New guidelines, better advice?

By Bob Veres

Most people think that the Securities and Exchange Commission (SEC) regulates the investment markets and providers of investment advice, and that the Financial Industry Regulatory Authority (FINRA) regulates the Wall Street sales agents.

But in fact, when it comes to your retirement plan, like a 401(k) account, the chief regulator is actually the United States Department of Labor.  Anybody who provides advice to these plans has to meet standards generally defined in the 1975 law known as ERISA (Employee Retirement Income Security Act), which is administered by the Department of Labor.

The list of retirement plan advisors is a long one.  There are independent financial advisors who receive fees directly for their work, and act in the best interests of the plan participants.  But many plans have been sold by insurance agents and brokers, who creatively introduce a growing array of hidden charges and fees and high-cost investments which, according to analysis by the White House Council of Economic Advisors, together have been quietly shifting roughly $17 billion a year out of the pockets of American workers into Wall Street bonus pools and insurance company coffers.

This month, the Department of Labor issued rules designed to stop these brokers and agents from working in their own interests rather than the interests of American workers.  The rule imposes iron-clad fiduciary requirements on anyone who provides investment advice to these plans or plan participants.  “Fiduciary” is a legal term that is grounded in case law, but essentially it means that the customer’s interests must be the priority when any investment recommendation is made.

In addition, the Department of Labor extended these new, stronger protective rules to anyone who recommends that consumers roll their money out of a retirement plan into an IRA.  Those investment recommendations, too, must also be made in the best interests of the customer.  This was intended to prevent insurance agents and brokers from recommending that their customers move money out of the newly-cleaned-up plan into the same high-commission products (like variable annuities and non-traded real estate investment trusts) that they had been recommending in the plan.

How well will this new set of rules protect consumers?  At this point, there is reason to be optimistic.  The larger sales organizations on Wall Street and in the insurance industry could be sued under this strict fiduciary standard if their brokers and agents continue their current practices, and they would be unlikely to prevail in court.  The safest course would be for these organizations to set up divisions made up of people who would be trained to recommend only lower-cost or high-performing investment options, meanwhile giving up the sly hidden fees that they have been collecting for decades.

Alas, the rule specifically states that existing arrangements will be grandfathered, which means that if you’re a participant in a plan at your workplace, you may not immediately feel the impact of new fiduciary obligations.  But over time, most companies are expected to take a closer look at their fee structure, and as they amend their plans, the money leaks will gradually be repaired.

Eventually, if the analysis is right and workers suddenly find themselves with, collectively, $17 billion a year more in their retirement accounts than they were getting before, we could see a difference in the number of people who can afford retirement.  The only losers would be Wall Street bonus pools, which, for most observers, actually makes this a win-win.

Cheaters, Thieves and Tax Havens

By: Bob Veres

Leaked information tells the story of prominent world leaders who avoided taxes or looted their country’s treasuries in order to squirrel away not only money, but expensive yachts, luxury homes, ownership of a candy company and investments in construction companies.  The Prime Minister of Iceland has already resigned as a result of the leaked client files of a Panamanian-based law firm that specializes in creating secret tax havens.

What, exactly, are we to make of the Panama Papers leak?

The sometimes shocking revelations that are making their way into news outlets is the result of a hack into the files of a giant Panamanian law firm known as Mossack Fonseca, which had apparently become the world’s go-to resource for kleptocrats and tax avoiders who wanted to hide assets away in shadowy offshore shell corporations.

The hackers ultimately sent 11.5 million records to the German newspaper Suddeusche Zeitung, which promptly shared the massive data trove with the various news organizations that are members of the International Consortium of Investigative Journalists.  Their analysis is far from complete, but what we know so far is what you probably already suspected: the leaders of certain countries like the Ukraine, Syria, Saudi Arabia and Russia have been squirreling away state resources into their own secret personal accounts, while prominent leaders in less corrupt nations have been quietly funneling money into offshore havens to avoid having to pay their fair share of taxes.  And this activity has apparently been going on for decades.

Nobody should be terribly surprised that close associates of Russian president Vladimir Putin—including cellist Sergei Roldugin, along with brothers Arkady and Boris Rotenberg—are connected to more than $2 billion in shadowy assets, some of which found their way back into Russia’s TV advertising business.   The Rotenbergs are also proud owners of seven British Virgin Islands-based companies that, in turn, control investment assets around the world.

Nor was the world astonished to learn that two cousins of embattled Syrian President Bashar Assad have been filtering tens of millions of dollars worth of the country’s oil revenues through numerous offshore accounts.  Former Iraqi interim prime minister Ayad Allawi managed, in his brief kleptocratic term in office, to secret away assets in a Panama-registered company called I.M.F. Holdings and a British Virgin Islands company called Moonlight Estates Ltd.

The embattled people of Ukraine are doubtless outraged to discover that Ukranian President Petro Poroshenko is sole owner of a British Virgin Islands firm that secretly controls a European candy factory, auto plants, a TV channel, a chocolate business and a shipyard.  And one wonders why Saudi Arabian king Salman Bin Abdulaziz Bin Abdulrahman Al Saud would want to hide assets offshore in several British Virgin Islands companies that hold $34 million in mortgages for luxury homes in London, and a fancy yacht that he uses for pleasure cruises.

The most immediate fallout from the released files is the resignation of the Prime Minister of Iceland, Sugmundur Gunnlaughsson, after it was revealed that the Panamanian law firm had secreted $4 million of bonds in his name through a British Virgin Islands shell company—assets he had never gotten around to revealing to the nation’s tax collector.

The list of offshore cheats also includes the former Prime Minister of the nation of Georgia, Argentine President Mauricio Macri, former Jordanian Prime Minister Ali Abu Al-Ragheb, former Qatari Prime Minister Hamad Bin Jassim Bin Jaber Al Thani, and some people whose names you might recognize: soccer player Lionel Messi and the late father of UK Prime Minister David Cameron, who apparently avoided British taxes for 30 years on his investment fund by employing accounts based in the Bahamas but incorporated in Panama.

High-ranking Chinese and Spanish officials, and six members of the British House of Lords also made the list.

As the hacked files are sifted through for more revelations, it reminds us that, while data security issues are a huge nuisance for all of us, they not an unalloyed evil.  Hacked files can sometimes lead to greater social transparency, and help us spot the people who cheat or steal, some of whom, by strange coincidence, happen also to be among the world’s wealthiest individuals.  But, if these assets are frozen by international monetary authorities, perhaps not for long.

Many Guns, Many Deaths

by Bob Veres

The recent news of three gunman shooting innocent civilians in San Bernardino, CA has prompted a number of news outlets to point out that this is nothing new.  Mass shootings—defined at shootings at a public place in which the shooter murdered four or more people, excluding domestic, gang and drug violence—are happening more than once a day in 2015.  Indeed, an interactive map that identifies each location since the December 2012 Sandy Hook shooting gives an alarmingly dense coverage of the U.S.  The map included in this article only shows the locations (deep red circles indicate places where more than one shooting took place), but the actual map (located here: tells the actual date and location of each incident.

The total: 1,042 mass shootings, 1,312 people killed, 3,764 wounded.  These numbers are compiled by Mass Shooting Tracker, which, the website notes, is crowdsourced and requires that all circles on the map be verified with news reports.  It may be missing some incidents.

Despite these alarming numbers, mass shootings still make up a small minority of all firearm deaths in America—which total more than 32,000 each year.  However, contrary to what you may hear, two-thirds of those deaths are suicides, not homicides.  Nevertheless, when you add in all the statistics, in 2012, the most recent year that we have accurate numbers, there were 29.7 firearm related deaths per 1 million Americans.  The comparable statistic in Canada: 5.1.  In Germany, the rate is even lower: 1.9 per 1 million citizens.  One possible explanation for a violent death rate that is orders of magnitude higher than other countries: more guns.  The U.S. makes up about 4.4% of the total global population, but owns 42% of the world’s civilian-owned guns.

Major Changes Ahead

by Bob Veres

When you look at recent history, the changes in our daily lives have been breathtaking.  Nine years ago, the iPhone hadn’t been invented yet and so there were no mobile devices to keep people staring at their screens as they walk around in public.  Facebook was a college phenomenon, there was no Twitter, and the cloud was that fluffy white thing passing by overhead.  No apps, nobody was talking about self-driving cars, solar panels were rare, and light bulbs were incandescent rather than LED.  America was heavily dependent on foreign oil, and you had to ride a cab rather than in the passenger seat of a stranger’s car if you wanted to get home from the airport.

What will be the next breakthrough technologies that will rock our world?  An article in SingularityHUB, published by Singularity University, offers a handful of predictions that are already in the early stages of changing our world today.

The first is clean energy, whose widespread adoption would dramatically disrupt the traditional oil and gas and coal industries, and make electricity dramatically cheaper for all of us.  The article says that every two years, solar installation rates have been doubling, and the cost of photovoltaic modules are falling by about 20%.  These panels are expected to halve in price by 2022, and they will be far more efficient in the amount of energy they capture.  By 2030, the article estimates that solar power will be able to provide 100% of today’s energy needs, and by 2035 energy will be almost free—kind of like cell phone calls are today.

The second big change is the fall of China as the world’s manufacturer, led by a return to locally-sourced manufacturing.  This will be driven by advances in robotics that are already finding their way to the factory floor.  The Chinese government is aware of the trend, and currently has an experimental facility that is being labeled as the world’s first “zero-labor factor” factory, where robots replace humans doing the hard rote work of assembling cars and appliances.

Unfortunately for China, the robots in Guangdong Province are no more productive than the robots here in the U.S. or anywhere else in the world.  They work 24 hours a day, and are unlikely to join labor unions.  Their cost is going down yearly.  So why would a company in the U.S. outsource manufacturing to China and incur the long shipping times and high transportation costs when they can assemble the finished goods right next to the customer base?  Manufacturing will once again become a local activity.

A third change will be what the industry is calling digital manufacturing—which you know as 3D printers.  The parts that the robots will be assembling have traditionally been made with lathes, saws, milling machines and drill presses, which physically remove material to obtain the desired shape.  Digital manufacturing produces those same components using the opposite approach, with powdered metal, droplets of plastic and other materials brought in to add materials to a frame.

The article says that in the early 2020s—less than a decade from now—households will buy low-priced 3D printers, and order things online.  The online services will send instructions to the 3D printers to manufacture the item right there in the spare bedroom.  Eventually, these printers may take jobs from the robots, who by then might be intelligent enough to organize their own protest rallies.

Why You May be 15 Years Younger Than You Think You Are

by Bob Veres

How long are you and I going to live?  None of us knows, of course, but this number is important for a variety of planning issues—including, of course, how long your money will have to last in retirement.  Actuarial tables tell us how long people will live on average, but that isn’t much help for planning a specific person’s life, and the averages conceal a lot of variation.

Living today is a huge advantage over living in the past, and living in a developed nation is a benefit as well.  As you can see from the chart, most children born in the late 1700s had a life expectancy below age 35; today, the global average is 70, and people who make it to age 65 have a good chance of living to 85 or longer.

If you’re above the national average in wealth and income, and especially if you have certain lifestyle characteristics like regular exercise and no tobacco usage, then there’s a good chance you’ll live longer than these averages.

There’s a website that can help you get a better feel for your expected lifespan; it’s called Living to 100 (  The site asks you a series of questions including your birthday, gender and marital status, and some interesting questions related to the number of new relationships you’ve developed over the last 12 months, the way you cope with stress and some of the sources of stress you’re currently experiencing, your normal sleep habits and your education level.

There are questions on nutrition, your height and weight, how often you eat red meat and sweets, and at the end, you are told how well your answers match up with the tendency to live a long life.  At the end of a tutorial on your answers and suggestions for improvement, you get a calculated life expectancy, and a list of things that could add as many as ten years to that life expectancy.

Chances are, you’ll be surprised at how long you’re expected to live, and astonished at the possibilities suggested in the list of potential changes to your lifestyle.  That means that you’ve managed your life and your health intelligently, and the extra years could be an unexpected bonus.  Of course, it also means that you should take a second look at how much you’ve saved and the possibilities of using your skills and experience to earn income during retirement.

Bottom line: you may discover that you have 15 more years to live than you expected based on your experience with your parents, which means you can start thinking of yourself as 15 years younger when you look at your options and personal timeline.

Medicare Fix-It

by Bob Veres

Congressional leaders and the Obama Administration have fixed the potentially alarming increase in Medicare Part B premiums under the recently-passed government budget deal.

Medicare Part B covers most health care services outside of hospitals, and thus represents one of the biggest expense items in the government-run health system. The program is voluntary, but 91% of all Medicare beneficiaries are enrolled in Part B.

The problem that had to be fixed arose because, under Social Security and Medicare rules, the government is required to collect 25% of all expected Part B costs from recipients each year—in the form of premiums. The total Part B cost was anticipated to reach $171.2 billion 2016.

However, another provision says that in years where there is no increase in Social Security benefits—such as next year—Medicare premiums must be held steady for current Social Security recipients. As a result, the entire increase would have had to be borne by enrollees who either don’t yet collect Social Security checks; enrollees with incomes above $85,000 (single) or $170,000 (married); or are dual Medicare-Medicaid beneficiaries. In all, these three categories represent 30% of 2016 Medicare beneficiaries—roughly 7 million Americans.

The new budget deal creates a $12 billion loan from the U.S. Treasury to the Medicare trust fund to reduce the impact on those Medicare participants. Instead of seeing their monthly premiums go up from $104.90 to $159.30, they will experience a more modest 14% premium increase, to $120 a month next year, plus a monthly surcharge of $3. This will allow premiums to rise more gradually, and spread the cost over a longer period of time.

Bear in the China Shop

by Bob Veres

China’s stock market appears to be back in free-fall, despite the Chinese government’s efforts to control stock prices and stem the panic. The chief culprit appears to be leverage: investors last year and in the first half of this year borrowed billions in order to buy stocks on margin, offering little or no collateral except the shares themselves. As prices fall and stock values drop below the level of debt, it triggers margin calls from the lenders, which forces investors to sell at any price, further depressing prices, causing more margin calls in a downward spiral whose bottom is not easy to see from here.

A recent report said that the volume of these margin loans dropped by 6%, or $23 billion over the past five trading days, which implies that there is still $383 billion more that could be called over the next months or years, an alarming 9% of the roughly $4 trillion in total market value on the Shanghai market.

But leverage is only part of the problem. The CSI Information Technology Index, a mix of high-tech names in China similar to the Nasdaq in the U.S., is still trading at around 75 times earnings, while Nasdaq’s PE is closer to 30. If the two indices were to normalize, it would imply that Chinese stocks could drop an additional 60% in value before the current bear market has run its course—and that’s assuming the debt situation doesn’t cause the market to overshoot on the downside.

One complication in the situation is the fact that, since late last year, foreign investors have been allowed to invest directly in Shanghai-listed stocks. Savvy market traders with years of experience in these death spiral events have been making program trades which bet on further drops. Chinese regulators recently suspended 34 U.S.-based hedge fund accounts from trading, including the Citadel Fund, and short selling is now totally forbidden.

Meanwhile, the economic fundamentals in China aren’t looking good. The Caixin China Manufacturing Purchasing Manager’s Index recently fell to levels which indicate economic contraction, and industrial output is at the weakest level since November of 2011. You don’t often see a market rally when an economy is sliding into recession, so at these valuations, you aren’t likely to find many bulls left in the Shanghai China shop.

The First Question to Ask Everyone

By Bob Veres

Suppose you truly want to connect with other people.  What’s your best strategy?

Most of us start off with questions like: what do you do for a living?  And: where did you grow up?  We ask for facts and then try to extrapolate a living person around the data that we gather.  But that doesn’t tell us who that other person is, and it represents polite conversation rather than a genuine attempt to connect.  Research shows that connecting with people is far more valuable than gathering data on them.  It’s also more interesting.

A better strategy, proposed by New Zealander Bernadette Logue, is to see everybody you encounter as a story, and to ask: What’s your story?  She points out that all stories are unique; your upbringing, challenges, your hard-learned lessons, experiences, achievements and gifts all communicate far more of relevance than your job description.

When you ask for someone’s story, you learn what they’ve learned, and you have an opportunity to connect on a deeper, more profound level.  A win-win.  Logue says that each person is like a new blockbuster movie, and the tickets are free.  she calls this “The question you should ask everybody you meet.”

The Value of Objective Planning

by Bob Veres

What is the value that people get when they work with an objective, client-focused financial planner?

Most planning firms are reluctant to toot their own horns—partly out of modesty, and partly out of a conviction that you probably have better things to do than read about how they help you with your financial life.  But every once in a while, it’s a good idea to stop and think about what you get for what you pay.

This list is organized in rough order of value, and if you feel you aren’t getting any of these benefits, please let us know immediately.

1) An independent financial planner helps protect you from financial predators.

It’s a touchy issue in the profession whether advisors who put their clients’ interests first should be “bashing the competition,” but in fact the Wall Street firms that pretend to offer financial planning guidance are seldom (if ever) looking out for the best interests of their customers.  When you work with a broker (also known, on the business card, as a “vice president of investments,”) you will be presented with separately-managed accounts that look like mutual funds except they share their fees with the brokerage firm, plus a lot of investments that have to pay people to recommend them—never a good sign for the end investor.

And since the investment markets are extremely complicated, it’s usually hard for a layperson to know when there are much better alternatives than the “opportunities” being presented.

2) An independent financial planner helps you keep track of–and make more efficient–your financial affairs.

It is not uncommon for financial planners to talk with clients who once had a will drawn up, but they’re not sure exactly when.  Now that you mention it, they’re curious about what, exactly, it says.  There’s an insurance policy in a drawer somewhere, and it may be term or it may be a cash value contract; all the client knows for sure is that he writes a check to the insurance company every year.  Upon inspection, it turns out the auto insurance policy he happens to own is way more expensive than the lowest rate available in the market, and the homeowner’s policy hasn’t been updated since the Clinton Administration.

And the investments are not uncommonly a hodgepodge of what a broker sold the client based on what he was told by his bosses to recommend at different times during the relationship.

Hopefully, this was never you.  But it does offer a certain peace of mind to know that everything is organized, in one place, and that somebody is paying attention to the details.  Because in your financial life, the details matter.

3) An independent financial planner will stand between his/her clients and the dysfunctional emotional decisions that everybody makes with their own investments.

Do you remember how it felt when Lehman Brothers went down, and the U.S. government was bailing out General Motors?  Many people sold everything at the bottom, and then waited, and waited, and waited to get back into the markets until it was “safe.”  They never dreamed that the markets would go on a six year bull run that would take us to new record highs.

The Morningstar organization has calculated the difference between investment returns and investor returns—that is, between the returns people get vs. what the markets (or individual mutual funds) have delivered.  Results?  It is not unusual, during various time periods, for individual investors to get about half the returns of the market.  How is that possible?  They may be moving the portfolio around, or buying an attractive-looking hot fund or selling a great fund that’s going through a rough patch.  They may sell out at the bottom of a scary period, or go all-in when the markets are about to take a nasty tumble.

For many of us, the best approach is to find good, solid investments and stay the course through thick and thin, ups and downs.  But it’s very hard to do those things on your own.  An independent advisor provides a dose of objectivity right when you need it.

4) An independent financial planner is a strong advocate for your future.

You know the statistics about the savings rate in America (the 2000-2008 numbers hovered around 0% of income, spiked briefly after the Great Recession and are now back in the 1% range again).  But the keepers of these statistics don’t tell you that they probably overstated the actual rate, because they didn’t include things like increasing credit card balances or home equity loans.  When people put money in their savings account, and at the same time run up more debt, it counts as an increase in their savings.

The problem for most consumers is that there is no voice in their environment advising them to pay themselves a fair percentage of the income they earn.  Instead, they’re bombarded by messages which make powerful arguments to do the opposite: to buy this, that or something else.  The entire advertising community conspires to take those dollars out of their hands before they ever hit an investment account.

Advisors become that rare voice speaking out in favor of saving.  And in some cases, they help identify expenditures that are not in line with your stated future goals.  Which leads us to:

5) An independent financial planner helps people identify what is important in their lives and prioritize their goals.

How many people do you know who have taken the time to identify what they really want out of life?

The incredibly sad truth is that the vast majority of people in our advanced, prosperous society have not taken the time to figure out what they really want out of the all-too-brief time they will spend on this planet.  And because they don’t know their destination, they will never reach it.  They are, in a very real sense, at the mercy of whatever agenda others have for them.

An independent financial planner will ask questions in your initial interview which help you recognize what you don’t know about what you want, and help you identify your most personal goals and desires.  That, alone, can be a priceless service.

6) An independent financial planner can help people turn seemingly impossible goals into a routine that can achieve them.

After years of running retirement planning spreadsheets, and working with successful individuals in the community, advisors eventually master one of the truly magical lessons of life: that any enormous goal can be broken down into manageable, monthly increments, and achieved by routine and persistence.  You save X amount of dollars every month in a portfolio that gets something close to what the market offers, and you will retire with a sum of money that seems impossible to you now.

Clients who have goals that they don’t believe they can achieve are put on a schedule that will get them there as a matter of routine.

Of course, this list doesn’t include specialized services like making retirement planning projections, charitable planning, creating special needs trusts for a disabled child, evaluating disability and long-term care insurance—and it doesn’t mention the comfortable knowledge that you can call an expert for advice on virtually any financial subject, and you’ll get an answer that is not tainted by a sales agenda.

The point is that the services offered by an independent financial planner can have enormous value to people who are motivated to enjoy successful, prosperous lives.  An independent planner’s only goal is your success and prosperity, which should not be—but is—unusual in our financial world.

The Other Dimension of Risk

by Bob Veres

When it comes to investing in the stock market, the risk that everybody talks about is the ups and particularly the downs, the bearish periods when the market falls dramatically and keeps falling for months or even years.  (Think: 2000-2002 or 2008)

The real damage isn’t the fall itself, but the fact that many investors watch the ongoing free-fall with increasing horror until they can’t stand the pain any more, sell out of the market at or near the bottom, and then lick their wounds on the sidelines and miss the recovery.  Over the course of this round trip, they lose real money, while those who had the fortitude to hang on recovered their losses.

Recently, professional advisors have begun talking about a different dimension of risk, which is just as insidious, just as potentially damaging to the wealth of their clients, but much-less-widely discussed.  It’s called “frame-of-reference” risk.

Frame-of-reference risk can be defined as the risk that people will look at the performance statement of their diversified investment portfolio and notice that its return is falling short (sometimes far short) of the market index they’re most familiar with—typically the Dow or the S&P 500.  They abandon the diversified investment approach and concentrate their holdings in the local market right as the other investments they sold are about to take the performance lead.

To see why this is a risk at all, consider the bull market in tech stocks in the late 1990s.  Figure 1 shows the rate of return in the late 1990s and early 2000s of U.S. stocks compared with an ABCD portfolio consisting of equal parts U.S. stocks, foreign stocks, commodity-linked equities and real estate investment trusts—a diversified mix of risk assets, rebalanced each year.

Notice that in 1995, the diversified portfolio got walloped by the U.S. market—a difference of more than 16 percentage points.  In 1997 and 1998, the differences were even more pronounced: almost 23% and just under 30%.  This was a time when many investors were telling their advisors that the rules of investing had changed, that technology, clicks and eyeballs were the new standard by which stock values should be measured.

If they abandoned their diversified ABCD strategy at or near the bottom, in late 1999, these investors would have been concentrated in U.S. stocks in 2000, when the diversified approach beat the U.S. market by more than 22 percentage points.  They would have missed the great return of a diversified portfolio in 2002, when it outperformed U.S. stocks by 21%.  The next three years also saw the diversified portfolio beat a concentrated U.S. stock holding, as  commodities, real estate and foreign stocks delivered solid returns.

The advantages of buy and hold are relatively straightforward—even if they’re not easy to appreciate during a market downturn. But what, exactly, are the advantages of hanging onto a diversified portfolio?

One answer lies in the mathematics of returns.  Notice (Figure 2) that gains and losses are not symmetrical, and the differences becomes greater with magnitude.  A loss of 10% requires a modest 11% gain to get back to the original portfolio value.  But a 20% loss requires a 25% gain, a 30% loss doesn’t recover until the portfolio has achieved a subsequent 43% gain and a 50% loss doesn’t get back to even until the battered portfolio gone up 100%.

When a portfolio holds different asset classes, which move up or down out of sequence with each other (which, in the vernacular, are “not highly-correlated”), it tends to smooth out yearly investment performance.  Portfolios that deliver smoother returns don’t have to experience extreme recovery to stay in positive territory.  As a result, they will have higher terminal values than choppier portfolios, even if the average yearly return is the same.

Another answer lies in the idea of reversion to the mean.  When one asset class (like U.S. stocks) is soaring, and everything else is lagging, that means the soaring asset class is getting relatively more expensive than the others.  Eventually, prices will return to normal in both directions, and the other investments will have their day in the sun.  So when someone abandons a diversified investment approach after years of underperformance, she loses twice.  She has already paid the “penalty” (so to speak) for being diversified when diversified was losing to U.S. stocks.  Then, when she goes all-in on U.S. stocks, she loses the “benefits” that eventually follow when those other asset classes go up faster than the Dow.  The late 1990s and early 2000s were a perfect example of this.

This can be summed up neatly by looking back at the investor’s dilemma during the tech bubble.  People who held a diversified mix of the four asset classes—U.S. stocks, foreign stocks, commodity-linked investments and real estate—enjoyed a 13.05% average yearly return from 1994 through 1999.  They achieved a 9.96% return in the subsequent five years, from 2000 through 2005.

Were they happier with their higher return in the first five years?  No.  They were firing their advisors, because the U.S. stock market happened to be gaining 23.55% a year, and they felt like losers.  Were they unhappy with the lower 9.96% yearly returns the diversified portfolio delivered in the subsequent five years?  No; in fact, they were ecstatic, because their portfolios were outperforming at a time when the U.S. market was losing value.

Of course, many investors today are facing this frame-of-reference risk head-on.  The U.S. market has been booming since the bottoming out in March of 2009, while the rest of the world has been mired in a recessionary hangover.  Commodities—most notably oil, but also gold—have been retreating lately.  Real estate had a bad stretch after the Great Recession.  It’s easy to question the value of those other assets in a portfolio with the benefit of hindsight.  But with the benefit of historical perspective, the underperformance of broad asset classes usually reverses itself, and we never know exactly when that will happen.

At times like we are experiencing today, when the U.S. markets are enjoying a long  uninterrupted run of good fortune, frame-of-reference risk starts to come out of the closet and threaten your financial health.   All we know about frame-of-reference risk is that, just like the more well-known volatility risks, it lures investors to abandon their long-term strategy at the wrong time—and when people give in to it, it becomes a net destroyer of wealth.