Objective information about financial planning, investments, and retirement plans

Smart Beta ETFs the Next Big Thing?


For those of us involved in financial services it is hard to check your Twitter stream or visit an industry website without seeing the term smart beta. ETF providers have really taken to this trend and have introduced many new ETFs based on some aspect of smart beta.

Nobody follows a trend quite like the folks who market mutual funds or ETFs and smart beta is the hip thing that all of the “cool kids” are doing. At a recent ETF industry conference sponsored by Morningstar (MORN) this was virtually all anyone was talking about in the sessions I attended.

What is smart beta and is it really smart?  Are smart beta ETFs the next big thing in ETF investing?

Smart Beta Defined 

According to Investopedia (for whom I am a frequent contributor):

“Investment managers that follow a smart beta investment strategy seek to passively follow indices, while also taking into account alternative weighting schemes such as volatility. That’s because smart beta strategies are implemented like a typical index strategies in that the index rules are set and transparent. Smart Beta strategies will differ from standard indices, such as the S&P 500 or the Barclays Aggregate, in that the indices focus on areas of the market that offer an opportunity for exploitation.” 

We will attempt to expand on that definition a bit below. 

Factor investing 

Most smart beta ETFs take an aspect or a factor from a traditional index. Traditional index ETFs passively track a market value weighted index like the S&P 500.  Some popular factors include low volatility, momentum; equal-weighted indexes, dividends and quality are common factors. An equal-weighted index would give equal weighting to a huge stock like Apple (APPL) and to the smallest stock in terms of market capitalization in the S&P 500 Index.

An example of a smart beta ETF based on a factor is the Powershares S&P 500 Low Volatility ETF (SPLV).

This ETF invests in the 100 stocks in the index that have exhibited the lowest volatility over the past 12 months. A sound idea in theory and perhaps ultimately in practice.

Like many smart beta ETFs the inception date of SPLV was May 5, 2011 over two years after the low point of the markets during the financial crises. The index the ETF follows was essentially created in the lab via back-testing, much like the Peter Boyle character in the movie Young Frankenstein. This means that most of the “history” of this ETF is via back-testing and not real performance data. As a presenter at the Morningstar conference said, he’s never seen a back-test that did not yield a positive result.

Looking at SPLV’s results, the ETF trails the S&P 500 index in terms of trailing three year returns 12.95% to 14.77% on an average annual basis for the period ending 10/19/2015. However for the year-to-date period through the same date SPLV has gained 1.27% versus 0.41% for the index.

Looking at another measure, standard deviation of return which measures the variability of the ETF’s returns (up and down) over the three year period ending 9/30/2015, the standard deviation for SPLV is +/- 9.63% versus +/- 9.74% for the index. My guess is that a selling point of this ETF would be lower volatility but over the past three years the smart beta ETF is only fractionally less volatile than the index and an investor would have considerably less money if they had held SPLV over a more traditional ETF like the SPDR S&P 500 ETF (SPY).

Is an investment in SPLV a bad idea? I don’t know because I have no idea how this ETF will hold up in a pronounced bear market. Yes it has performed better than the full index so far in 2015 including the volatility in August and September. How will it do if we hit a rough patch like 2000-2002 or 2008-2009? Good question.

A growth area 

According to data from Morningstar as of 6/30/2015:

  • There were 444 smart beta products listed in the U.S.
  • These products accounted for $540 billion in assets under management which was 21% of all U.S ETF assets.
  • Of the new cash flows into ETFs over the past 12 months, 31% went into smart beta products.
  • The assets in these products grew 27% over the same period.
  • A quarter of new ETF launches over the past five years were smart beta products.

Who uses smart beta ETFs? 

From what I have heard and read smart beta ETFs are being used largely by financial advisors and institutional investors versus individuals. You might say so what? These folks are likely investing your money either via your relationship with a financial advisor who may use them in a portfolio or use a TAMP (turnkey asset management program) program offered by a third-party to manage your money.

Reasons to use Smart Beta 

Morningstar cites several reasons investors and advisors might consider smart beta ETFs:

  • To manage portfolio risk
  • To enhance portfolio returns
  • For tactical asset allocation, meaning an allocation that is based in part on the advisor’s assessment of market conditions
  • Reducing fees versus actively managed mutual funds
  • To use an active strategy grounded by an index core

Many, including me, view strategic beta as a form of active management. A presenter at the Morningstar conference suggested that any smart beta ETF with an expense ratio of 50 basis points or higher should not be considered as this is the lower end of the fee range for the better actively managed mutual funds offering an institutional share class.

What does this mean for individual investors? 

Again I suspect that most of the money invested here will be institutional or via financial advisors. As an individual investor working with a financial advisor who suggests using smart beta ETFs in your portfolio, you should ask them to explain their rational. Why are these ETFs a better choice than an asset allocation strategy using more traditional index products?

If you will using smart beta ETFs on your own, be sure that you fully understand the underlying index which was likely created post-financial crises via back testing. Understand that smart beta strategies may look good on paper but in reality they can take a number of years to prove themselves.  Lastly understand that strategies that look good in testing may not work as well when millions of dollars are actually invested there real-time.

For financial advisors 

Most financial advisors that I know are very deliberate in testing new products and investing ideas before using them with clients. With the rise of third-party advisors such as TAMPs and ETF strategists, financial advisors still need to understand the underlying products and strategies being used to invest their client’s hard-earned money.

The Bottom Line 

Smart beta is the next evolution of ETF investing or so say the firms trying to gather assets into these products. I’m not saying that smart beta isn’t an enhancement or that I am against new investing inovations. I am leery of any investment vehicle designed to solve a problem or fill a role in portfolios that have not gone through a full stock market cycle. With any investment vehicle that you are considering, be sure to fully understand the benefits, the risks and the costs. How smart is smart beta? We really won’t know until the market goes through a full cycle that includes a significant correction.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.

How Much Apple Stock Do You Really Own?


Apple (AAPL) stock has been a great investment over the years. Based upon its stock price and the number of shares outstanding it is the largest U.S stock based upon market capitalization.  This means it is the largest holding in popular index mutual funds and ETFs like Vanguard 500 (VFINX) and the SPDR S&P 500 ETF (SPY).

Chuck Jaffe recently wrote an excellent piece for Market Watch discussing the impact that a recent drop in Apple stock had on a number of mutual funds that hold large amounts of Apple.  He cited a list of funds that had at least 10% of their assets in Apple.  On a recent day when Apple stock fell over 4% these funds had single day losses ranging from 0.22% to 2.66%.

The point is not to criticize mutual fund managers for holding large amounts of Apple, but rather as a reminder to investors to understand what they actually own when reviewing their mutual funds and ETFs.

Stock overlap 

In the late 1990s a client had me do a review of their portfolio as part of some work I was doing for the executives of the company. He held 19 different mutual funds and was certain that he was well-diversified.

The reality was that all 19 funds had similar investment styles and all 19 held some of the popular tech stocks of the day including Cisco (CSCO), Intel (INTC) and Microsoft (MSFT). As this was right before the DOT COM bubble burst in early 2000 his portfolio would have taken quite a hit during the market decline of 2000-2002.

Understand what you own 

If you invest in individual stocks you do this by choice. You know what you own. If you have a concentrated position in one or more stocks this is transparent to you.

Those who invest in mutual funds and other professionally managed investment vehicles need to look at the underlying holdings of their funds.  Excessive stock overlap among holdings can occur if your portfolio is concentrated in one or two asset classes. This is another reason why your portfolio should be diversified among several asset classes based upon your time horizon and risk tolerance.

As an extreme example someone who works for a major corporation might own shares of their own company stock in some of the mutual funds and ETFs they own both inside their 401(k) plan and outside. In addition they might directly own shares of company stock within their 401(k) and they might have stock options and own additional shares elsewhere. This can place the investor in a risky position should their company hit a downturn that causes the stock price to drop.  Even worse if they are let go by the company not only has their portfolio suffered but they are without a paycheck from their employer as well.

Concentrated stock positions 

Funds holding concentrated stock positions are not necessarily a bad thing. A case in point is Sequoia (SEQUX) which has beaten its benchmark the S&P 500 by an average of 373 basis points (3.73 percentage points) annually since its inception in 1970.  Sequoia currently has about 26% of its portfolio in its largest holding and another 8% in the two classes of Berkshire Hathaway stock.  Historically the fund has held 25-30 names and at one time held about 30% of the portfolio in Berkshire Hathaway (BRK.A).  Year-to-date through August 14, 2015 the fund is up 16.5% compared to the benchmark’s gain of 2.88%.

The Bottom Line 

Mutual fund and ETF investors may hold more of large market capitalization stocks like Apple and Microsoft than they realize due to their prominence not only in large cap index funds but also in many actively managed funds. It is a good idea for investors to periodically review what their funds and ETFs actually own and in what proportions to ensure that they are not too concentrated in a few stocks, increasing their risk beyond what they might have expected.

Please feel free to contact me with any questions, comments or suggestions about this article or anything else on The Chicago Financial Planner. Thank you for visiting the site.

What is a Hedge Fund?


The term hedge fund is used often in the financial press.  I suspect, however, that many investors do not really know what a hedge fund is.

What is a Hedge Fund?





Investopedia defines a hedge fund as follows:

“An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).” 

Here are a few basics about hedge funds to help you understand them.  Note this is certainly not meant to be an in-depth tutorial but rather is meant to provide an introduction to hedge funds.

Who can invest in hedge funds? 

In order to invest in a hedge fund you must be an accredited investor.  The current definition of an accredited investor is someone with a net worth of $1 million (excluding the equity in their home) and at least $200,000 in income ($300,000 with a spouse) over the past two years.  Many hedge fund investors are institutional investors such as foundations, endowments and pension plans.  About 65 percent of the capital invested in hedge funds comes from institutional investors.

What is the minimum investment? 

The minimum required to invest is often $1 million or more though some smaller hedge funds and funds of funds may have lower minimums.  New companies like Sliced Investing are seeking to change these high minimums by allowing investors to invest as little as $20,000.

Do I have access to my money? 

Unlike mutual funds, ETFs, closed-end funds and individual stocks hedge funds typically do not offer daily access to your money.

Some hedge funds allow investors to subscribe (invest) or redeem their money monthly, for others this might be quarterly or based upon some other time period.  Most hedge funds will require advanced notice for redemptions which might be as long as 180 days.  This allows the fund managers time to raise sufficient cash and allows for an orderly sale of fund investments especially if the redemption is a significant amount.

Some hedge funds also require a lock-up which means that there are no redemptions allowed during this initial period.  A typical lock-up period is one year, though some are as long as two years.  In some cases the lock-up period is “soft” meaning that redemption can be made but there will often be a penalty ranging from 2 percent to as high as 10 percent. 

Some hedge funds may also have the ability to enforce “gates” on redemptions which means they can decide to process only a portion of the redemptions requested.  This provision came into focus during the 2008-2009 market downturn as hedge fund redemptions requests swelled as many investors sought to raise cash.

What types of fees are charged? 

The fees charged by hedge funds vary widely.

Many hedge funds charge a management fee of 2 percent or more.

There might also be incentive fees of 10 to 20 percent of the fund’s profits or more.  This rewards the fund manager for superior performance.  The flip side of this is that the manager generally only collects an incentive fee if the fund’s performance exceeds its former highs, known as a high water mark.

If a fund loses 5 percent in a given year, no incentive fees will be paid to the manager the following year until the 5 percent loss is made up.

The term two and 20 is a common one in the hedge fund world meaning that the fund would charge a 2 percent management fee and a 20 percent incentive fee.  This may seem pricey but if the performance is stellar then investors won’t mind paying it. 

What types of investment strategies are available? 

There is a vast range of investment strategies across the hedge fund landscape.  These might include long-short, global macro, market neutral, convertible arbitrage, distressed securities and many others.  Additionally there are a number of fund of funds offered which means that the fund offers a collection of strategies and fund managers under one umbrella.   

What should I consider before investing in a hedge fund?

From reading the above you might ask yourself why would I invest in hedge funds?  Let’s remember that hedge funds are considered alternative investments.  Ideally they will have a relatively low correlation to the traditional long-only equity and fixed income investments in your portfolio.  At their best well-managed hedge funds can add balance and reduce the overall risk of your portfolio, in some cases the strategies are designed to provide absolute returns across all investing environments.

Before investing in a hedge fund or any alternative investment make sure you have considered and fully understand the following:

  • The fund’s investment strategy.
  • How this investment strategy fits with your overall portfolio and investing strategy.
  • What the fund “brings to the table” that you can’t get with more traditional long-only stock and bond investments.
  • Who is managing the fund and their history and investment track record.
  • The required minimum investment.
  • Any redemption restrictions and/or lock-up periods.  Make sure that you won’t need to tap this money during this time period. 

The Bottom Line 

Like any investment option you might consider it is important to understand the pros and cons of hedge funds in general and any specific fund or strategy that you might be considering for your portfolio.

Disclosure: This blog post was written for Sliced Investing pursuant to a paid content arrangement I have with the company’s representatives as part of an effort to raise awareness about alternative investment options. All views expressed are entirely my own, and were not influenced or directed by Sliced Investing.

Photo courtesy of Wikipedia

Why Using Home Equity to Invest in the Stock Market is a Bad Idea


Not that I needed one but an email newsletter that I received from attorney Dale Ledbetter recently served as an excellent reminder what a poor idea using home equity to invest in stocks really is.  From his email:

Strong stock market encourages the resurrection of a bad practice – borrowing money against the value of your home to play the market. The horror story set out below is likely to be repeated if these practices continue.

A married couple, both of whom were in their late 80s, was persuaded by their bank to take out 100% value equity line of credit against their home. They were then persuaded to turn these “borrowed assets” over to the bank’s securities subsidiary where they were told the return would easily exceed the cost of the credit line. 

The broker then advised the couple to put 95% of the total proceeds into a single stock. The securities account tanked, resulting in an almost 100% loss. In the meantime, the house dropped in value by $100,000, resulting in a foreclosure proceeding. The bank then refused to permit a $150,000 short sale to bona fide buyers. 

The husband died. The wife, who now lives in a constant care facility, is entering bankruptcy to force the bank to take the house. 

Of course, the bank and their securities subsidiary blame it all on the elderly couple who they described as “sophisticated investors.” Both husband and wife had been schoolteachers and had no training or experience in the securities industry or in investment strategies. The fact that both were in their late 80s and suffering from diminished capacity, was not enough to deter the aggressive sales tactics of their “trusted advisors.” 

Aside from what would seem to be blatant investment fraud on the part of the bank and their advisory unit, this piece reiterates why using your home equity to invest in the stock market is such a bad idea.  Here are a few specific reasons that I discourage this practice.

Did you really forget the 2008 housing market crash this soon? 

For those with short memories an overinflated housing market crashed and triggered a meltdown in the economy and drastically reduced the value of many homes.  We are still recovering from this and although home values have improved in many parts of the country we learned that home prices will not always go up and that real estate is not the safe store of value we were led to believe.

To put this another way let’s say you tap your home equity to invest in the stock market.  What if the value of your home decreases 10 percent, 20 percent or more?  Now you have to pay back that home equity loan on a house that isn’t worth nearly as much as when you took out the loan.  You could find yourself underwater on your home or worse in foreclosure.  You could also find that your plans to fund a comfortable retirement or your children’s college education are out the window.

What if your investments tank?

Much like these poor folks in Mr. Ledbetter’s example above, not all investments are a sure thing.  What happens if you borrow against your home equity to invest in the stock market and things don’t work out?  If the specific investments you or someone else chose drop in value you are now stuck with investments worth less than your original investment and you will be stuck paying off the loan which is still based upon the amount borrowed.

Even if you went with a few index funds and the stock market drops you will find yourself in the same boat.  Again this is a great strategy to ruin your otherwise well-planned financial future.

Who exactly is suggesting this idea? 

Like the poor folks in Mr. Ledbetter’s example take a look at anyone suggesting this idea to you with a very jaundiced eye.  What is in it for them?  Are you the only one with any real skin in the game?

In the example above the bank won at last twice.  They got the interest on the loan and their brokerage unit made money via fees and perhaps other sources on the investment side.  They had no skin in the game and will likely come out whole even after the foreclosure.  

The Bottom Line

Generally, in my opinion, anyone who would suggest this idea to an investor is motivated by greed and does not have the best interests of their clients at heart.  Using your home’s equity to invest in the stock market is just not a sound idea.

There might be instances where tapping home equity to invest can be a good idea, but these are very limited and should only be undertaken by truly sophisticated investors who fully understand the risks involved.

Please feel free to contact me with your questions. 

Please check out our Resources page for more tools and services that you might find useful.

Are Brokerage Wrap Accounts a Good Idea?


A reader recently emailed a question regarding a brokerage wrap account he had inherited from a relative.   He mentioned that he was being charged a one percent management or wrap fee and also suspected that he was incurring a front-end load on the A share mutual funds used in the account.

Upon further review we determined that the mutual funds were not charging him a front-end load.  Almost all of the funds being used, however, had expense ratios in excess of one percent plus most assessed 12b-1 fees paid to the brokerage firm as part of their expense ratios.

Are brokerage wrap accounts a good idea for you?  Let’s take a look at some questions you should be asking.

What are you getting for the wrap fee? 

This is the ultimate question that any investor should ask not only about wrap accounts but any financial advice you are paying for.

In the case of this reader’s account it sounds like the registered rep is little more than a sales person who put the reader’s uncle into this managed option.  From what the reader indicated to me there is little or no financial advice provided.  For this he is paying the brokerage firm the one percent wrap fee plus they are collecting the 12b-1 fees in the 0.25 percent to 0.35 percent on most of the funds used in the account.

Before engaging the services of a financial advisor you would be wise to understand what services you should expect to receive and how the adviser and their firm will be compensated.  Demand to know ALL aspects of how the financial advisor will be compensated.  This not only lets you know how much the relationship is costing you but will also shed light on any potential conflicts of interest the advisor may have in providing you with advice.

What’s special about the wrap account? 

While the reader did not provide me with any performance data on the account, from looking at the underlying mutual funds it would be hard to believe that the overall performance is any better than average and likely is worse than that.

Whether a brokerage wrap account or an advisory firm’s model portfolio you should ask the financial advisor why this portfolio is appropriate for you.  Has the performance of the portfolio matched or exceeded a blended benchmark of market indexes based on the portfolio’s target asset allocation?  Does the portfolio reduce risk?  Are the fees reasonable?

What are the underlying investments? 

In looking at the mutual funds used in the reader’s wrap account there were a few with excellent returns but most tended to be around the mid-point of their asset class.  Their expenses also tended to fall at or above the mid-point of their respective asset classes as well.

Looking at one example, the Prudential Global Real Estate Fund Class A (PURAX) was one of the mutual funds used.  A comparison of this actively managed fund to the Vanguard REIT Index Fund Investor shares (VGSIX) reveals the following:

Expense ratios:



Expense Ratio



12b-1 fee




 Trailing returns as of 12/31/14:

1 year

3 years

5 years

10 years












While the portfolio manager of the wrap account could argue the comparison is invalid because the Prudential fund is a Global Real Estate fund versus the domestic focus of the Vanguard fund I would argue what benefit has global aspect added over time in the real estate asset class?  Perhaps the attraction with this fund is the 30 basis points the brokerage firm receives in the form of a 12b-1 fee?

Looking at another example the portfolio includes a couple of Large Value funds Active Portfolios Multi-Manager A (CDEIX) and CornerCap Large/Mid Cap Value (CMCRX).  Comparing these two funds to an active Large Value Fund American Beacon Large Value Institutional (AADEX) and the Vanguard Value Index (VIVAX) reveals the following:

Expense ratios:





Expense Ratio





12b-1 fee






Trailing returns as of 12/31/14:

1 year

3 years

5 years

10 years






















Again one has to ask why the brokerage firm chose these two Large Value funds versus the less expensive institutionally managed active option from American Beacon or the Vanguard Index option.  I’m guessing compensation to the brokerage firm was a factor.

Certainly the returns of the overall wrap account portfolio are what matters here, but you have to wonder if a wrap account uses funds like this how well the account does overall for investors.

The lesson for investors is to look under the hood of any brokerage wrap account you are pitched to be sure you understand how your money will be managed.  I’m not so sure that my reader is being well served and after our email exchange on the topic I hope he has some tools to make an educated evaluation for himself.

The Bottom Line 

Brokerage wrap accounts are an attempt by these firms to offer a fee-based investing option to clients.  As with anything investors really need to take a hard look at these accounts.  Far too many charge substantial management fees and utilize expensive mutual fund options as their underlying investments.  It is incumbent upon you to understand what you are getting in exchange for the fees paid.  Is this investment management style unique and better?  Will you be getting any actual financial advice?

The same cautions hold for advisory firm model portfolios, the offerings of ETF strategists and managed portfolios offered in 401(k) plans.  You need to determine if any of these options are right for you.

Please feel free to contact me with your questions. 

Check out an online service like Personal Capital to manage all of your accounts all in one place.  Also check out our Resources page for more tools and services that you might find useful.

Dow 18,000 – A Big Deal?


In February of 2013 I wrote Dow 14,000 – Big Deal or Just a Number?  Today the Dow Jones Industrial Average closed at 17,778 after a 421 point gain.  This is on the heels of a better than 200 point rise yesterday marking the average’s largest two day gain in 12 years.  Dow 18,000 looks like it will not be far off.

Just as I thought Dow 14,000 was a pretty meaningless number, I also think Dow 18,000 is equally meaningless.  In fact there are many, including yours truly, who think the Dow Jones Industrial Average isn’t all that meaningful as a benchmark.

Rather than focusing on the level of the market you should focus on your portfolio and your investment strategy.  Some specific action steps you might consider:

Rebalance your portfolio

You should have a strategy to review your overall portfolio on a regular basis (annually, semi-annually etc.) to ensure that your asset allocation is within your target allocation.  Invariably certain asset classes will outperform or under perform.  Bringing your portfolio back into balance forces you to sell off some winners and fund those asset classes that have underperformed.

Market leaders and laggards shift periodically and this approach adds a level of discipline to your strategy.  Mostly rebalancing helps mitigate investment risk.

Keep expenses low 

You can’t control how the markets will perform.  You can control your investment expenses.  Specifically:

  • Mutual fund and ETF expenses.
  • Trading costs at your custodian.
  • The cost of financial advice

Revisit your investment strategy 

I view market highs as a great time to revisit your investment strategy and your financial plan.  If you’ve been fully and properly invested your portfolio has hopefully risen along with the markets.

Where does this leave you in terms of progress towards achieving your financial goals?  This is a good time to revisit your financial plan.

The Bottom Line

Is Dow 18,000 a big deal?  Not in my book and frankly I wonder if anyone besides the financial news media really cares.  I suggest focusing on the details of your portfolio and your strategy and ignoring the hype.

Check out an online service like Personal Capital to manage all of your accounts all in one place.   Check out our Resources page for more tools and services.

Tis the Season for Stock Market Predictions


As I listen to CNBC in the background and read the financial press it is the season for the pundits to make their 2015 stock market predictions.  Some of these predictions relate to the level of the market in general, others include “hot stocks for 2015.”

Many of these people are pretty smart and I’m not dismissing their research.  What I am saying is that that I’m not so sure any of this is useful.  But in the spirit of the season here are my 2015 stock market predictions.

The stock market might go up 

The consensus seems to be that 2015 will be a good year for the stock market.  They might well be right.  The U.S. economy is improving, oil prices are low, etc.

The stock market might go down 

The experts could be wrong or worse there could be some sort of adverse event that spooks the market and perhaps the economy.

My official stock market predication is that I have no clue 

While this is all fun and provides something for the cable news talking heads to discuss, at the end of the day nobody has a clue what 2015 or any year holds for the stock market or the economy.

Focus on what you can control 

We have no control over what the financial markets will do or over how your stocks, mutual funds, ETFs, or any other holdings will do.  But as investors you can control a number of things including:

  • The cost of investment advice
  • The expense ratios of mutual funds and ETFs owned
  • Your asset allocation
  • Your overall investment strategy
  • How much you save and invest in our 401(k) and elsewhere
  • How much you spend.

I’m not denigrating the value of stock market research and analysis.  But for most of you reading this post I’m guessing that you are long-term investors versus being traders.  If that is the case you are, in my opinion, far better off controlling what you can control and investing in line with your financial plan than in trying to chase predictions and hot segments in 2015 or in any year.

Start 2015 out right, check out an online service like Personal Capital to manage all of your accounts all in one place.  Check out our Resources page for more tools and services.

Is the Dow Jones Industrial Average Still a Relevant Stock Market Index?


The Dow Jones Industrial Average (DJIA) of 30 large stocks has long been arguably the most watched index for those following the stock market.  As I write this IBM a long-time index component reported a major miss in its quarterly earnings.

The stock was down some 7% for the day and due to this decline the DJIA was been down most of the day.  The index finished up some 19 points but without the drag of IBM the index would have been up around 100 points according to a commentator on CNBC.  This begs the question is the Dow Jones Industrial Average still a relevant stock market index?

It’s just 30 stocks 

The DJIA is a weighted average (the actual weighting formula is very complex) of the price of the 30 stocks that comprise the index.  Originally the index was supposed to represent the stocks of large industrial companies.  Over the years the composition of the index has changed to reflect the changing nature of American business.

Here are the 30 companies that comprise the index:







3M Co
American Express Co
AT&T Inc
Boeing Co
Caterpillar Inc
Chevron Corp
Cisco Systems Inc
E I du Pont de Nemours and Co
Exxon Mobil Corp
General Electric Co
Goldman Sachs Group Inc
Home Depot Inc
Intel Corp
International Business Machines
Johnson & Johnson
JPMorgan Chase and Co
McDonald’s Corp
Merck & Co Inc
Microsoft Corp
Nike Inc
Pfizer Inc
Procter & Gamble Co
The Coca-Cola Co
Travelers Companies Inc
United Technologies Corp
UnitedHealth Group Inc
Verizon Communications Inc
Visa Inc
Wal-Mart Stores Inc
Walt Disney Co


Certainly a nice mix of manufacturers, retail, financial services, and technology related companies.  Three major names absent from the index include Google, Facebook, and Apple.  While these are large and influential companies they do not represent the total focus of the investment universe.

Chuck Jaffe wrote this excellent piece on the topic of the Dow It’s time to ditch the Dow Jones Industrial Average  over at the Market Watch site.

Investing options are varied and global 

Of the major market benchmarks the broader S&P 500 seems to hold a lot more sway with many money managers and others in the finance and investing world.  I know that personally I am a lot more concerned with this index as a benchmark for large cap mutual funds and ETFs than the Dow.

The NASDAQ is also widely watched due to its heavy tech influence.  I think the bursting of the Dot Com bubble put this index on the radar to stay back in early 2000.

Other key benchmarks include the Russell 2000 for small cap stocks, the Russell Mid Cap, the EAFE for large cap foreign stocks and many others for various market niches.  Additionally there are any number of index mutual funds and ETFs that follow these and other key benchmarks for those who want to invest in these segments of the stock market.

While I’m guessing the Dow will remain a widely watched and quoted stock market indicator I and many others find it increasingly irrelevant.  It is always a good idea to benchmark your investments against the appropriate index for a single holding or a blended, weighted benchmark to gauge your overall portfolio’s performance.

Five Things to do During a Stock Market Correction


As you may or may not know the stock market has been going through some tough days recently.  For example the S&P 500 Index is down about 8% from its all-time high reached in September of this year.  While we are not officially in correction mode (this is usually defined as a 10% or greater drop in an index) there has been a lot of volatility lately.  Here are five things you should do during a stock market correction.

Do nothing

Assuming that you have a financial plan with an investment strategy in place there is really nothing to do at this point.  Ideally you’ve been rebalancing your portfolio along the way and your asset allocation is largely in line with your plan and your risk tolerance.  Making moves in reaction to a stock market correction (official or otherwise) is rarely a good idea.  At the very least wait until the dust settles.  As Aaron Rodgers told the fans in Green Bay after the Packers 1-2 start, relax.  They have since won three straight.  Sound advice for fans of the greatest team on the planet and investors as well.

Review your mutual fund holdings

I always look at rough market periods as a good time to take a look at the various mutual funds and ETFs in a portfolio.  What I’m looking for is how did they hold up compared to their peers during the market downturn.  For example during the 2008-2009 market debacle I looked at funds to see how they did in both the down market of 2008 and the up market of 2009.  If a fund did worse than the majority of its peers in 2008 I would expect to see better than average performance in the up market of 2009.  If there was under performance during both periods to me this was a huge red flag.

Don’t get caught up in the media hype

If you watch CNBC long enough you will find some expert to support just about any opinion about the stock market during any type of market situation.  This can be especially dangerous for investors who might already feel a sense of fear when the markets are tanking.  I’m not discounting the great information the media provides, but you need to take much of this with a grain of salt.  This is a good time to lean on your financial plan and your investment strategy and use these tools as a guide.

Focus on risk

Use stock market corrections and downturns to assess your portfolio’s risk and more importantly your risk tolerance.  Assess whether your portfolio has held up in line with your expectations.  If not perhaps you are taking more risk than you had planned.  Also assess your feelings about your portfolio’s performance.  If you find yourself feeling unduly fearful about what is going on perhaps it is time to revisit your allocation and your financial plan once things settle down.

Look for bargains

If you had your eye on a particular stock, ETF, or mutual fund before the market dropped perhaps this is the time to make an investment.  I don’t advocate market timing but buying a good long-term investment is even more attractive when it’s on sale so to speak.

Markets will always correct at some point.  Smart investors factor this into their plans and don’t overreact.  Be a smart investor.

New Money Market Rules – How Will They Impact You?


The Securities and Exchange Commission (SEC) recently passed new rules governing money market funds.  These rules are designed to combat liquidity problems should the economy experience another period of crisis such as in 2008.

New Money Market Rules – How Will They Impact You?

I’ve read a few articles on this issue but I do not claim to fully understand all of the implications for investors.  I will likely do a follow-up to this post at some point in the future when I know a bit more. Here are a few items from these new money market rules that might impact you.  You might also check out this excellent piece by Morningstar’s John Reckenthaler.

Floating NAV – Institutional Money Market Funds 

For institutional money market funds the stable $1 net asset value (NAV) per share will be gone.  The NAV of these funds will be priced out to four decimal places and will be allowed to float.  Your shares may be worth more or less than what you paid for them upon redemption.

Again this applies to institutional money market funds.  Retail money market funds, defined as funds owned by natural persons, along with government and Treasury-based money funds will retain their stable $1 NAV.  From what I have been told, money market funds owned by participants within a 401(k) or similar retirement plan are considered to be retail funds as well.  I’m not quite as sure with regard to an institutional share class money market fund held by an individual investor.

Liquidity Fees and Redemption Gates 

Both retail money market funds, again excluding funds investing in government and Treasury instruments and institutional funds, will be subject to liquidity fees and redemption gates (restrictions) under certain circumstances.

  • If liquid assets fall below 30%, a fund’s board may impose a 2% fee on redemptions.  This is at their discretion.
  • If liquid assets fall below 10%, a fund’s board must impose a 1% fee on redemptions.  This fee is mandatory under the new rules.
  • If liquid assets fall below 30%, a fund’s board may suspend redemptions from the fund for up to 10 days. 

How will these new money market rules impact you? 

Money market funds will have two years from the date the final SEC rules appear in the Federal Register to be in compliance with the floating NAV, liquidity fee, and redemption gate rules.

According to Benefits Pro:

“Nearly $3 trillion is invested in money-market funds. As of July 3, 2014, more than $800 billion was held in the institutional money-market funds affected by today’s reforms, according to the SEC.” 

Among the main users of institutional money market funds would be pension plans, foundations, and endowments.  They will be the ones directly impacted by the change to a floating rate NAV; however the beneficiaries of these funds will ultimately be impacted should this change have a negative impact on the underlying portfolio.

The liquidity fees and redemption gates will directly impact individual investors.

A 1% or 2% fee on redemptions would be quite a hit to your balance, especially if viewed in terms of today’s interest rates on money market funds in the range of 0.01%.

The ability to delay redemptions up to 10 days could also have an impact especially if you had written a check off of that account to pay your mortgage or some other bill.

The true test will be if we experience the extreme conditions like those that marked the 2008-09 economic down turn.  None the less as an investor it would behoove you to ask your bank, custodian, or financial advisor how these changes might impact any money market funds you hold and also if it makes sense to switch to another cash option.

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