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STA Weekly Report – Why You Are Your Portfolio’s Worst Enemy, and What To Do About It

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Why You Are Your Portfolios Worst Enemy, and What To Do About It
Weekly Technical Comment
Most Business Owners have No Succession Plan or Exit Strategy
Upcoming Event – Business Transitioning Wrestling a Deal to Close
401k Plan Manager

Benjamin Graham, the well-known economist and founder of value investing, once said that “the investor’s chief problem and even his worst enemy is likely to be himself.

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He recognized that behavioral biases often cause investors to make costly mistakes in their decision-making. In fact, a University of California study confirmed Graham’s observation when it found evidence that behavioral bias often overwhelmed empirical data as investors made decisions. Luckily, over the last several decades, cognitive scientists have identified a wide range of these biases that investors face and has provided us the opportunity to develop ways of overcoming them.

While there are many biases that investors must contend with there are a handful worth discussing in more detail as they are among the most prevalent and potentially the most damaging to long-term investment results.

Framing Bias

Framing bias is when we make decisions based on the form in which data or information is presented rather than the content of the data or information. For example, when you have a glass of water filled halfway, you can either say it is half full or you can say it is half empty. While both ways are correct, one way of framing the information may elicit a more positive view than the other. If you are like most investors, you spend a great deal of time paying attention to financial news media and are thus highly susceptible to framing bias. Let’s take a hypothetical example about a fictional company named Business Source Industries (BSI). Ask yourself how you would react when you read a headline like “BSI hits $50 per share, a new 52-week high” compared to “BSI hits $50 per share, down 75% from its three-year peak”. One headline may cause euphoria while the other causes panic. These emotions can lead to mistakes which as investors, we seek to avoid. The question is how do we effectively avoid falling victim to this?

How to overcome framing bias

The best way to overcome this bias is first to pause and think beyond the headline information presented. Ask yourself, how could this information be communicated differently that might change how I feel about it? Also, developing more self-awareness about how one acts in response to feelings like fear can be helpful. Self-awareness ultimately provides us with an opportunity to counteract framing bias.

Optimism Bias

Optimism bias is a cognitive bias that causes a person to believe they are at a lesser risk of experiencing a negative event than others. In fact, optimism bias likely explains why most people overestimate their prospects for professional achievement, having above average health, and living longer than average lives. As you might expect, investors similarly fall prey to optimism bias as they often overestimate their investing skills, underestimate risks, and fail to accept warning signs. Unfortunately for investors, when this happens it can lead to financial losses as they might invest in assets they don’t understand, underestimate the risk of capital loss, or fail to accept warning signs like industry disruption that might otherwise lead them to exit an investment.

How to overcome optimism bias

To overcome optimism bias investors should consider a wide array of potential investment outcomes. That’s the reason professional investors cite bull, bear, and base cases in their analyses. This approach forces you to consider both the upside possibilities and the downside risks in any given investment. Also related to considering possible outcomes, investors should think in terms of probability distributions. Some outcomes may be low probability while others are higher probability. Determining expectations for an investment should take these probabilities into account. This will result in a more realistic assessment of risk/reward. Additionally, investors should always be conservative in their assumptions when evaluating investment opportunities as this can reduce the risk of negative surprises.

Overconfidence Bias

To their detriment, many investors often get lucky when they pick a few stocks that generate strong returns. As a result, they begin to buy into the idea that they have above average ability to pick stocks, avoid losses, or build portfolios. Unfortunately, failing to identify signs of overconfidence can lead to taking outsized positions, taking on large risks, and making costly mistakes. In fact, as overconfidence grows, the cost of mistakes grows because oftentimes the capital put at stake is larger when confidence is high.How to overcome overconfidence bias

In addition to considering all possible outcomes of an investment as you would in dealing with optimism bias, investors can mitigate the risk of overconfidence bias by slowing down and taking the time to consider the contrarian view. Investors should ask themselves how an investor who has an opposing view might support their thesis. This provides a balanced set of information to assess before impulsively putting capital at risk. Additionally, setting position limits as part of a well-defined approach to portfolio construction can help. However, it is important to stick to the discipline and not make exceptions to these constraints. Position size constraints naturally encourage diversification which can help contain risk resulting from overconfidence bias.

Anchoring Bias

Anchoring bias is a term used in psychology to describe the common human tendency to rely too heavily, or “anchor”, on one piece of information when making decisions. This is something that investors must overcome, especially today. The reason is that many investors anchor to prior historical events and extrapolate them into the future. A perfect example is what happened to many investors following the dot-com crash in 2000-2001 and financial crisis of 2008. Following those events investors became anchored to the thought that every 5% correction would necessarily continue and become a 40%+ correction. This creates a situation where any normal correction or pull back is met with panic which can ultimately lead to knee-jerk decisions to sell.

How to overcome anchoring bias

To prevent falling victim to anchoring bias, investors should put in the time to critically think through investment decisions. Some investors even have a rule where they have to wait until the next day to make a change. While this may be excessive, simply allowing yourself to digest information and consider the impact of decisions is helpful. You should also ask whether you are looking at the correct data to make your decisions and whether you have a grasp of history. While history rarely repeats, it does tend to rhyme, so knowing some financial market history can improve your ability to stave off anchoring bias. Also, it is important to evaluate investments from several angles and perspectives. This can help you consider a wider scope of facts and information that should ultimately improve your probability of success. Lastly, consider seeking perspectives from other people as they can provide additional information or provide counter-arguments that improve outcomes.

Source: STA Wealth Management

Of course, these are only a handful of the many biases that investors must navigate. The work required to effectively do so can undoubtedly be time consuming and complex. However, an experienced and knowledgeable advisor who understands your investment objectives and risk tolerance can help. This is especially true when the advisor has a well-defined investment process that incorporates a sound risk-management process and can help you develop a plan to mitigate the impact of your biases.


NASDAQ 100 Gaps to New Record High

It started after the market closed on Thursday when a raft of big internet and technology stocks reported huge earnings which pushed their stock prices higher in after-market trading. It continued on Friday when those stocks scored explosive gains on strong volume.

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The Technology SPDR (XLK) surged 2.6% on Friday to a new record which solidified its role as the market’s strongest sector for the year. Those gains were reflected in a 2.9% gain for the Nasdaq 100 which was the day’s strongest index. The chart below shows the PowerShares QQQ gapping into record territory on strong volume. The black bars on top of the chart plot a “ratio” of the QQQ divided by the S&P 500. After lagging behind the SPX over the past four months, the QQQ/SPX ratio climbed to the highest level since early September. The QQQ (which tracks the 100 largest non-financial stocks in the Nasdaq market) gained 1.7% last week versus an SPX gain of 0.2%. The QQQ was led higher by big gains in Amazon (13%), Intel (7%), Microsoft (6%), Alphabet (4%), Facebook (4%), and Apple (3%). Several of those stocks hit new record highs.

Weekly Snapshot of Global Asset Class Performance

If you have any questions, please feel free to email me at


STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)


For decades vast wealth has been created for millions of Americans through growing private businesses. However as business owners, especially Baby Boomers, reach the later stages of their careers, a new study by US Trust shows that the majority do not have a formal succession plan or Exit Strategy.

For decades vast wealth has been created for millions of Americans through growing private businesses. However as business owners, especially Baby Boomers, reach the later stages of their careers, a new study by US Trust shows that the majority do not have a formal succession plan or Exit Strategy.

U.S. Trust recently released its 2015 US Wealth and Worth Survey, which sampled a group of millionaire business owners with at least $3 million in investable assets.  In this study, nearly two-thirds of business owners do not have a succession plan (which could include either a sale or transfer of the company). Since most of the business owners rely on their businesses for income, the lack of such planning means that their main source of income could be in jeopardy.

Additionally, the results showed many owners have failed to think about the future of their businesses beyond their own lives. Only 16 percent plan to pass the business on to their families, and 64 percent of older business owners (those over 50) have no formal succession plan. In addition, the majority of business owners have not formulated a strategy for ensuring the highest possible valuation of the business or its continuity beyond the life of the current owner.

Many business owners, whose finances and identity are so closely tied to their companies, simply don’t want to think about giving them up. According to the report, three-quarters of the millionaire business owners founded their companies and only 8 percent inherited them.  Thus, most are first generation businesses. Without a plan, many may intend to simply work well past retirement age.

Many entrepreneurs never plan to stop working or they wait until they are ready to retire (not a good plan – what if the unthinkable happens). Others have a plan in mind that they may or may not have even communicated to key stakeholders, but leave its execution to chance by not formalizing it. In my experience not having a formal plan leaves a very low likelihood of an optimal transfer or sale of the business.

At STA Wealth, we find that succession planning is a crucial part of long-term business planning that helps prepare for a smooth, strategic exit by the owner or for an unexpected change in circumstance, such as illness, disability or divorce.

Five Key Elements of a Succession Plan or Exit Strategy

The benefits are vital to all stakeholders, whether they be the founder, the employees or the clients who have placed their trust with the firm. When they’re ready to transition, the business owners are uniquely positioned to capitalize on the value of the firms they’ve built.

The majority of business owners we work with are focused on ensuring that the businesses they’ve built will endure—they want to create a lasting legacy. But they are not always sure how to pursue that goal – especially when there is just one owner (with multiple partners, we find that it can be a little easier…but not easy).

It’s for that reason, at STA Wealth, we believe that business owners need to think through five key considerations necessary to create a successful plan and exit strategy. These elements will benefit the company’s owner(s), whether their goal is internal succession, external succession or a combination of both.

1. Create a Clear Vision

The initial challenge business owners face when developing a plan is to actually understand where to start. There must be a willingness to look closely at personal and professional goals, and an ability to look impartially at the value of their company. Rather than asking what a successful succession plan looks like, a better question for the founding principals would be to ask themselves “What does a successful transition look like—for me?”. Getting to that answer requires personal reflection and careful consideration. Please note that if there are multiple owners, that each owner’s goals need to be accounted for. Setting personal, professional and firm-related goals will help create a clear vision for the owners and the firm, as well as an improved peace of mind for employees, clients and other stakeholders.

2. Determine The Business Valuation

There are many approaches to determining a firm’s value. But operating cash flow (typically viewed as Earnings Before Interest, Taxes, Depreciation, and Amortization or EBITDA) is the common denominator used to establish fair value. Unlike book value, revenue or net income, cash flow is the best indicator of company profitability and overall operating efficiency. Prospective buyers want to see dependable, growing and predictable flows.  Quality of cash flow matters, too. Buyers typically pay a multiple (or measure of equity or firm value relative to revenue or earnings that it generates) based on the quality of cash flow and its growth rate. Companies will fetch top dollar for such things as a stable client base; revenues that are overwhelmingly from a recurring business; a track record of growth and strong margins; and a core group of professionals who are committed and incentivized to operate the firm as the founders reduce their responsibilities and ownership stake (a.k.a. Key Employees).

Many firm owners may either want a quick exit or may want to retain a degree of control in a transition – either can also impact valuations. It’s worth considering bringing in a valuation specialist or transaction intermediary to review the mix of goals, revenue streams, expense structure, legal structure, finances, clients and other available information. A specialist can help ensure that a fair and realistic firm valuation is achieved. While there are many approaches to valuation, attributes that are always considered include risk, scalability, growth and cash flow quality.  It is also time to clean up the books. As any valuation is dependent on EBITDA, it is important to make sure that the books and records are in good shape. For that, we review an audit by your CPA firm.

3. Maximizing Value

Buyers place a high value on business continuity—assurances that clients and key employees will remain in place once the firm begins its transition. Clients who can easily follow disengaged staff out the door are an obvious risk to a successful transition. This risk can be mitigated by hiring key employees and professionals who are a good long-term fit and by creating a compensation strategy with incentives that help employees share in the firm’s success. Creating a structure that allows key employees to participate in ownership is a powerful value driver in successful business succession planning.

Firm value is also enhanced by institutionalizing client relationships—which means ensuring that clients are connected to the firm rather than to any individual employee (or even the owner). Additionally, firms can reduce risk and maximize value by documenting all processes, including compliance procedures and contingency plans. Firms that demonstrate systematized business practices will yield higher valuations than those without this level of transparency.

4. Maximize Scale

Efficiency is another key value driver. It’s worth exploring ways to facilitate growth without adding fixed overhead. Not only do strong margins benefit owners in the short term but they can also serve as a platform for future firm growth—always appealing to prospective buyers. But there’s an important distinction to be made here: While efficient operation is desirable, being lean to the detriment of staff workload and compromised client service is not. Buyers aren’t necessarily seeking a bargain, but they do want lower transaction costs per unit of revenue. Efficiencies can be created, for example, by automating workflows to streamline operations and by creating a segmented service offering that fits the revenue profile of each client segment. Creating proportionally lower costs will equate to higher margins and drive EBITDA and possibly the multiple you receive even higher.

5. Demonstrate Consistent Growth

Buyers will pay a premium for firms that are rigorous about new business development and that have an effective customer growth strategy. The most sought-after companies have multi-tiered growth strategies that utilize customer referral, cross-selling (where possible), marketing, and public relations programs to capture customer revenue opportunities from a number of different channels.  Successful firms tend to have well-documented business development compensation and incentive plans in place for the entire staff, to ensure that everyone has a vested interest in the firm’s growth.

Today’s business owners have spent their careers building firms on a foundation of successful relationships, the entrepreneurial spirit and the desire to grow and expand. Establishing a succession plan that secures their firm’s legacy beyond the founder’s working life is critical not just to their firm and their clients but also to the long-term success of the next generation of leadership. The succession-planning process can take as many as five to 10 years to establish and implement—and there’s just one chance to get it right…having a plan that works for you, your family, your employees and all stakeholders.

Understanding the many factors that influence a succession plan is the first step. Business owners who take the long view by starting to address their risks, scalability, growth and cash flow, will see their efforts pay dividends when it is time to implement their exit strategy (whether solicited or unsolicited).

For more on this topic, listen to Scott’s recent interview with Rick Hunter. Rick Hunter leads the Houston office of Lexbridge with over 20 years of experience in investment banking and corporate finance.

If you have any questions please feel free to email me at


STA Financial Planning Department
Scott Bishop, Executive VP of Financial Planning, Partner
Patrick Fleming, Senior Director of Wealth Management
Elena Sharma, Financial Planner
Stephen Kirby, Financial Planning

Upcoming Event: Business Transitioning: Wrestling a Deal to Close

Strategic Considerations for Business Owners and Entrepreneurs to Maximize the Value of Their Business.  We invite you to join us for an exclusive opportunity to understand the most significant milestones
in the lifecycle of a business transition. Learn first-hand from our panelists stories detailing succession planning, strategic partnerships, recapitalization and sale transactions. Hear how business owners  optimally position themselves to attract and command the most lucrative buyout offers while demystifying a myriad of issues to preserve the company’s legacy.

Business Transitioning
Wrestling a Deal to Close

November 9, 2017
4:00 pm – 6:00 pm
You are cordially invited to attend an exclusive presentation
With reception to follow

The Live Oak Room
at the Norris Conference Center in CityCentre
816 Town & Country Blvd. Houston, TX 77024

Seating will be limited. Direct inquiries to Amanda at or 713.400.1562
by Thursday, October 26.


Scott Bishop Partner, STA Wealth Management
Rick Hunter Managing Director, Lexbridge
Manish Seth Partner, ABIP CPAs and Advisors
Michael Churchill Manager, ABIP CPAs and Advisors
Peter Ellen Senior Vice President, Amegy Bank
Vibhu Sharma Wood Group Mustang
Jack Selman President, Selman, Munson & Lerner


Disclaimer: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.



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