive is Massive

The active versus passive management battle has raged on for decades now. Active managers are constantly seeking alpha (returns above those of the fund's benchmark index) while index fund providers proclaim that such a pursuit is a fool's errand in the long run.

The thought of beating the market is attractive to all of us. Why settle for an average return of 9% if we can have 11% with the same risk exposure? This argument is at the heart of the actively managed portfolio manager's pitch. As one of my old bosses used to say "Fantastic! If it's true."

Yet few actively managed funds consistently beat their benchmark indexes. You may see a nice run here and there but eventually the market catches up to them. This happens in part because there almost always is increased risk exposure required to beat the markets, which means eventually the downside potential of that increased exposure will happen. The law of large numbers is hard to avoid.

Take a look at the latest Standard & Poor’s Indices Versus Active Funds Scorecard. The only asset class category where the majority of actively managed funds beat their index was Large Cap Value funds over the 3 and 5 Year time horizons. 

Remember, the active portfolio managers of the funds that are trying to beat the markets are all participating in the same market. Some will outperform the market and some will underperform the market but in the end they will all average out to the market.

Does this mean you should buy the indexes and "set it and forget it"? No, it just means that in most cases actively managed funds are not worth their price premium.

What to do?

What we do at Course Pilot Financial is take an active investment management approach using passive investment products like index funds and ETFs that track specific asset class or sector indicies. I know, it sounds weird to actively manage passive investments but stick with me.

Your financial life is comprised of a set of variables. Some of these variables are controllable and some are not. When it comes to your investments you can control how much money you put in to our investment pool, how you invest that money, when you take the money out and how much you take out. When it comes to the "how you invest your money" variable or "your portfolio" the one true controllable variable is risk exposure.

How much money should you put at risk? What is the expected return on this investment? And what is the downside potential? All of these questions are much easier to answer using passive/index tracking investments. 

Why? Because we know how the indicies have behaved in the past and this gives us much more clarity about how they might behave in the future. Does this mean we can predict the future? No, of course not. But we can model likely outcomes given certain asset allocations over time.

History has given us the range of outcomes that are possible from the "irrational exuberance" of the dot com bubble to the great depression and everything in between. These range of outcomes and their interrelationships help us create a framework that we can use to design and manage portfolios that meet your needs without taking unnecessary risks.

Below are a few advantages of this approach: 

  1. Focus is kept on your goals. You are not investing to beat the index, you are investing to achieve your life goals. It is possible to come up short of your goals even if you beat the S&P 500 every year if you fail to manage your other variables properly. It is equally possible to achieve all of your ideal goals while never beating the index.
  2. Confidence. Using index tracking investments allows us to model with confidence and provide you with an actual measurement of the likelihood of success. Example: 86% chance of exceeding your goals. That's powerful stuff. It helps you sleep at night. We aren't relying on picking the right stocks and hoping we were right.
  3. Low Cost. Index funds and their ETF counterparts of dramatically less expensive than their actively managed counterparts. Hiring an investment advisor to help you achieve your goals is smart but paying more than you need to for a packaged investment product that will likely underperform a less expensive option is silly.

What do you think? Are you investing in active funds or passive funds? Have I changed your mind? I know I mixed in an example that has a bit of a marketing pitch feel to it but I did so to articulate a point that I believe to be true regardless of whether you hire an advisor (Course Pilot or other) to manage your portfolio. 


Think Like Lance Armstrong

Little changes make a big difference over time. 

It is only natural to be a little shaken up by big negative events. The financial crisis of the last couple of years has erased trillions of dollars in value from investor's accounts, resulted in millions of job losses and left the world with more uncertainty than most of us are comfortable with. When faced with traumatic events it is not uncommon for the fight or flight instincts to kick in and for you to respond with dramatic adjustments in an effort to either counter or shield yourself from the dangers presented.

Panic moves however are rarely the best course of action. 


I encourage my clients to think like Lance Armstrong and his team did during their seven year Tour de France winning streak. Make small adjustments and analyze how they will add up to big wins over time. Watch this clip below from The Discovery Channel's "The Science of Lance Armstrong" or add the full feature to your Netflix queue.

Sure Lance is one of the greatest athletes the world has ever known but remember he had to survive cancer before he went on to win those seven tour titles. No one would have blamed him if he retired from cycling after his victory over cancer but instead he chose to continue to pursue his goals. In order to win, Lance and his team didn't look for a single magic bullet but rather looked to small improvements in as many areas as they could.

Over the course of the 2,000 mile race, during which Lance would spend some 90 hours on his bike, the gap between first place and the rest of the field usually comes down to only a minute or two. Gaining a mere second per stage on his rivals would be a huge improvement. So, as you see from the clip they went to work on riding position, aerodynamic, frame weight, and even the shape of screws to gain every second they could. In the end all those little changes added up to pay huge dividends.

Take the same approach with your financial life. 

Look at all facets of your financial life, all of your goals, all of  the variables within your control and see what making small adjusts does to improve your chances for success. What if you saved 1% more than you are now? What would happen if you pushed out your planned retirement age by 1 year? What if you adjusted your planned spending to a staggered approach instead of a straight line assumption?

If you are in your 30s, 40s, or 50s, you are likely looking at an investment plan that spans some 30 to 50 years. Imagine how little changes will add up over that amount of time.

What small changes have you made so far? How are they adding up? I would love to hear your story.

Focus on What You Can Control

I am always amazed at how much time and effort is spent discussing the markets. Talking about the markets is a lot like talking about the weather. No amount of talking or analysis will change what happened or shape where things are going. Yes, the markets (and the weather for that matter) can have a significant impact your your plan's success but focusing on a variable that is out of your control is not where you should invest your time.

Cursing the wind and yelling at the ocean is useless.

Yelling at the ocean.

Yelling at the ocean.

The markets are important, and understanding how they move is a key component of creating a successful investment plan. However, you should be less concerned with the day to day swings of the markets than you are with the following controllable variables of your plan:

  • Your Savings Rate - How much money are you putting away each pay period? Can you increase it by 1%? Whether the markets swing your portfolio up or down by 10% this year will likely have much less of an impact than a slight increase in your savings rate might. The up and down years will average out over time, that's the way markets work, but an increase in savings compounds over time and can make a huge difference to your goals. Saving an extra $1,000 per year at an average annual return of 8% will add up to $49,085 over a 20 year time period. 
  • Retirement Age - When do you plan to retire? What if you adjusted your planned retirement age by 1 year? How might that affect your plan? Assuming you are socking away $10,000 per year in your 401(k) and your retire in 21 years instead of 20, you would have an additional $51,115.
  • Risk Exposure - If you find yourself losing sleep over the ups and downs of the stock market then it is highly likely that your portfolio is too risky. For you. The Vanguard Intermediate Treasury fund (VFITX) has had an average annual rate of return of 7.01% since its inception in 1991. In its worst year (1999) it was down a mere 3.52%. What would moving from a plan with an target rate of return of 8% (and the risk that comes with it) mean to your portfolio over 20 years? If we apply our $10,000 savings per year for 20 years example we would expect to have $56,745 less for retirement spending. However, risk being what it is, that 8% portfolio might have a lot less certainty due to its higher exposure to stocks. The Vanguard Total Stock Market Index fund (VTSMX) for example has an average rate of return of 7.40% since inception in 1992. But that extra 0.38% (compared to VFITX) of annual return came with some significant volatility as the fund had five down years with the worst being negative 37.04% in 2008.
  • Planned Spending - Money lasts longer when you spend it slower. Reducing planned annual retirement spending by 3% can add years to your nest egg. While it is often difficult to estimate your cost of living 20 years out, having an understanding of how your planned spending will impact the success of your plan is a smart idea.

We all get caught up in the daily news from time to time and it is natural to feel powerless as the waves seem to whipsaw us about. But you have a lot more control than you think. Once you start exercising that control you will find the daily market updates much less interesting.