WSJ: Five Gifts for the Financially Savvy

By SIMON CONSTABLE

This is the time of year when many of us buy loved ones a special gift. This is the fourth year I’ve compiled a list of suggestions, all with a financial theme. Think of them as reminders that we all need to be savvy about money. As usual, there is something for budgets small or large. Read more here.

Photo by lasse bergqvist on Unsplash

WSJ: How Important is "Active Share" for Fund Managers?

By SIMON CONSTABLE

Just how active is the manager of your actively managed mutual fund? And how much
does it matter?

A debate is on over the concept of “active share”—a measure of how much a portfolio’s
stocks differ from those in its benchmark. The issue is whether it is a valid way to
evaluate managers.

It all started in a 2006 working paper and 2009 article by Martijn Cremers and Antti
Petajisto, then professors at the Yale School of Management. They suggested ranking
funds from zero to 100% based on how much their holdings diverge from a benchmark
index. An active share of 60%, for example, means that 40% of the fund’s stocks merely
match what is in an index—a mix that would make the fund’s manager a “closet indexer,” the professors wrote. Read more here.

WSJ: What Does Confirmation Bias Mean?

By SIMON CONSTABLE

In an effort to understand why investors do what they do, the term “confirmation
bias” is often trotted out. Most basically, it means that people tend to find evidence, in
the form of data or anecdotes, to support their position and ignore evidence to the
contrary.

That might make sense for politicians arguing with each other, but it can be dangerous
for investors.

“From a behavioral-finance perspective, the mind likes to see what it likes to see, and
so it filters information,” says Steve Wood, chief market strategist at Russell
Investments. “You need to expose that bias to the pressure of data.”

In particular, he says, don’t seek out data that supports your position. Instead, look at
all data and try to objectively assess it. In other words, we all want to prove we’re right.
But doing so could lead us to ignore the facts that suggest we’re wrong.

Mr. Wood uses the example of being predisposed to a certain conclusion when discussing inflation. When he talks with some people who were part of the workforce
in the inflation-ridden 1970s, they are often predisposed to seek out inflation
protection in their portfolios.

But right now, according to most government measures of prices, inflation looks tame
and likely to remain so. Still, those who have confirmation bias toward the idea that
there is already or is going to be inflation might conclude they need assets in their
portfolio to protect against it, says Mr. Wood.

The result: Suboptimal investment choices are made.

See original story here.

MarketWatch: This is why people carry credit card balances

By SIMON CONSTABLE

A puzzle that has long vexed personal finance experts may have been solved by an unlikely source: the Federal Reserve.

The problem in question: Why do people so often carry credit-card balances costing 10% to 20% a year, while at the same time keeping money in savings accounts that pay less than half of one percent?

On the face of it, such actions make no sense. And yet two out of three people surveyed by Ohio State University thought it was not a good idea to pay down such debt using savings.

Why is this view so prevalent? People trust that their savings will be there when they need the money more than they trust the banks to lend at such times.

That’s not my view; it’s the Federal Reserve, the banker of last resort to the banking system. It’s an institution that knows only too well how well, or otherwise, banks behave.

The Fed itself sums up the situation facing consumers who might want to borrow.

“There are no guarantees it [credit] will be there when they need it,” states a recent working paper from the Consumer Payments Research Center at the Federal Reserve Bank of Boston. Or put another way, you can’t rely on the bank to lend to you when you need it.

“Savings act as insurance so that even in the worst case when the consumer cannot borrow, she can still consume,” says the report by Scott Fulford, professor of economics at Boston College, and previously a visiting scholar at the Boston Fed. The study analyzed Equifax data from 1999 through 2013, as well as data from the Consumer Finance Monthly survey conducted by Ohio State University.

This lack of trust helps explain why two-thirds (67%) of survey respondents to the Consumer Finance Monthly survey said it was not a good idea to pay off credit card balances with savings.

While this behavior baffled so-called experts, it actually makes sense when you think about it. You have a legal and moral right to access your savings. You can rely on the funds being there. Borrowing, on the other hand, is a privilege that you can’t be sure of especially if you hit a rough patch and become a worse credit risk.

There are other reasons to build up savings even while borrowing.

For people who have racked up substantial debt it can make sense to build savings while they pay down the credit card balances, explains Linda Leitz, a financial planner for Colorado Springs-based financial planning firm, It’s Not Just Money Inc.

The risk of not building savings while paying off a credit card is that once the balance is paid off the same habits that caused the debt will return. “Saving regularly helps them build the emotional muscle,” she says.

See original story here.