Investment Management
Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. ~ Albert Einstein
Compounding Returns is the Path to Wealth
It is no surprise that Albert Einstein was absolutely correct in his observation that compound interest is indeed a wonder of the world. The power of compounding escapes most people because they have not been taught it, and therefore do not understand it.
Compound investing is simply earning interest on the interest, or earning gains on the gains. Picture a snowball growing larger and larger as it rolls down a mountain - just the same, your investment accounts can literally grow exponentially over time.
Compounding involves reinvesting the capital gains and dividends an asset generates which then produces additional gains to earn even more. Compounding is crucial because it is such a powerful way of earning higher returns without having to do more work or take on more risk. Some forms of investing do not reinvest the amount earrned at all, or do not easily or frequently reinvest the earnings.
By investing in the securities markets, you can easily (automatically) and frequently (monthly) take whatever is earned and continually reinvest. The 3 keys to harnessing the power of compounding are
Along the investing journey there are risks that can delay and possibly derail compounding returns and your quest for a comfortable and prosperous retirement.
Capital Preservation is Paramount
The primary question to be answered when investing in the markets is "risk-on?" or "risk-off?" At Hancock Adviors we utilize sophisticated quantitative market analysis to evaluate that question. In other words, we run with the bulls as long as possible but hide from the bear when conditions warrant. The vast majority of the time the markets are risk-on, but when that tide turns we step aside and move into defensive hedges such as cash, US Treasuries, gold, and inverse ETFs. By detecting and avoiding large market declines, we ensure that our clients sleep well at night and can stay in the game during periods of turmoil.
Besides peace of mind, there are distinct monetary advantages of managing drawdowns such as:
Do You Know Your Current Risk?
Many financial advisors and sophisticated investors look at risk-adjusted metrics in order to compare investing approaches. This concept and the mathematics behind risk-adjusted metrics can be used to compare the returns of portfolios while evaluating their respective risk levels. This means two things: if you compare portfolios offering similar returns, you can choose the one exposed to less risk. Or alterntatively, if you compare portfolios offering similar risk, you can choose the one that expects higher returns.
The best metric we have found to compare strategies is the Ulcer Index. It is superior to Sharpe ratio, Sortino ratio, and others because the Ulcer Index takes into account downside volatility only, and also measures both the depth and duration of drawdowns.
Momentum
There are hundreds peer reviewed academic studies over the last 30 years, including Nobel prize winners, showing that momentum is the factor that most strongly predicts the immediate future of an asset. At Hancock Advisors I use momentum analysis and rely on the empirical fact that asset prices follow trend patterns which, once identified, can be exploited to provide outperformance. I use a diversified combination of rules-based tactical allocation strategies that are applied to a universe of global asset classes represented by low-cost, liquid ETFs. Those separate strategies are then combined to create a portfolio, thus reducing several forms of risk. According to each strategies' quantitative signals, asset allocations are dynamically rebalanced as indicated on a daily, weekly, or monthly schedule.
I believe it is of paramount importance an investment strategy 1) utilize a globally diverse set of assets such as US & international equities and bonds, commodities, real estate, & foreign currencies and 2) be able to adapt as markets change. Moving to defensive assets when markets are falling, or to assets showing momentum when markets are rising just makes more intuitive sense than a static allocation per the conventional buy-and-hope approach.
By using momentum analysis as the foundation of our portfolios, and combining different strategies that each utilize rules-based methods, lookback periods, and rebalance time frames, we are able to invest in portfolios exhibiting excellent risk-adjusted metrics. This allows our clients to stay invested in any market condition and reap the life changing benefits of compound returns.
It is no surprise that Albert Einstein was absolutely correct in his observation that compound interest is indeed a wonder of the world. The power of compounding escapes most people because they have not been taught it, and therefore do not understand it.
Compound investing is simply earning interest on the interest, or earning gains on the gains. Picture a snowball growing larger and larger as it rolls down a mountain - just the same, your investment accounts can literally grow exponentially over time.
Compounding involves reinvesting the capital gains and dividends an asset generates which then produces additional gains to earn even more. Compounding is crucial because it is such a powerful way of earning higher returns without having to do more work or take on more risk. Some forms of investing do not reinvest the amount earrned at all, or do not easily or frequently reinvest the earnings.
By investing in the securities markets, you can easily (automatically) and frequently (monthly) take whatever is earned and continually reinvest. The 3 keys to harnessing the power of compounding are
- Reinvest the gains
- Stay invested longer
- Improve rates of return
Along the investing journey there are risks that can delay and possibly derail compounding returns and your quest for a comfortable and prosperous retirement.
- Firstly, the behavioral risk of not reinvesting your gains is simply overcome by choosing to delay spending or consumption of your investment gains. Instead of cashing out your earnings regularly, you can choose to reinvest them to make that additional money work for you.
Additionally, some forms of investing do not provide compounding at all (CD's, bonds, mortgage notes), and some forms of investing do not easily or frequently provide compounding (real estate). - Secondly, waiting to begin investing is another risk because time in the markets is definitely on your side. In terms of the snowball, think of the height of the mountain as the length of time your investments grow - a higher mountain is better. If you haven't begun investing yet, now is the time to start. As the old proverb says "The best time to plant a tree was 20 years ago. The next best time is today."
- Thirdly, improving rates of return can be done by reducing the risks to which your portfolio is exposed. That is because painful drawdowns require ever larger gains to get back to even. An analogy to think of is two racers equally capable of 200 mph but one has longer pit stops during the race. That racer will be slower overall even though capable of the same top speed as the winner.
Capital Preservation is Paramount
The primary question to be answered when investing in the markets is "risk-on?" or "risk-off?" At Hancock Adviors we utilize sophisticated quantitative market analysis to evaluate that question. In other words, we run with the bulls as long as possible but hide from the bear when conditions warrant. The vast majority of the time the markets are risk-on, but when that tide turns we step aside and move into defensive hedges such as cash, US Treasuries, gold, and inverse ETFs. By detecting and avoiding large market declines, we ensure that our clients sleep well at night and can stay in the game during periods of turmoil.
Besides peace of mind, there are distinct monetary advantages of managing drawdowns such as:
- higher ending total values of your portfolio
- increasing your safe withdrawal rate in retirement
- reducing sequence of returns risk
Do You Know Your Current Risk?
Many financial advisors and sophisticated investors look at risk-adjusted metrics in order to compare investing approaches. This concept and the mathematics behind risk-adjusted metrics can be used to compare the returns of portfolios while evaluating their respective risk levels. This means two things: if you compare portfolios offering similar returns, you can choose the one exposed to less risk. Or alterntatively, if you compare portfolios offering similar risk, you can choose the one that expects higher returns.
The best metric we have found to compare strategies is the Ulcer Index. It is superior to Sharpe ratio, Sortino ratio, and others because the Ulcer Index takes into account downside volatility only, and also measures both the depth and duration of drawdowns.
Momentum
There are hundreds peer reviewed academic studies over the last 30 years, including Nobel prize winners, showing that momentum is the factor that most strongly predicts the immediate future of an asset. At Hancock Advisors I use momentum analysis and rely on the empirical fact that asset prices follow trend patterns which, once identified, can be exploited to provide outperformance. I use a diversified combination of rules-based tactical allocation strategies that are applied to a universe of global asset classes represented by low-cost, liquid ETFs. Those separate strategies are then combined to create a portfolio, thus reducing several forms of risk. According to each strategies' quantitative signals, asset allocations are dynamically rebalanced as indicated on a daily, weekly, or monthly schedule.
I believe it is of paramount importance an investment strategy 1) utilize a globally diverse set of assets such as US & international equities and bonds, commodities, real estate, & foreign currencies and 2) be able to adapt as markets change. Moving to defensive assets when markets are falling, or to assets showing momentum when markets are rising just makes more intuitive sense than a static allocation per the conventional buy-and-hope approach.
By using momentum analysis as the foundation of our portfolios, and combining different strategies that each utilize rules-based methods, lookback periods, and rebalance time frames, we are able to invest in portfolios exhibiting excellent risk-adjusted metrics. This allows our clients to stay invested in any market condition and reap the life changing benefits of compound returns.