The distractions that are messing with your investing


For long-term investors, one of the most notoriously difficult tasks is keeping your eyes on the prize.

That means sticking to the long-range plan and staying disciplined. It also means not getting sidetracked by negative headlines or the worry du jour that investors are fretting over this particular week, such as geopolitical tensions, interest rates and inflation. On the contrary, the market loves to climb a wall of worry, as they say.

To that end, we recently sat down with Alex MacAndrew, CFA, and Investment Director at Covestor, to talk about how investors can avoid the short-term distractions that can lead to bad, emotion-driven decisions. He also discusses his role at Covestor and some recent initiatives to help investors reach their financial goals.

Below is an edited transcript of the interview with MacAndrew:

Q: Let’s talk about the market. How should investors approach the recent geopolitical tensions in Ukraine and elsewhere around the world?

A: The first thing investors should remember when they’re seeing those scary headlines and images is to not make decisions based on their emotions. The nature of being a long-term investor is that you have to be prepared for events that will negatively impact the market.

That’s why when you’re assembling an overall portfolio, you really want to determine what’s called your risk tolerance. You want to figure out what kind of loss you’re willing to endure. Of course, it’s notoriously difficult to accurately determine your risk tolerance. It’s tough for people to predict how they’ll react to say a 20% loss without actually experiencing it, and the pain and anxiety that go along with it.

So if an investor goes into shell-shock or starts seriously panicking when markets fall, that suggests he or she shouldn’t have as much of their portfolios in stocks. They would need to lower the overall risk of their portfolios.

Another thing to remember about geopolitical shocks is that they can offer opportunities to long-term investors. Aggressive investors can use a market pullback as an attractive entry point.

Q: Let’s talk about interest rates. In the U.S., the Federal Reserve is “tapering” its bond purchases that are designed to keep rates lower. We’ve been hearing about rising interest rates for years, but it just hasn’t happened yet. That said, how should investors position for higher rates?

A: First, let’s go over the basics of bonds and some definitions.

Bonds have a duration. This the length of time until they mature. And bond investors receive periodic interest payments until maturity.

When you’re trying to figure out how sensitiv a bond is to rising interest rates, you want to look at the duration. Generally speaking, the longer the duration, the more sensitive bonds are to rising rates.

So if an investor is worried about rising interest rates, they may want to shorten the duration of their overall bond portfolios.

Rising interest rates can impact stocks as well. For example, stocks with higher dividends such as utilities can be hurt by rising interest rates.

My own feeling is that while the Fed is slowly ending its bond purchases known as quantitative easing, it will be quite careful when it eventually begins raising interest rates. The Fed will probably start very slowly. I don’t think the Fed will crank up interest rates and potentially squash the still-fragile economic recovery. I think they will be very sensitive to that.

Q: Let’s move on to inflation. Like rising interest rates, you hear a lot about inflation. But we haven’t seen much of either. If you look at overall consumer prices in the U.S., there hasn’t been much inflation, although obviously we have higher prices for healthcare, college tuition and some food items. What can investors look at if they’re worried about higher inflation?

A: Yes, overall there hasn’t been much inflation and inflation concerns have been overblown.

But if investors are concerned about inflation, it makes sense to start thinking about where that inflation is going to come from.

If energy prices rise, it could make sense to get exposure to that equity sector. In general, you want to own industries that can pass along higher prices to the consumer.

Some investors buy gold for inflation protection. I think investors need to be careful with that assumption. If you look at the past 10 years, gold hasn’t always moved with inflation. Gold seems more correlated with fear than inflation. When investors are fearful, they can buy gold regardless of what inflation is doing.

If investors are worried about inflation in commodity prices, they could buy a diversified basket of commodities. There are exchange-traded products that do this such as iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP). In fact, we use it in the Covestor Core portfolios that we launched earlier this year.

Q: Can you tell me a little about how Covestor works, and your role as Investment Director?

A: Covestor is an investment marketplace. We have nearly 150 portfolios on the platform that investors can choose from. Almost all of them are actively managed by portfolio managers. It’s similar to investing in managed accounts. Investors select managers and portfolios that suit their goals, and the trades are replicated in their own brokerage accounts.

We also have more passively managed, “Core” portfolios of ETFs, and some of them have no management fees.

On the active side, there are long-only stock portfolios as well as more complex strategies such as long-short, and other hedge-fund-like strategies.

The portfolio managers are external; they are not employees of Covestor. We connect with the managers’ brokerage account, and when they trade we then replicate the trade in investors’ accounts. Covestor sits in the middle, and we have technology to replicate manager trades in client accounts.

We have a marketplace that helps investors filter down to find portfolios that meet their goals. Everything is curated by Covestor, and I’m on the Investment Management team that evaluates portfolio managers before they join the platform.

Q: You mentioned the Covestor Core portfolios of ETFs that don’t charge any management fees. What was the rationale for launching those?

A: The Core Portfolios are designed and maintained by the Investment Management team, and we launched them primarily because of demand from clients.  We believe passive portfolios have a place for investors. Some of our clients want passive ETF portfolios. We offer both passive and active. Passive portfolios can be produced for very low cost, and we do it without charging any management fees. But we also have active strategies, and many clients want a bit of both, much like how they approach investing in mutual funds.

Q: Is Covestor a “robo-adviser?”

A: No, Covestor is not what some people are calling automated advisers or robo-advisers.

The service we offer is much different. We have a wide variety of strategies and portfolios on the platform, including active and passive. Some online investment advisers only have one basic product.

Like some other online investment advisers, we have passively managed portfolios. But what sets us apart are the more than 100 actively managed portfolios on Covestor’s platform.

DISCLAIMER: The investments discussed are held in client accounts as of July 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.