Tag Archives: risk

Buyer Beware

Posted August 7, 2014 by admin. tags:Tags: , , , , , , , , , ,
Buyer Trap

Written by Nathan White, Chief Investment Officer of Paragon Wealth Management. 

The artificially low interest rates and asset purchases engineered by the Federal Reserve are causing a misallocation of private investment.  Investors and savers have been clamoring for anything with yield and it is prompting many people to put their money in horrible investments.  This is one of the unintended consequences of Fed’s extraordinary accommodative actions that have been in place for years now.  Investors are taking on a lot of risk and illiquidity to generate what are often very low returns.  They are sacrificing the returns and liquidity that are so crucially needed for the long-term.

There are a lot of bad financial products being sold to investors today that take advantage of investors’ desires to avoid risk and get a “safe” return.  Financial companies are always happy to create a product that sells the best in the current environment.  The angst from the financial crisis and the desire for yield in this low rate environment are helping many salespeople aggressively push the following bad investments:

Structured Products – Structured products are unsecured debt securities of banks and offer payouts that depend on the value of an underlying security.  The most common types pay out a fixed coupon as long the stock or underlying index stays above a buffer price.  If the price drops below the buffer price then the coupon is not paid and you could be issued the stock or participate in the downside below the buffer price.  The reason these products attract investors is the relatively higher coupon than is generally available from fixed income and the downside protection offered by the limited buffer.  I liken these structured products to buying a bond but having the downside risk of a stock.  The upside return is capped while only part of the downside exposure is protected.  Why sell away upside?  The end result is a lower return than could have been achieved with a simple combination of stocks and bonds.

Equity Indexed Annuities (EIA’s) – Equity Indexed Annuities offer a combination of participation in the market’s upside and a minimum guaranteed fixed return. The sales pitch goes along the lines of, “you get the upside of the stock market without any of the downside”!  Who wouldn’t want that!  Utopia! However, the old adage of “if it sounds too good to be true then it isn’t” certainly applies in this case.  EIA’s returns are tied to an index such as the S&P 500 of which the buyer gets a certain percentage of the increase but is also capped on the upside.  For example, an annuity with a participation rate of 70 percent and a cap of 8 percent would be credited with 7 percent of the index was up 10 percent.  If the index was up 30 percent the annuity would cap you at 8 percent.  If the market returns is negative or lower than then the credited index return there is a minimum guaranteed return of say 3 or 4 percent that is credited.  In addition, the calculations used to determine the index return are less than optimal and omit dividends. The insurance company also has the right to change the terms during the life of the contract.  Commissions are typically between 5 to 10 percent and surrender charges can be 10 percent or higher.  The annual fees and expenses are often 2 percent or higher which reduce the aforementioned possible returns even further.  The statements you get are very confusing and difficult to determine how much the annuity is really worth.  Complexity disguises the costs.  In a November 2011 Reuters article by Marla Brill, Eric Thomes, senior vice-president of Allianz (the largest issuer of EIA’s) said that the average annual returns of these products have been around 4 to 6 percent after expenses but not surrender charges.  He was quoted as saying, “These are for someone who’s looking for safety and is happy with the potential to get a slightly higher return than a fixed annuity or a bank CD”.  Here is an insurance executive’s own admission of what these products really are. The salespeople certainly don’t pitch them this way!

EIA’s have primarily been the domain of insurance agents but are now being peddled by brokers as well.  After brokers started selling these, FINRA (their regulatory arm), had to issue a warning to investors alerting them of the risks and characteristics of EIAs.  Not very many investment products ever get their own warning!  So, if you like limited upside, limited access to your money, high commissions and fees, complex formulas and changing terms, these annuities are for you.  The bottom line with these subpar products is they are an expensive way to get a low return.

Non-traded REITs – These are Real Estate Investment Trusts that are registered with the SEC but don’t trade on an exchange and have become very popular the last few years.  However, they are very expensive, highly illiquid, rife with conflicts of interest, can be very risky, resulting in returns lower than promised.  Front-end fees range from 12% to 15% with the typical commission of 7% going to the broker.  InvestmentNews reported that almost $20 billion of non-traded REITs were sold last year translating into about $1.4 billion in commissions.  The NAV or price of the REIT is often reported the same quarter after quarter and when combined with the income element produces a nice steady upward trending graph on sales literature that is pleasing to the eye.  They are positioned as low volatility investments but because they don’t trade the volatility can’t be measured.  In order to produce the illusion of a high payout they often use leverage and/or the dividend paid often includes a return of capital.   If investors saw how much had been taken out of their value in fees in their first statements they would be shocked.  In April of this year, the research firm Securities Litigation & Consulting Group produced a study that after fees and expenses, non-traded REITs had an average annual return of 5.2% from 1990 to 2013.  Now that the real estate market has largely recovered so have prices and that means you should be very careful about what type of real estate investments you buy.  Low interest rates are making many subpar or questionable projects seem good.  When interest rates inevitably rise it will expose these faulty investments.

All three of the above products share similar characteristics of high commissions and fees, illiquidity, and limited or low returns.  Because illiquid portfolios do not report their prices in a continuous manner they can create the illusion of stability or low risk.  The reward for illiquidity should be higher.  The perceived safety is expensive and usually not worth the cost.  There must be a price paid to avoid volatility.  One can often replicate the same strategies these products employ on the open market – that’s what the issuers are doing!  The true risk with many of these products is missing out on the upside returns that are crucial to investing.

So what’s the best way to reduce risk and get a decent return?  A diversified portfolio can be best “hedge” long-term.   A simple portfolio using stocks and bonds can generate income and help one stay ahead of inflation while providing access to funds if needed.  Historically, a portfolio with 60 to 70 percent bonds, 20 to 30 percent stocks and about 10 percent cash is close to the “sweet” spot for minimizing volatility.   From 1950 to 2013, a 30/60/10 mix of Stocks/Bonds/Cash has had an average return of about 7.7 percent with a maximum one year loss of 5.4 percent with over 84 percent of the years producing positive returns (Source: NDR Asset Allocation – Risk & Reward, based on S&P 500, Barclays Long-Term Treasury Index & T-Bills).

If you or anyone you know is being pitched on any of these products please contact us.  We can offer a lower cost liquid alternative.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

The Year In Review

Posted January 17, 2013 by admin. tags:Tags: , , , , ,
Cold Winter

Written by Dave Young, President & Founder of Paragon Wealth Management
2012 continued the volatility that’s characterized markets since the global financial crisis, which will be marking its fifth anniversary in
September.  This year’s market moves were driven by three primary issues, Europe, the Middle East, and U.S. Politics.

We had a back and forth flow of good and bad news all year out of Europe.  Positive indications for Europe’s economy in the first quarter led to the strongest start for markets in recent memory.  These gains were promptly given back as concerns rose in the second quarter. Markets then rallied in the second half of the year when the European Central Bank announced that it would provide liquidity to governments and financial institutions – to the point that for 2012 as a whole, Europe’s stock market actually outperformed the U.S.

Middle East problems added to the mix this year.  This time it was Syria, Libya, Egypt, Israel and Iran that kept things stirred up.
Problems there always add an element of fear to investors in the U.S.

Our politicians provided a lot of political theater due to the election
year.  Markets rallied from June through October and then sold off into the election. After a short post election sell off, the markets surprised a lot of nervous investors and rallied through December.

The final act of the year was the drama surrounding the “fiscal
cliff”.   According to the press the fiscal cliff was the “Big Scary” issue that was going to sink the stock market.  Instead, our politicians
came through an hour before year end and voted on a 150 page bill they had three minutes to read.  As usual, it doesn’t cut spending, doesn’t significantly raise revenue and kicks the can down the road another few months.  The more things change the more they remain the same.

Overall the year was very volatile and very choppy.  The surprise this year was that in the face of all of the negative news most markets moved higher.

The Outlook for 2013

In the short term, through 2014, there are a lot of reasons to be bullish on stocks.  The US housing market has hit bottom and should be a positive force in 2013.

Growth in the middle class in emerging markets will continue to provide opportunities for investors and for companies selling into those markets.  Huge new oil discoveries should put a cap on the price of oil, which is always a boost for the economy.  Stock valuations are still favorable.  Low interest rates that hurt bonds are very good for stocks.

Over the long term, I have some serious concerns.  The biggest obstacle is going to be the debt that our politicians continue to grow.
We are 16+ Trillion in debt and going further into debt every day.
Forty two cents of every dollar that the federal government spends is still borrowed from our kid’s and grandkid’s future. Based on current policy, that 16 Trillion dollar debt isn’t going to magically disappear.  At sometime in the future it will have to be addressed.  If it isn’t then we will experience a real cliff.  That is the one that we will be watching out for.

Investing is difficult.  It rewards those who have the discipline to stick with their long-term strategy during challenging times. It punishes those who jump in and out and are always chasing what worked most recently.

Always focus on what you can control. That includes managing your risk by making sure your risk tolerance is set properly.  Following a disciplined, systematic process that has a long term track record.  Stay focused on your strategy and let the long-term results take care of themselves.

We appreciate the opportunity to be your financial advisor.  Please contact us if you have any questions or concerns.

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

Paragon Advised Investors To Consider Alternatives to Treasury Bills

Posted May 17, 2012 by admin. tags:Tags: , , , ,
Gravel road up the mountain

Provo, Utah- Paragon Wealth Management’s financial advisers encouraged investors to consider alternatives to treasury bills until rates move back up.

“Treasury bills yield nothing,” said Dave Young, president and founder of Paragon Wealth Management. “Bonds and gold could have significant risk at these levels, which are near all-time highs. Both are owned for safety but ironically carry significant downside risk going forward. A home makes some sense because values are low, but it’s hard to get overly excited when a home’s 50-year return is half that of stocks.”

Young said it could be better to follow a proven investment strategy that invests in stocks. He said stocks have gotten the best returns long-term, even though the last 12 years have been extremely difficult in the stock market.

“Stocks are currently the most beat up, out of favor and undervalued of the five asset classes, which makes them even more compelling,” said Young.

Paragon’s wealth managers have been investing in stocks since they opened their doors in 1986. Paragon’s growth portfolio, Top Flight, has generated a total return of 418.55 percent versus 86.96 percent for the S&P 500 from its inception on January 1, 1998 through March 31, 2012. Its compound annual return is 12.32 percent versus 4.52 percent for the S&P 500 during that time period. (Visit www.paragonwealth.com to see complete track record and full disclosures).

“Even the best managers have a tough time staying ahead of the markets,” said Dave Young. “Since the market bottom in March 2009, the legendary Warren Buffett is up only  44 percent versus 80 percent for the S&P 500. Another high profile investor, Jim Cramer of CNBC’s actual track record is surprisingly dismal. If you had followed his advice over the past 10 years, you would have earned only 1.68 percent compounded per year.”

Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

How Much Risk is too Much?

Posted March 25, 2008 by admin. tags:Tags: , , , , , , , , ,

Written by Dave Young, President

Most investors assume that high risk (and the additional stress that goes with it) inevitably accompanies the potential for high returns.

Steve Shellans, the editor of MoniResearch, decided to test this theory by using a statistical formula to accurately measure the amount of stress various investment strategies typically inflict on investors.

He decided to use the Ulcer Index, and according to Nelson Freeburg, the respected editor of Formula Research, the Ulcer Index is “perhaps the most fully realized statistical portrait of risk there is.”

The Ulcer Index is different from other risk measurement indexes, such as standard deviation, beta, and the Sharpe ratio, because it does much more than simply measure portfolio volatility. Traditional risk indexes falsely assume that all volatility is bad. The reality is that investors welcome upside volatility—but deplore downside volatility.

The Ulcer Index accounts for this basic psychological fact by ignoring upside volatility and penalizing downside volatility.

In addition, it increases the penalty based on the depth and the duration of the drawdown. At a more technical level, the Ulcer Index calculates the difference between each day’s equity and the most recent equity peak. The formula then squares these numbers, averages them, and uses the square root of the average as the Ulcer Index. The smaller the number, the lower the risk.

Paragon’s Top Flight Portfolio certainly delivers the kinds of returns that are typically associated with high-risk funds.

But does it carry the same risk—and the same potential to cause ulcers—as other aggressive, high-return funds? According to the Ulcer Index, the answer is a definitive no.

How does Top Flight maintain such high returns with such a low Ulcer Index rating?

Paragon’s models and systems are based on a quantitative and technical approach to money management. Generally, fundamental analysis is not used. Using this very innovative and creative approach to money management has allowed Paragon Wealth Management to create portfolios such as Top Flight that have generated exceptional returns while taking on lower levels of risk than its benchmark, the S&P 500.

Portfolio Protection: How we Anticipate Market Movement

Posted February 21, 2008 by admin. tags:Tags: , , , , , , ,
Charts and Graphs

Written by Dave Young, President

At Paragon we follow the mantra of the three “P’s” – Private, Proactive, and Protective. These guiding principles direct our unique approach to investment and wealth management. I thought this would be a good time to focus specifically on the Protective side of our investment approach – what we do to monitor and benefit from market movements.

In one of my newsletters, I wrote about how a consistent investment program can minimize the negative effects of inevitable market downturns. Unlike many advisors who talk about accepting what the market gives, we embrace the challenge of getting the best the market has to offer while avoiding the worst. Our portfolios are designed to maintain and/or accentuate the positive movements of the markets while limiting the negative movements. A pretty tall order, right? Well, what else do you hire an investment manager for?

We are often asked about the criteria we use to choose investments for maximum investor benefit. The protective aspect of our investment philosophy leads us to perform quantitative analysis that considers many market indicators to help determine market risk. What is quantitative analysis? I’m glad you asked. Investopedia defines quantitative analysis as “a business or financial analysis technique that seeks to understand behavior by using complex mathematical and statistical modeling, measurement and research.” In other words, it’s a way to objectively measure things.

In the investing world, quantitative analysts are usually stereotyped as pure numbers people who disregard the qualitative aspects (management expertise, industry cycles, labor relations, etc.) of companies or markets. Many investment managers will often adhere to one type of analysis (fundamental vs. technical) while eschewing all others. This is usually a result of their training, education and experience. We find this to be a narrow and incomplete point of view. We don’t believe that any one style of analysis can give a full picture of market behavior by itself. They all have advantages and disadvantages, and we feel it most effective to use the best elements of each style.

At Paragon, we employ a type of quantitative analysis that incorporates fundamental, technical, behavioral and qualitative factors. These quantitative indicators give us a feel for the market at the present time. They help us determine where the strength of the market is, the degree of the strength and any changes in strength that appear to be occurring. We use them to find out what other market participants are actually doing and what they think about both the current market and where it might be headed.

One of the primary models we use is based upon a composition of monetary, economic, valuation and sentiment indicators. This model attempts to identify periods of outperformance and underperformance of the stock market by gauging the external environment of the market while staying in harmony with the primary trend.

Another one of our favorite models is a sentiment model that uses a variety of indicators to measure investor psychology and the changes in attitude as they occur. This model indicates what percentage of all investors can be classified as bullish on the stock market at any given time. This allows us to anticipate reversals in investor psychology, and thus the market. Our policy is to mirror the general sentiment until it reaches an extreme, at which point we take a contrary position. High bullish sentiment has frequently coincided with intermediate-term peaks in stock prices. Conversely, when sentiment has fallen to low levels (meaning investors are bearish), markets have typically been near a bottom. By understanding sentiment we can take advantage of these market movements by anticipating them before they occur.

Another type of sentiment indicator we rely on uses the CBOE Equity Put/Call ratio. When sentiment gets extreme we can use this information to anticipate market movements that are contrary to the general expectations. Put/call ratios track the activity of highly speculative options traders, who are notorious for being wrong when taking extreme action. In practical terms, this means that the S&P 500 tends to perform poorly when an extreme in optimism has been reached. Conversely, extreme pessimism is often accompanied by high market performance. By keeping our eye on put/call ratios we can identify the extreme sentiment levels that tend to precede reversals in the market and move our investments accordingly.

Other models that we use measure items such as earnings yields, Treasury bill yields, price/dividend ratios, median price/earnings ratios and the number of stocks hitting 52 week new highs or lows. By watching each of these indicators we can get a well-rounded picture of the current state of the market as well make good educated guesses about what will happen next.

Our general policy is to stay invested in the market, using these models to assess overall market risk. When our indicators signal an increase in risk, we reduce our exposure to the market by degrees while keeping the majority of the portfolio invested. Only rarely do they signal for us to be entirely out of the market.

While these models do measure a great many financial indicators, they can’t eliminate risk altogether. Many market events are simply unpredictable. The markets, like life, are full of the unexpected, and the only way to succeed is to stay in the game, keep your head up and be as informed as possible.

Finding the Right Balance Between Risk and Reward

Posted January 3, 2008 by admin. tags:Tags: , , , , , , , ,
Man Surfing

Written by:  Nathan White CFA, Portfolio Manager

Investing is all about the trade-off between risk and return. Higher risk means higher potential returns. Lower risk means lower potential returns. There’s simply no escaping this fundamental fact, although some inexperienced investors work overtime to ignore it.

In my estimation, ignoring the trade-off between risk and return inevitably leads to poor results. I also believe it’s the number one reason people become frustrated with investing and ultimately fail to meet their goals. When new investors evaluate investments, they tend to focus on the potential return and tune out the risk. In many cases, they may not understand where the risk is coming from or what it means. Or perhaps they believe that if they don’t acknowledge the risk, it won’t apply to them. Either way, it’s a big mistake.

Facing risk doesn’t have to be a terrifying ordeal. In fact, evaluating risks versus potential returns is part of the decisions we all make every day—what route to take to work, what house to buy, what profession to pursue, whom to marry, what to have for lunch, and so on. When it comes to investing, understanding where the risks come from is essential. Overly aggressive investing leaves you vulnerable to greater losses, while ultra-conservative investing is also a risky strategy because of the gains you inevitably miss out on.

How much risk you’re willing to take on should be based on several factors, including your personality and stage in life. Those who are risk averse or are in a capital preservation phase of life (such as retirement) often want to stick with conservative savings instruments like CDs, savings accounts, or money market accounts because the risk of losing money is incredibly low. These products serve a useful purpose. However, the trade-off for these products is the low returns they generate. You are not being paid much because you are not risking much.

Let’s assume that you are in retirement and that you always invest in CDs because you like the steady, low-risk returns. Let’s also assume that CDs have averaged about 5% per year. Inflation, the measure of how buying power decreases over time, will effectively reduce your return by 2-3%, leaving you with only 2-3% left to withdraw without reducing the principal. For the vast majority of people, that isn’t much to live on. The trade off for reduced investment risk is an increased likelihood that you will not meet your financial goals.

As I mentioned earlier, the goal of an investment portfolio is to achieve the best possible returns for a certain level of risk. Paragon’s Managed Income portfolio seeks to achieve a lower degree of volatility and risk than our Top Flight portfolio or other more aggressive offerings. To accomplish this, we create different combinations of securities with different historical levels of volatility and return.

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