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Posts from the ‘Financial Literacy’ Category

7
Feb

GameStop, Reddit, and Market Mania: What You Need to Know

Over the course of 11 trading days from January 13 to January 28, 2021, the stock of GameStop, a struggling brick-and-mortar video game retailer, skyrocketed by more than 2,200% — creating a mix of excitement and concern throughout the financial world, as well as among many people who pay little attention to the stock market.1 Other stocks of small, struggling companies made similar though less dramatic moves.

At the heart of this story are two very different sets of investors: (1) professional managers of multibillion-dollar hedge funds, who took large, risky positions betting that GameStop stock would drop in price; and (2) a small army of individual investors, connected through social news aggregator Reddit and other social media sites, who worked together to buy large numbers of shares in order to drive the stock price up.

As the stock price rose, fund managers were forced to buy more and more shares at ever-increasing prices to “cover their bets,” while individual investors continued to buy shares in hopes of continuing the momentum. The opposing forces created a feeding frenzy that sent the stock to dizzying heights far beyond the fundamental value of the company.2 The stock price peaked on January 28 and lost almost 90% of its peak value over the next five trading days.3

If you are confused, concerned, intrigued — or a combination of all three — here are answers to some questions you may have about the recent market volatility triggered by “meme” stocks, an Internet term for stocks heavily promoted through social media.

1. What is a hedge fund, and what were the hedge funds doing?

A hedge fund is an investment company that uses pooled funds to take an aggressive approach in an effort to outperform the market. These funds are typically open to a limited number of accredited investors and may require a high minimum investment.  Hedge funds use various high-risk strategies, including buying stock with borrowed money or borrowing stock to sell, called buying or borrowing on margin. This enables the fund to increase potential profits but also increases potential losses. (Individual investors can use these high-risk techniques, but the investor must meet certain financial requirements in order to establish a margin account and accept the increased risk.)

In this case, certain hedge funds borrowed shares of GameStop and other struggling companies on margin from a brokerage firm and sold the shares at the market price, with the expectation that the share prices would drop significantly by the time they had to return the shares to the lender. The funds  could then buy shares at the lower price, return the shares, and pocket the difference, minus fees and interest. When GameStop share prices began to rise quickly against expectations, the “short sellers” began to buy shares at market prices in order to protect against future losses. These purchases helped drive share prices even higher — supply and demand — which led to more purchases and even higher prices. This created a situation known as a     short squeeze.4

To understand the level of risk faced by the short sellers, consider this: An investor who owns shares of a company can lose no more than 100% of the investment, but there is essentially no limit to the potential losses for a short seller, because there is no limit to how high a stock price might go. This is why short sellers were willing to buy at ever-increasing prices, accepting large losses rather than risking even larger losses. In addition, they were forced to add additional funds and/or other securities to their accounts to meet margin requirements; investors must keep a certain percentage of the borrowed funds as collateral, and the higher the stock prices went, the more collateral was required in the margin accounts.5

2. What is Reddit, and what were the Reddit investors doing?

Reddit is an online community with more than a million forums called subreddits in which members share information on a particular topic. Members of a subreddit dedicated to investing coalesced around a strategy to buy GameStop stock in order to push the price up and squeeze the hedge funds. The potential for this strategy was first suggested on the forum in April 2020, but it exploded on Reddit and other social media sites in January 2021, after a change in the GameStop board of directors that encouraged bullish investors coupled with an announcement from a well-known short seller predicting that the stock price would quickly drop.6

While some investors genuinely believed that GameStop was undervalued, the movement developed into a crusade to beat the hedge funds in what amateur investors perceived to be a “game” of manipulating stock values, as well as a more pragmatic belief that there was money to be made by buying GameStop low and selling high. The fact that many young investors were gamers who felt an affinity for GameStop added to the sense of purpose.7

The strategy worked more powerfully than the amateur investors expected, and some who bought the stock in the early stages of the rally and sold when it was flying high earned large profits. However, those who joined the excitement later faced large losses as the stock plummeted. Once some hedge funds had accepted losses and begun to close their short positions, there was no longer demand for shares at inflated prices.8

3. Why did brokerage firms limit trading activity for certain stocks?

At various points during the peak trading activity, some brokerage firms stopped the trading of GameStop and other heavily shorted and heavily traded stocks. They also placed restrictions on certain stocks, limiting trading to very small lots and/or raising margin requirements. In a typical situation, an investor must maintain a 50% margin, meaning the investor can borrow shares or funds equal to the shares or funds in his or her account. Restrictions varied in response to the recent trading, but at least one brokerage firm raised margin requirements on certain stocks to 100% for long positions (purchasing stocks to hold) and 300% for short positions.9

The stoppages and restrictions elicited accusations of unfairness from investors and some members of Congress, who believed the brokerage firms were protecting the hedge funds. In fact, the moves were dictated in large part by clearinghouses that process trades from the brokers. These clearinghouses require that brokers keep a certain level of funding (collateral) on deposit in order to cover both sides of any given trade. As trading and values increased, clearinghouses asked for larger deposits. By halting and/or restricting trading of highly volatile stocks, brokers were able to reduce the required collateral, which enabled them to meet the new deposit requirements in a timely manner.10

The restrictions also helped protect investors from being overextended and suffering outsized losses amid extreme volatility. And to an extent, they protected the broader stock market. The New York Stock Exchange (NYSE) regularly suspends trading of individual stocks when price swings exceed certain limits. On February 2, when the price of GameStop was plunging, the NYSE suspended trading five times throughout the day, with each suspension lasting less than 12 minutes.  Although GameStop remained in the spotlight, more than 20 other stocks also had trading suspended throughout that day.11

4. What happens next?

It may take months or years before the full effects of the recent activity play out in the financial markets, but one clear takeaway is that social media, combined with accessible low-cost trading platforms, allows like-minded groups of retail investors to exert power that matches large-scale institutional investors. More than 10 million new brokerage accounts were opened in 2020, and many new investors are trading securities online and through smartphone apps.12

Some hedge fund managers have already stated that they will rethink their focus on short selling.13 And new services aimed at providing tools for professional investors to track investing discussions on social media platforms have quickly risen and may become a staple of investment research.14

Although the larger stock market remained resilient throughout the episode, extreme volatility is always a concern, and the Securities and Exchange Commission issued a statement saying, “The Commission is closely monitoring and evaluating the extreme price volatility…[which] has the potential to expose investors to rapid and severe losses and undermine market confidence. As always, the Commission will work to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate capital formation.”15

What about GameStop and other companies involved in the volatility? The huge price swings had little or nothing to do with the actual value of the companies, and they will need to make fundamental business changes to address the underlying weakness that caused them to be targeted for short sales in the first place. The changes on the GameStop board that helped spark the rally, adding leaders with online expertise, may help the company compete in the marketplace, but that remains to be seen.16

As an investor, the lesson for you might be to tune out market mania over “hot stocks,” especially when there is little to back up the sudden interest other than speculation. The wisest course is often to build a portfolio that is appropriate for your risk tolerance, time frame, and personal situation and let your portfolio pursue growth over the long term. This strategy may not be as exciting as the wild ups and downs of stocks in the spotlight, but it’s more likely to help you reach your long-term goals.

The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Investments offering the potential for higher rates of return also involve higher risk.

Margin accounts can be very risky and are not appropriate for everyone. Before opening a margin account, you should fully understand that: you can lose more money than you have invested; you may have to deposit additional cash or securities in your account on short notice to cover market losses; you may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities; and your brokerage firm may sell some or all of your securities without consulting you to pay off the loan it made to you.

1, 3) Yahoo! Finance, for the period January 13, 2021, to February 4, 2021

2, 4–5) Kiplinger, January 30, 2021

6–7) Bloomberg, January 25, 2021

8) The New York Times, February 3, 2021

9) CNBC, January 28, 2021

10) The Wall Street Journal, January 29, 2021

11) New York Stock Exchange, 2021

12) The Wall Street Journal, December 30, 2020

13) Barron’s, January 29, 2021

14) MarketWatch, February 1, 2021

15) Securities and Exchange Commission, January 29, 2021

16) The New York Times, February 1, 2021

21
Apr

Coping with Market Volatility: Cash Can Help Manage Your Mindset

Holding an appropriate amount of cash in a portfolio can be the financial equivalent of taking deep breaths to relax. It could enhance your ability to make thoughtful investment decisions instead of impulsive ones. Having a cash position coupled with a disciplined investing strategy can change your perspective on market volatility. Knowing that you’re positioned to take advantage of a downturn by picking up bargains may increase your ability to be patient.

That doesn’t mean you should convert your portfolio to cash. Selling during a down market locks in any investment losses, and a period of extreme market volatility can make it even more difficult to choose the right time to make a large-scale move. Watching the market move up after you’ve abandoned it can be almost as painful as watching the market go down. Finally, be mindful that cash may not keep pace with inflation over time; if you have long-term goals, you need to consider the impact of a major change on your ability to achieve them.

Having a cash cushion in your portfolio isn’t necessarily the same as having a financial cushion to help cover emergencies such as medical problems or a job loss. An appropriate asset allocation that takes into account your time horizon and risk tolerance may help you avoid having to sell stocks at an inopportune time to meet ordinary expenses.

Remember that we’re here to help and to answer any questions you may have.

All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful.

Asset allocation is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.

Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies.

30
May

Retirement Confidence Increases for Workers and Retirees

The 29th annual Retirement Confidence Survey (RCS), conducted by the Employee Benefit Research Institute (EBRI) in 2019, found that two-thirds of U.S. workers (67%) are confident in their ability to live comfortably throughout their retirement years (up from 64% in 2018). Worker confidence now matches levels reported in 2007 — before the 2008 financial crisis.

Confidence among retirees continues to be greater than that of workers. Eighty-two percent of retirees are either very or somewhat confident about having enough money to live comfortably throughout their retirement years (up from 75% in 2018).

Retirement plan participation

Retirement confidence seems to be strongly related to retirement plan participation.  “Workers reporting they or their spouse have money in a defined contribution plan or IRA, or have benefits in a defined benefit plan,  are nearly twice as likely to be at least somewhat confident about retirement (74% with a plan vs. 39% without),” said Craig Copeland, EBRI senior research associate and co-author of the report.

Basic retirement expenses and medical care

Retirees are more confident than workers when it comes to basic expenses and medical care. Eighty-five percent of retirees report feeling very or somewhat confident about being able to afford basic expenses in retirement, compared with 72% of workers. Confidence in having enough money to pay medical expenses in retirement was also higher among retirees than workers: 80% versus 60%. However, 41% of retirees and 49% of workers are not confident about covering potential long-term care needs.

Debt levels

The survey consistently shows a relationship between debt levels and retirement confidence. “In 2019, 41% of workers with a major debt problem say that they are very or somewhat confident about having enough money to live comfortably in retirement, compared with 85% of workers who indicate debt is not a problem. Thirty-two percent of workers with a major debt problem are not at all confident about their prospects for a financially secure retirement, compared with 5% of workers without a debt problem,” said Copeland.

6
Mar

The lessons learned from “the old Enron story” still apply.

The following is from Edward Mendlowitz’s Feb. 24, 2015 Blog.
“in his book Money: Master the Game, Tony Robbins dredges up the old Enron story, which I agree with, and want to call to your attention now.  Here is a brief listing copied from Tony’s book of the lauds, Enron received right up until their bankruptcy filing.

Mar 21, 2001 Merrill Lynch recommends
Mar 29, 2001 Goldman Sacks recommends
June 8, 2001 J.P. Morgan recommends
Aug 15, 2001 Bank of America recommends
Oct 4, 2001 A G Edwards recommends
Oct 24, 2001 Lehman Brothers recommends
Nov 12, 2001 Prudential recommends
Nov 21, 2001 Goldman Sacks recommends (again)
Nov 29, 2011 Credit Suisse First Boston recommends
Dec 2, 2001 Enron files Bankruptcy

Millions of Investors trusted these venerable firms and followed their recommendations.  A question I had at the time was, “How much work did they do before they made their recommendations?”  I could not have been too much since every recommendation was wrong.  Another observation is that many of the largest mutual funds has significant positions in Enron.

Now, lets fast forward to today.  Has anything changed?  Were lessons learned?  Are more intensive analysis being done now?  I suggest that nothing has changed.  Examples are in the many recommendations to buy oil stocks a few months ago before a subsequent additional 35% drop.  …Next, as Robbins points out, most actively managed mutual funds do not outperform the index they are trying to beat….

The principles in the book are easy to understand, digest and act on…. I have condensed them [his seven steps] and … restate as follows:

1. Commit to regular savings program
2. Know and understand why you are investing in
3. Develop a plan and, while at it, reduce spending, keep investment costs low and shed debt
4. Allocate your assets carefully and rebalance periodically
5. Create a lifetime income plan
6. Invest like the .001%, i.e. don’t be stupid and re-look at step 2
7. Be happy by growing and giving

All good advice you can start following today.

 

 

 

20
Sep

Fees of a Fee-Only adviser are only paid by the client.

I have not understood why there has been any resistance to requiring financial planners and investment managers to be held to a fiduciary standard.  A recent article in the Wall Street Journal (WSJ) may indicate why some do not want to be held to a fiduciary standard.

The Free Dictionary by FARLEX defines a Fiduciary as: “An individual in whom another has placed the utmost trust and confidence to manage and protect property or money. The relationship wherein one person has an obligation to act for another’s benefit.”

A fiduciary relationship encompasses the idea of faith and confidence and is generally established only when the confidence given by one person is actually accepted by the other person.”

Many of us believe it is putting the client first. 

Jason Zweig’s September 20th article “ ‘Fee-Only’  Financial Advisers Who Don’t Charge Fees Alone” may show why there is resistance to a fiduciary standard for financial planners and investment managers.  They found that 24% of the 33,949 certified financial planners (CFP) they analyzed described their compensation as “fee-only”. 

The article notes that “Securities lawyers and government regulators say that an adviser who works for a brokerage firm or insurance company that charges commissions shouldn’t describe his services as ‘fee only’, even if the adviser himself doesn’t charge commissions to his clients.” Although none of the CFPs at major banks and brokerage firms, the WSJ identified 661 listed CFPs who call themselves ‘fee-only’” at some of the major banks and brokerage firms.  The problem extends beyond CFPs. 

Can you argue that if the compensation is not accurate, the advisor is not a fiduciary?

The WSJ Article

26
Aug

Risk

It is important for you to understand your tolerance for risk and capacity to recover from investment losses.  Financial professionals need to understand this also.  It is part of the understanding needed to help develop a foundation to guide you through your life’s journey. 

Risk tolerance is your capacity to withstand a loss.  Your capacity to withstand a financial loss is your ability to recover from or absorb a financial loss and still be able reach your financial goals. If the probability of an investment portfolio is too low, then the person does not have the capacity to withstand the loss.

If you do not have the tolerance or capacity to withstand a loss, something else may need to be changed.  It may be any combination of actions including: increasing income, lowering expenses, increasing savings, or lowering financial goals.   

The reliability of your sources of income is another factor to consider.  If have a good job with a strong reliable company in a growing industry, you are in a better position to withstand investment losses.   However, if you are not satisfied with your employment you are not in as good of a position to withstand investment losses. 

Age and health are two other factors to consider.  If you are in the earlier stages of you career, you have more time and resources to recover from investment losses.  The existence of health issues generally reduces the ability and flexibility to withstand losses. 

Future plans to start a new business and to travel extensively are two other factors to consider.  These plans may reduce your ability and flexibility to recover from investment risks. 

This discussion is an introduction to an understanding of your risk tolerance and capacity.  Without this understanding, your financial planning may not be achievable.
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7
Aug

Tips for selecting a fianncial professional

Linda Stern (Reuters) provided some tips for getting help selecting a financial planner and/or adviser in her August 4, 2013 column in the Chicago Tribune.

The first part of the article summarizes the battle that has been going on since the 1990s to impose a requirement that all financial planners and/or advisers put their client’s interest first.  The point she was making is that you should not wait until Congress decides who should be covered and by what standard as an excuse for not getting help with your financial matters. 

“If you are getting your financial advice for free, you are not getting an adviser who is putting…” your interest first.  “Smart and unconflicted financial advice is worth something…”  Many of us provide guidance, support, etc. for those that want to manage their financial matters themselves.

“Look for the term ‘fiduciary planner’.”  Until Washington waters it down, it means the adviser has to make sure your investments are the best possible investments for you.”  Those that have the Personal Financial Specialists Credential (PFS) had to establish they had the specified experience, specified education and successful completion of the required examination.  As a member of the AICPA, we are also are subject to the AICPA Code of Professional Conduct.  CPA/PFS professionals must maintain objectivity and integrity, be free of conflicts of interest, and shall not knowingly misrepresent the facts.  Some believe these requirements are the essence of the fiduciary duty.

“Regardless of where you get your advice, make sure your assets are held in a bona fide brokerage account insured by the Securities Investor Protection Corp. “

Bottom line is that you should not delay planning.  Delays can limit you alternatives and require more effort to reach your financial goals.  You should also do your due diligence in selecting a professional to guide you through the process.
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12
Jun

“Simple Ways to Stop Doing Dumb Things with Money”

Carl Richards spoke at a conference I attended this year.  I decided to read his book, “The Behavior Gap – Simple Ways to Stop Doing Dumb Things with Money”.

 The book does not attempt to provide a simple way for people to achieve their financial goals.  It provides observations to show how to avoid doing dumb financial things.  Start by taking “… a deep breath and reflect on past decisions.”  Identify actions you took or did not take that did not turn out as you expected.  Identify how you can make better decisions in the future.

You need to recognize that not every decision will be perfect.  Recognize where you are and where you want to be.  Stay “…in tune with reality, with your goals, and with your values.”  You will need to move forward and recognize what changes are needed to reach your goals.

 Following is a small sampling of key points he makes in the book:

“We can stop chasing fantasies.  We are not going to get what we want by beating the market or picking the perfect investment or designing the perfect bulletproof financial plan.”

 ‘Our assumptions about the future are almost always wrong.”  “…we can take sensible steps to protect ourselves from life’s inevitable surprises.”

 “Your financial decisions should align with what you know about yourself and the world”.

“The process of financial planning is vital” not the financial plan.

“Our objective is “…to do the best we can and move forward. “

 The author does not claim that his ideas are original.  His goals are to clarify or simplify to give the reader the confidence to improve their financial decisions.
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30
Nov

Picking a financial adviser

Aparna Narayanan’s November 5th article in The Wall Street Journal  provides tips on how to decide on which financial adviser you should work.  The article is the basis for this discussion.

Determining what help you are seeking is the first step.  You could be looking for an answer or guidance to one or more questions, a comprehensive plan and/or investment management.  Generally people are trying to provide a framework to improve their financial well being.  Often the issue that motivated someone to see a financial adviser is not what needs the most attention.  This cannot always be determined in the introductory meeting.

Understand how the adviser is paid.  You want to understand if the compensation arrangement could create a conflict of interest.  Some advisers get paid only by their clients, in fees that are hourly, a fixed amount or a percentage of investment assets.  Others get commissions or a combination of fees and commissions.  Some advisers are legally required to put their client’s interests first as fiduciaries.

Each adviser has their own approach to an introductory meeting.  Many will offer a free introductory meeting.  The information required for an initial meeting varies among advisors.  The more information you have available the broader the initial discussion can be.  It is best that your partner or spouse is also at the initial meeting.
Understand the purpose of an initial meeting is generally not to provide answers.  The purpose is to see if you (and your spouse or partner) wants to work with the advisers.  The reverse is also true.    The adviser is trying to determine if there is a good fit with you and your needs.

There is no such thing as a bad question.  Listen to the responses to see if the adviser you want helping you with your financial issues.

Let the adviser know once you have made a decision as to who you want to work with.  Also let those you are not going to work with know you will be working with someone else.  This will eliminate unwanted follow-up with you.

READ MORE 

 

 
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10
Aug

Parents need to educate their children about money.

The Journal of Accountancy reported, 08/09/2012, the results of a survey conducted for the AICPA.
Some of the findings were:
30% of parents never talk to their children about money or have had only one talk with their children about money.

67% strongly agreed that they knew enough about personal finance to teach their children about personal finance. 
Some tips from the National Financial Literacy Commissions include:

Start early by discussing that delayed gratification is the basis for budgeting and savings goals.

Discuss things they are interested in. 
Frequent discussions about good financial habits should include how they relate to current and future benefits (needs).

Your actions should reinforce good financial behavior.

There is a lot of evidence that children are not getting introduced to financial related matters early enough.  Some schools are starting to include these topics.  These efforts need to be expanded.  Parents should assume the responsibility now and not wait for the schools to provide these topics.  Parent should also request/demand that the schools include financial educations.

These topics should include behavioral finance.  This is an increasing volume of studies showing that some of our instincts are detrimental to our financial well being.

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Link to AICPA’s 360 Degrees of Financial Literacy:

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