Entries by Dr. Erik Davidson, DBA, CFA

What’s the Purpose?

“You, Lord, give perfect peace to those who keep their purpose firm and put their trust in you.”

Isaiah 26:3-4

“What’s the purpose?” is one of the most important questions we can ask in life. To this central subject, the Bible provides the answers for us . . . in Matthew 22:37, Jesus says that “the great and first commandment” is “You shall love the Lord your God with all your heart and with all your soul and with all your mind.” In Ephesians 2:10, we see that “For we are his workmanship, created in Christ Jesus for good works”. While as to what is required of us, Micah 6:8 instructs “but to do justice, and to love kindness, and to walk humbly with your God?”.

On this question of purpose, Pastor Rick Warren has taught and written extensively on the importance of living a “purpose-driven life”. His best-selling book, The Purpose Driven Life, has sold 32 million copies and been translated into 85 different languages. Millions of lives have been impacted as they have come to more fully understand their life’s purpose in relationship with God. Knowing our purpose is everything.

Just as the question of “What’s the purpose?” is imperative for our life’s journey, it is also critical to our investment journey as well. When investing, there are many important, sensible questions for investors to consider, incl. “What’s the state of the economy?”, “What are the prospects for growth?”, “Is inflation a significant risk?”, “How do valuation levels look?”, “What about global trade?”, “Will the Central Bank be adjusting monetary conditions?”, etc. However, the first and most important question investors need to ask themselves is “What’s the purpose of the investment?”.

Over the course of my career, the biggest mistake I have seen investors make is by not first asking themselves “What’s the purpose of the investment?”. By not asking that question first, oftentimes investors will miscalibrate their investment strategy with their financial objective(s). If the purpose of the investment is for a short term (less than five years) goal such as a planned major purchase or expenditure, then a lower risk strategy, maybe even a “savings” strategy rather than an “investment” strategy is likely the best course of action. However, for those financial goals that are long-term (more than five years) such as young children’s college funds, retirement, a vacation home, estate plans, charitable bequests, etc. a longer term investment strategy is prudent. The other questions about the economic, market, and political environment while important, are all secondary to primary question of the purpose of the investment. Too often, investors make the mistake of focusing their attention on the prospects for the coming days, weeks, and months while their financial goals are oftentimes measured in years, decades, and even generations. This disconnect can lead to dire outcomes.

Knowing our purpose is very important as we go through life. Regularly recalling that purpose can help to guard us against the idols, distractions, and temptations of this world that call out to us every day. Likewise, knowing the purpose of our investments can help to keep us from the behavioral traps and temptations that afflict all investors to one degree or another. Knowing purpose is foundational to faith as well as to investing.


 

 


Dr. Erik Davidson, DBA, CFA

Dr. Erik Davidson, DBA, CFA

Erik Davidson, DBA, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

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*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

Go Ye Into All The World

“And he said unto them, Go ye into all the world, and preach the gospel to every creature.”

Mark 16:15

I once heard an interesting observation that many people who live in rural areas can be very afraid of the perceived dangers of a big city…crime, traffic, strangers, etc. And as a corollary to that, many city dwellers can be exceedingly fearful of the risks to be found out in the country…wild animals, getting stranded, isolation, etc. This idiosyncrasy of human behavior is known as “familiarity bias” in that the risks with which we are most familiar appear less threatening to us while those risks with which we are less accustomed can be quite terrifying.

In investments, one of the most well-researched examples of this familiarity heuristic is what is referred to as “home country bias”. Home country bias is the condition by which investors show an excessive preference for investments emanating from their home market over those opportunities found in other parts of the world. With this behavioral predisposition, domestic risks generally seem relatively tame because they are more familiar when compared to those perils coming from overseas which are less well understood. While instinctual, home country bias could cause suboptimal decision-making by investors with possibly detrimental effects on their long-term investment results.

These days in particular, the flames of investors’ home country bias are reasonably being fanned by a litany of worries that are coming from outside our borders…China trade disputes, Brexit, Hong Kong protests, slowing Chinese economy, stagnating European economy, declining Japanese population, Middle East tensions, terrorist threats, etc. Add to that the recent outperformance of the US stock market versus the rest of the world and it is quite understandable that US investors are currently beset by home country bias. However, because of this familiarity bias, investors may be making the behavioral mistake of focusing on the risks of investing internationally while overlooking the opportunities that can be found abroad. Consider the following:

  • 96% of the world’s population is outside the United States.
  • Amidst concerns for the greying US population with a median age of 38.2, the median age for the other 7.2 billion people on our planet is much younger at 29.8.
  • While the US population growth is only 0.8% per year, the population outside the US is growing at 1.1%.
  • 85% of the world’s economic production (Gross Domestic Product) comes from outside the United States.
  • The US may have the world’s largest capital markets, but nevertheless 70% of the world’s securities (stocks and bonds) market value is found outside the United States.
  • The US economy (real GDP) is likely to growing around 2.3% this year, but the overall global economy outside the US will grow about 3.5%
  • The US stock market is near its all-time highs, however International Developed as well as Emerging Market stock market indices are both still 20% below their 2007 all-time highs.
  • While there is growing concern that US stock market valuations (Price/Earnings, Price/Book, etc.) may be getting a little lofty, valuations of International Developed and Emerging Market stock market indices trade at least a 25% discount to their US peers. Relative interest rate differentials make these even more attractive.

Sources: CIA World Factbook, Standard & Poor’s, MSCI, and Factset

While we do not know for sure, it is possible that the Disciples were also wrestling with their own home country bias as they pondered what to do next with their lives as their physical time with Jesus came to an end. Could that be why Jesus had to remind them several times about the importance of venturing into foreign lands? Once, with the Great Commission (Matthew 28, Mark 16, and Luke 24) and again just prior to ascension (Acts 1), we see Jesus’ instruction to go outside of their homeland. Even more so in today’s global society, the Bible’s instruction to go out into the world still applies. And as scary as it can be at times, the admonition probably applies even to investing!

Therefore, getting practical, as a general rule, it makes prudent investment sense to allocate between 25% – 50% of one’s equity exposure to International Developed and Emerging Market stocks. For example, if an investor’s overall portfolio allocation to equities is 60%, then 25% – 50% of that 60% should be allocated to international and emerging market stocks, i.e. 15% – 30% of the entire portfolio.

Go ye therefore into all the world!


 
 
 

 


Dr. Erik Davidson, DBA, CFA

Dr. Erik Davidson, DBA, CFA

Erik Davidson, DBA, CFA, is the Chief Economic Advisor for Inspire Investing. Previously, Dr. Davidson served as the Chief Investment Officer for Wells Fargo Private Bank, overseeing more than $200B in assets. Dr. Davidson holds a doctorate degree from the DePaul University’s Kellstadt Graduate School of Business with his research focus in Behavioral Finance.

LinkedIn

*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

Blessed are the Risk Takers

“He who watches the wind will fail to sow, and he who observes the clouds will fail to reap.”

Ecclesiastes 11:4

As human beings, our capacity to worry is quite exceptional. In a worldly sense, this predilection towards fear is very understandable as bad things do happen in our lives and in the world around us. In fact, at times our worry has likely kept us from danger or harm. Personally, I know that even as the years have gone by, I have found it very difficult to break the grip of fear in my own life. If anything, I can take some small comfort in the fact that the nature of my worries has changed as time has gone by. These days, I find myself still worrying, but about different things than I did in my earlier years. That probably does not count as progress though!

Given our very human predisposition to worry, it should be no surprise that fears are especially heightened when it comes to investing. In fact, the foundational theory in the area of behavioral economics, Prospect Theory, by Noble laureate Daniel Kahneman (author of Thinking Fast and Slow) and Amos Tversky showed that humans are so overcome by fear that we instinctively weigh loss and gain prospects unevenly thereby causing suboptimal decision-making. Especially in the wake of the trauma of the Financial Crisis of 2007 – 2009, investors are predisposed to see danger lurking around every corner. These days, the list of fears that investors face is quite long: trade disputes with China, Brexit, domestic political divisiveness, Hong Kong protests, inverted yield curves, recessionary concerns, etc.

Nevertheless, despite the enticing self-preservation benefits of fear, the Bible is filled with admonitions against it (Isaiah 41:10, Luke 12:22, etc.) because of the obstructive effect it can have on our God-given destinies. Many times in the Bible, the challenge is put forward to “fear not”. Both the Old and the New Testaments have numerous stories of ordinary people overcoming their fears and taking significant risks with extraordinary, even miraculous results (think Moses, Esther, the Disciples, et al.).

In the Parable of the Talents (Matthew 25), it is illuminating to read of the master’s praise, “well done, good and faithful servant”, for the two employees who took risks with the funds that had been entrusted to them. Yet, maybe even more instructive is the scorn directed at the servant who was afraid and went and hid the entrusted funds in the ground . . . “You wicked and slothful servant.” and “cast the worthless servant into the outer darkness”. If this isn’t a call to guard our hearts against acting out of fear, I don’t know what is!

Carrying over this Biblical call of risk-taking to investing, it is important for investors to be on guard against getting wrapped around the wheel of whatever the “worry of the day” may be. Rather, investors should undertake prudent risks aligned with the timeframe of their financial objective. Certainly, for short-term (less than five years) financial objectives such as planned major purchases or expenditures, risk-taking should be minimized. Actually, these sort of short-term financial goals are better viewed as “savings” rather than “investment” strategies. However, for those financial goals that are long-term (more than five years) such as young children’s college funds, retirement, a vacation home, estate plans, charitable bequests, etc. a spirit of prudent risk-taking is necessary in order to grow the funds while outpacing inflation and taxes.

The history of the stock market shows the wisdom of the Bible’s guidance on fear and risk-taking. Going back to its inception in 1927, the S&P 500, the benchmark U.S. stock market index, despite dramatic corrections and crashes, has had a total return of approximately 10% annualized. During this very long time period, despite prior generations’ “worry list” including wars, rise/fall of Communism, recessions, famines, assassinations, political discord, etc. there has never been a 14-year holding period in which the total return of the S&P 500 has been negative. Prudent risk-taking pays off over the long-term. Source: Standard & Poor’s

Obviously, “blessed are the risk-takers” is not actually one of the Beatitudes (Matthew 5). Nevertheless, investors who believe that the Bible has wisdom applicable to contemporary life are well advised to consider its guidance as it relates to fear and risk-taking as they make investment decisions.