Why our philosophy makes sense

A number of examples in the past week again confirm why our investment philosophy makes sense.

In Tuesday’s Wall Street Journal, a “Streetwise” column stated that “the overwhelming consensus before Christmas” was the dollar would take off, the euro would fall and emerging stock markets “needed to brace for turmoil…”

“Three months later, the dollar’s weaker, the euro is up strongly,…” and emerging stock markets are showing triple the gains of the broad US stock market.

The consensus predictions were all wrong.

We remained invested in emerging stock markets for those clients which they are appropriate and our clients have benefited. We don’t make bets on currencies, as they are too hard to predict.

Last Wednesday, the Federal Reserve increased short term interest rates by .25%. Most would have predicted or thought that the 10 year Treasury note would have risen that day. Not only did the 10 year rate decrease on Wednesday, it has continued to fall from around 2.5% to 2.398 as of Wednesday.

Predicting the direction of interest rates is very difficult. This is why we do not make bets on interest rate movements. When we purchase fixed income investments for our clients, we buy varying maturities of high quality bonds. We are investing to provide the portfolio stability, not to gamble on the direction of interest rates.

In March of 2010, when the Affordable Health Care Act, or Obamacare, was enacted, few would have recommended investing in managed health care stocks. As discussed in a New York Times column in Sunday’s business section, this conventional wisdom would have been very wrong.

“The numbers are astonishing. The Standard & Poor’s stock index returned 135.6 percent in those seven years through (last) Thursday…But the managed care stocks, as a whole, have gained nearly 300 percent including dividends…UnitedHealth, the biggest of the managed care companies, with a market capitalization that is now more than $160 billion, returned 480 percent, dividends included. An investment of $100 in the company’s stock when Obamacare was signed into law would be worth more than $580.50 today.”

We do not let political views influence our decision making. We do not generally recommend individual stock picking and this is why. Because we recommended that our clients own broad asset classes, one of which is large US company stocks, our clients benefited by owning these managed health care stocks and they reaped the rewards.

We cannot predict the future. We don’t try to. It is not a winning strategy.

We can help your long term investment performance by avoiding making bets and predictions. We will continue to invest for the long-term in a disciplined, rational and low-cost manner, which has been successful in an always uncertain future.

When Should Strategy Be Changed

Yesterday, the Federal Reserve increased short term interest rates for the first time in 2017 and just the third .25% increase in short term rates since 2009.

Prior to the Fed announcement, I was contacted by a Detroit Free Press personal finance reporter for my comments. She wanted to know what would happen to the stock market, are we changing our investment strategy and our outlook for future interest rates.

Our reply to the Detroit Free Press was the following:

“We expected very short term interest rates to rise by .25% at this week’s Federal Reserve meeting. We anticipate that there will be at least two-three additional .25% short term interest rate increases during the remainder of 2017. We view these as positive, as the economy continues to be strong and not headed into a recession. While it is difficult to predict the future, it is reasonable that the Fed will continue to increase short term rates throughout 2018, if the economy continues to remain strong and there is an infrastructure plan enacted.

We are not changing our investment strategy based on the Fed actions. We have a long term investment strategy to have our client’s very diversified, both in the US and internationally, so we would not recommend changes based on just today’s Fed actions. We have recommended that client’s should refinance mortgages, if they have not done so already. While we are positive about US and global stock markets for the long-term, we have been reminding clients that there has not been a significant stock market correction in over 9 months. Thus, a temporary decline, in the midst of a long-term rising market, should be expected and considered a normal occurrence.”

We were quoted in the Detroit Free Press article on the Federal Reserve action, which you can read here.

Changing a strategy should be based on evidence that a current strategy is not working or that evidence exists that modifications would be necessary or a better strategy exists.  The principles and general investment philosophy which we adopted when we formed our firm in 2003 are still valid and have stood the test of time.

We are disciplined and have a strategy that is well defined and transparent, which we adapt to the individual needs of our clients. The stock mutual funds that we have utilized since inception have excellent track records, over the long and short term, especially when compared to their respective category peers. They are some of the lowest cost mutual funds in the industry as well as provide excellent tax management, to minimize your taxes, as applicable.

We have avoided hedge funds, alternative investments and junk bonds (higher risk fixed income products) and making bets on certain sectors, such as energy. We are confident that these decisions were correct and have been significantly to your advantage. As Warren Buffett and a great deal of other evidence shows, most alternatives and hedge funds do not provide the long-term performance or diversification benefits which they claim.

If you are not a client of our firm, you may think you are doing well. But do you really know? That may be a relative term or feeling, until we meet and review how well your portfolio has performed or how your investments are structured.

  • When we meet with prospects, we nearly always find that their existing portfolios are:
    • taking too much risk in certain areas,
    • under-invested in asset classes that have higher expected returns
    • more invested in asset classes or individual stocks which have lower expected returns
    • paying more in fees than they should be
    • not being managed in a manner which reduces their taxes as much as they could be
  • All of our current clients were formally prospects. Nearly all of them formerly worked with other advisors, but after they met with us, they understood our rational approach to investing and the other benefits we could provide.

We are confident in the future and confident in our investment strategy.

The financial markets: where do they go from here?

The stock markets in the US and throughout the world have been performing very well.

Major US and global stock indices have risen nearly uninterrupted for months. There have not been any pullbacks, or even a minor correction, since the Brexit vote in late June, 2016.

As our clients know, we do not make predictions or believe that anyone can consistently and accurately predict the near term direction of stocks or stock markets. Our role is to work with you to develop a financial and investment plan which are appropriate for your goals and time frame. To implement this plan, we recommend a globally diversified portfolio of both US and International stock funds, with an appropriate allocation of fixed income investments.

Given that stock markets have increased without any correction in almost 9 months, you should be prepared for a pullback or correction in stocks, at some point. When that occurs, it should be viewed as normal. We are not basing this on an event which we expect or can predict. We are just being realistic and want you to be emotionally ready.

Remember, in almost every year, there is a time when stocks decline 10% or more from a peak to a bottom point, even in a year which is positive for stocks.

One “known” risk that could shake the market would be a delay or trouble in passing health care reform or tax reform legislation. However, it is often unexpected events which cause sudden market moves.

While we view a correction of some type in the near term as normal, we are still positive about US and global stock markets, for the long term. We expect very short term interest rates to rise again at next week’s Federal Reserve meeting. It is possible there will be at least two-three additional .25% short term interest rate increases, after next week’s meeting, during 2017. We view these as positive, as the economy continues to be strong and not headed into a recession.

We do not feel that US stocks are in “bubble” territory, which would warrant a major downturn, such as occurred in 2007-09. Stocks have increased because of expectations of corporate and individual tax reform, as well as continued positive corporate earnings reports and future earnings expectations.

Many have asked us whether the rise in stocks is just due to the November election. Trump’s election certainly caused stocks in general to increase late in 2016, but we feel that much of the further increases in 2017 are still stock specific. Individual stocks react or move based on a company’s future earnings expectations and reported results.

For example, if most of the earnings reports of companies in 2017 had been below expectations or most companies issued lower future earnings guidance, the major stock indices would be lower today, irrespective of Trump, future legislation and de-regulation. This has not been the case. Companies have reported good earnings and better future guidance.

Stocks which have not delivered good news have been punished, in spite of the election. For example, Target and Under Armour have decreased by 22% and 27% in 2017, respectively, after announcing poor earnings and guidance earlier this year. So not all stocks have risen along with the general market.

For further reading about how markets perform after reaching new highs, see our blog posts, Actionable Information and Dow 20,000: The Implications.

We continue to be confident in our strategy and recommendations.

  • We firmly believe that a globally diversified portfolio is very important, given the unknowns about so many issues, such as:
    • corporate tax reform legislation
    • the direction of oil prices
    • the direction of interest rates
      • How can you know who the winners or losers may be?
  • We actively monitor your accounts for rebalancing to keep your risk in stocks at the level which is appropriate for you. This discipline will provide you with the best chance for a successful investment experience.
  • We provide you with a rational approach for your financial future, rather than allowing emotions to dictate financial decisions.

We recommend investing in passively managed globally diversified funds, not in individual stocks or just in large US companies, such as are included in the S&P 500. The funds we recommend provide you with diversification and the best chance to perform well versus actively managed funds and their respective benchmarks, at low costs.

As further evidence of how difficult it is to beat a benchmark, I noted the following in preparing this essay.

  • Seventeen of the 30 large US stocks in the DJIA outperformed the S&P 500 (the respective benchmark) during 2016.
  • Of those 17 companies which outperformed the S&P 500 (the respective benchmark) during 2016, only 7 of these companies have outperformed the S&P 500 during 2017, through March 6, 2017.
  • Six of the 30 stocks have underperformed the S&P 500 during both 2016 and YTD 2017, through March 6, 2017.

While this is very short term evidence and a very small sample, it is further confirmation of why our investment approach makes sense in both the short and long term.

Lessons from Buffett and Our Market Thoughts

Warren Buffett’s Berkshire Hathaway Inc.’s Annual Shareholders Letter was released last Saturday morning.

As broad US stock market indices continue to reach new highs this week, Buffett’s thoughts and actions are important.

Much of what follows is Warren’s writing, quoted from his Annual Letter. These thoughts are important today and will be vital lessons in the years and decades to come.

Reading these highlights and following his wisdom will help you to be more disciplined, financially successful and a better investor.

  • Berkshire Hathaway is a very different company than it was in 1970s through the early part of this century. Berkshire grew in those years based on Buffett’s investing in stocks of many large US companies and the vast insurance companies and the huge float (cash) they generate.
  • Over the past decade, he has focused more on buying large companies outright, as well as making many opportunistic investments, particularly during times of crisis, such as during the financial meltdown of 2008-09.

What are the lessons from this year’s Buffett Annual Letter which impact you and your financial life?

The future, fear and costs:

After citing that the DJIA has grown over his lifetime from 66 to 11,497 by 12/31/1999, he stated how the growth continued through the end of 2016 to 19,763, another increase of 72%. (Today, the DJIA is above 21,000.) He then wrote about the future:
  • “American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that.  Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.”
  • “Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics -that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media…”
  • “During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.”

Even Buffett can’t always beat the benchmark

Warren Buffett is clearly recognized as being one of the top investors of our lifetimes, as he has built an extraordinary conglomerate of companies and stock holdings. In this year’s letter, he did not discuss his stock sales and new purchases. However, his actions provide more lessons.

As smart as Buffett is, he makes mistakes and not every stock he buys becomes a home run. During 2016, Buffett sold the 63.5 million shares of Wal-Mart that was owned at 12/31/15.  He accumulated $4 billion in Wal-Mart between 2005-2012, during which time the stock far underperformed the S&P 500, Buffett’s benchmark. In a CNBC interview this Monday, he said that it is just too hard for large retailers to compete against Amazon.

As I wrote about last year, Lessons from Warren Buffett which can help you, Buffett’s top 5 stock holdings as of December 31, 2015 have under-performed the S&P 500 over the past 5-10 years. He may have done great with these stocks since he bought them decades ago, but they have not performed as well in the last 5-10 years.

This shows how difficult it is to succeed over the long term in selecting and holding individual stocks. Even for an “expert,” it is very difficult to vastly outperform the stock market, let alone even matching the index.

Buffett clearly recommends others should use an investment philosophy which is consistent with our firm’s investment approach. He clearly states: “Both large and small investors should stick with low-cost index funds.”

This is further evidence of why we feel so strongly about our investment philosophy of utilizing broadly diversified mutual funds on a global basis, which are similar to indexes/ benchmarks with extremely low costs. We are confident that our investment strategy is the best way to capture the long-term expected returns of the world’s stock markets with the greatest chance for success. As even Warren Buffett has recently shown, trying to pick a group of individual stocks just isn’t the best approach.

He writes at length about why hedge funds and alternative investments, with very high fees, are terrible long-term investments. If these investments interest you at all, read pages 21-24 of this year’s Annual Letter, here. They will be of much less interest to you after you read about Warren’s 10 year $1 million charitable bet, which he clearly will win.

Stock Purchases in 2016-17 market: Apple and airlines

Even though the market is at all time highs, and has been for months, Buffett and one of his associates purchased 61 million shares of Apple in late 2016 for $6.7 billion. And before Apple announced their earnings on January 31, 2017, Buffett has purchased an additional 76 million shares of Apple during January, 2017.

Berkshire’s Apple purchases were in the range of $110-121 per share. They stopped buying when the share price rose to $130-140/share range, where it is now. Buffett has made a huge gain already, but he could have purchased Apple shares for much cheaper many times in the past, and anytime prior to 2015. He may do well in the long-term with Apple’s stock, but he clearly should have been an Apple buyer years ago, if he bought shares in the last few months.

Additionally, Berkshire purchased billions of dollars of 4 major US airline stocks during 2016. He has said for two decades that airlines are terrible investments. He wrote in 2007 that they are the “worst sort of business.” This shows that we all need to be flexible, that times and thought processes should change based on what is going on in the world now, not just what occurred in the past. Airlines are now profitable and producing free cash flow.

Buffett’s Apple and airline purchases shows that he feels it still makes sense to continue purchasing stocks in the current stock market, as long as he feels he is buying at a reasonable price and the companies have good long-term prospects.

Do not be afraid of downturns, be prepared
  • Buffet wrote: “Charlie (Munger) and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.”
  • “The lesson for us is that we must be prepared and expect that there will be significant down periods in the markets. They will happen. They are buying opportunities or a time to just wait out the down cycle. They are not times to sell or panic.”
Focus on the long term positive progress, not on negative talk
  • Buffett repeated his message from last year, of the importance of long term focus and the dynamism of the US economy.
  • He wrote: “Our efforts to materially increase the normalized earnings of Berkshire will be aided – as they have been throughout our managerial tenure – by America’s economic dynamism. One word sums up our country’s achievements: miraculous. From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.”
  • “You need not be an economist to understand how well our system has worked. Just look around you. See the 75 million owner-occupied homes, the bountiful farmland, the 260 million vehicles, the hyper-productive factories, the great medical centers, the talent-filled universities, you name it – they all represent a net gain for Americans from the barren lands, primitive structures and meager output of 1776. Starting from scratch, America has amassed wealth totaling $90 trillion…. This economic creation will deliver increasing wealth to our progeny far into the future. Yes, the build-up of wealth will be interrupted for short periods from time to time. It will not, however, be stopped. I’ll repeat what I’ve both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history.”

Huge investments in wind energy and railroad infrastructure:

  • Berkshire owns BNSF, a huge railroad company, and Berkshire Hathaway Energy (BHE), a large multi-state energy company. Buffett and the executives of these two companies are so confident about the long-term future and their ability to generate reasonable returns that they invested $8.9 billion in plant and equipment in 2016. They know society will need transportation and energy.
  • Buffett cites the investments these companies have made in “planet-friendly technology.” He wrote: “In wind generation, no state comes close to rivaling Iowa, where last year the megawatt-hours we generated (from BHE) from wind equaled 55% of all megawatt-hours sold to our Iowa retail customers. New wind projects that are underway will take that figure to 89% by 2020.
  • “Bargain-basement electric rates carry second-order benefits with them. Iowa has attracted large high-tech installations, both because of its low prices for electricity (which data centers use in huge quantities) and because most tech CEOs are enthusiastic about using renewable energy. When it comes to wind energy, Iowa is the Saudi Arabia of America.”
  • “BNSF, like other Class I railroads, uses only a single gallon of diesel fuel to move a ton of freight almost 500 miles. Those economics make railroads four times as fuel-efficient as trucks! Furthermore, railroads alleviate highway congestion – and the taxpayer-funded maintenance expenditures that come with heavier traffic – in a major way.”

If you have read this far, we appreciate it. I have read every one of Buffett’s Annual Letter for decades and continue to find each year’s filled with many nuggetts of valuable advice.

We hope that you find this and each week’s essays valuable and informative.

Disclosure: Brad Wasserman, author of this blog post, owns a small number of Berkshire Hathaway shares, which were purchased years ago to enable me to attend the Berkshire annual meeting. All my other stock investments are in DFA mutual funds, as we recommend to our clients.

Source: Berkshire Hathaway 2017 Annual Letter, released February 25, 2017. See berkshirehathaway.com.

Green, Yellow or Red?

US stock markets have gone nearly straight upwards since the November 8th Presidential election.

In the last 3 1/2 months, there have not been any significant declines of major US stock indices. There has rarely even been a day when markets were down 1%.

Thus, you should be prepared for some YELLOW territory, or proceed with caution.

We are not making any stock market predictions, just pointing out that you should be mentally prepared for more volatility than we have had recently.

Down periods are normal, even in the midst of generally rising markets. Declines can occur quickly, without warning.

Dips or declines may come from economic news, unexpected events or missed expectations, such as if there was a significant delay in the Trump tax reform package, which the new Treasury Secretary hopes will be passed by Congress prior to Labor Day.

For the long term, we remain rationally optimistic, so GREEN is appropriate. For long term investors, you should maintain your appropriate allocation to stocks.

As markets have increased, we have rebalanced your portfolio, where applicable, so that you do not take on unnecessary stock risk. This is how we implement our discipline of buying low and doing some selling high.

We do not believe in RED. We do not recommend trying to time the markets, by getting completely out of the markets because they have increased and then trying to buy back in at a lower price. This is a loser’s game.

While US and international developed country stock markets have performed well so far in 2017, emerging stock markets (those of lesser developed countries) have more than doubled the returns of the larger countries’ stock markets.

This is why we believe in holding globally diversified portfolios and why we recommend allocations to emerging market stocks. These markets can be quite volatile but have higher expected long term returns.

As you proceed on your financial road, maintaining an appropriate stock allocation will lead to GREEN rewards, as long as you can handle the periods of YELLOW, when caution and good judgement are necessary.

We will advise and guide you, as you navigate the financial path of your future.

Investments Like No Other

In 2006, Warren Buffett pledged and began donating billions of dollars of his Berkshire Hathaway stock to the Bill and Melinda Gates Foundation.

On the 10th anniversary of Buffett’s initial gift, the Gates Foundation 2017 Annual Report describes the incredible accomplishments their investments are making.

Gates stresses his optimism and the progress that the world is making in the area of global health and extreme poverty. He concludes that “we’re confident of one thing: The future will surprise the pessimists.”

I strongly recommend reading the Gates Foundation Annual Letter.  The 5 minutes you spend will be eye opening and informative. It clearly explains and illustrates the progress, discoveries and challenges which the Foundation is working on.

Gates states that “extreme poverty has been cut in half over the last 25 years. That’s a big accomplishment that ought to make everyone more optimistic. But almost no one knows about it. In a recent survey, just 1 percent knew we had cut poverty in half, and 99 percent underestimated the progress.” In the survey, 70% of the respondents thought poverty had increased by 25% or more since 1990.

The Gates Foundation focuses on improving health and alleviating extreme poverty in the developing world. In the US, the Foundation supports programs related to education and low income families. The Foundation makes grants in all 50 states and supports work in more than 100 countries.

The Gates Foundation Report is relevant to our firm’s long term investment approach and philosophy because of our message of rational optimism as well as the importance of the global economy. As the world becomes healthier, life expectancy increases and poverty decreases, the middle class and economies throughout the world will grow.

The Foundation measures their success in many ways, but they watch certain numbers to guide their work and measure their progress. They don’t take credit for all of these trends, as the report begins by acknowledging that the “vast majority of global health and development funding” comes from contributions by donor nations and other philanthropists.

In the introduction to the Annual Letter, Bill and Melinda Gates stress the importance of foreign aid and the priority to lift up the poorest. This is “…one of the greatest…values (of our nations) is the belief that the best investment any of us can ever make is in the lives of others…the returns are tremendous.”

122 million: per UN figures, 122 million children’s lives have been saved since 1990, as tracked by the reduction of the number of childhood deaths under the age of five. The number of childhood deaths per year has been cut in half since 1990. More children survived in 2015 than in 2014, more in 2014 than in 2013, etc.

The Gates’ started the Foundation to save children’s lives. They learned other lessons as they addressed this goal. “If parents believe their children will survive-and if they have the power to time and space their pregnancies-they choose to have fewer children.” They learned the link between healthier children, better nourishment and increased mental capacities, which leads to parents having more time and money to spend on health and education.

This begins the process of how families and countries get out of poverty. Thus, as Melinda says, “reducing childhood mortality is the heart of the work for us. Virtually all advances in society – nutrition, education, access to contraceptives, gender equality, economic growth – show up as gains in the childhood mortality chart, and every gain in this chart shows up in gains for society.”

86%: Vaccine coverage is the highest it has ever been, 86% for the basic childhood vaccine package. This is one of the biggest reasons for the decrease in childhood death. And the gap between richest and poorest countries is the lowest it’s ever been.

350,000 to 37: In 1988, the global campaign to end polio was launched. At that time, in 1988, 350,000 new cases of polio were reported annually. The last cases in Europe and India were reported in 1998 and 2014, respectively. Worldwide, in 2016 only 37 new polio cases were reported in 3 countries, which are each affected by war and conflicts. These conflicts are inhibiting the distribution of the polio vaccine. The vaccine is close to eliminating polio. This should spur momentum for eradication of other diseases in the future.

However, “nutrition is the biggest missed opportunity in global health.” Bill says “malnutrition destroys the most human potential on the planet.”

I learned from reading this report how the Gates Foundation is continuously learning what the major challenges are for each issue and how they are working to find solutions to these major issues. Read the report. Learn for yourself. You will be moved.

The Gates Foundation has two important assets: optimism and huge amounts of money to address these challenges. As Melinda states, “Optimism is a huge asset. We can always use more of it. But optimism isn’t a belief that things will automatically get better; it’s a conviction that we can make things better.”

Massive assets: Huge resources, along with passion and intensity, are reasons for continued optimism that progress will be made in the Gates Foundation’s areas of focus.
* In 2015 and 2014, the Foundation spent $4.2 billion and $3.9 billion, respectively, on direct grantee support.
* Warren Buffett is donating over $2 billion per year to the Gates Foundation, which is likely to continue at even higher levels as Berkshire Hathaway stock has increased. His annual gifts to the Gates Foundation have to be spent.
* Buffett has donated $17.2 billion between 2006 and July, 2015.
* As of 12/31/15, the Foundation’s assets were almost $40 billion.

Bill cites Steven Pinker’s book The Better Angels of Our Nature. It shows that “violence has dropped dramatically over time…global poverty is going down, childhood deaths are dropping, literacy is rising, the status of women and minorities around the world is improving.” Most people do not realize these things.

Bill and Melinda end the report optimistically, yet recognizing the challenges they are trying to solve. “As hard as polio is, malaria is harder. As hard as reproductive health is, nutrition is harder than that. As hard as it is to save children under five, saving newborns is the hardest test of all.”

But remember their message: “The future will surprise the pessimists.”

We agree with them.

If you would like to assist in furthering the Gates’ and Buffett’s efforts, they recommend making a donation to UNICEF, “as an organization that is successful at serving families and children worldwide.”

Sources: Gates Foundation 2017 Annual letter and other information from the Gates Foundation website, www.gatesfoundation.org

Money, Family and Love

Money can be a source of happiness as well as challenges.

How you handle money and financial issues with your spouse and family members is a matter of great responsibility.

We encourage you to talk with your family members openly, in an age appropriate manner, about financial matters and investing lessons you have learned. We can assist you with these discussions, if you would like.

These conversations are an important part of any relationship. Conversations about money are vital to good relationships, whether it is within a marriage or between generations. These conversations can represent real love and caring.

For couples, we strongly recommend that both of you be involved in your financial planning and attend meetings with us. Even if one of you is less interested, it is still valuable that both of you be informed, aware and involved in the decision making of your family’s finances.

For emotional and personal reasons, as it is financially and age appropriate, we recommend to grandparents to leave some inheritance directly to their grandchildren. This can have a significant impact beyond just the dollars, to both the giving generation as well as the younger recipients.

How you pass on your assets to children and grandchildren is vital. For parents with significant assets (which is defined by each situation), we recommend that assets be passed to children via trusts, not directly to the children without a trust. This is vital in the event of a subsequent divorce by one of your children. You can discuss this with us, as well as an estate planning attorney.

For parents, teaching your children solid financial values can be a great challenge. If you are fortunate to pass down good financial values, you will have succeeded at something quite important.

We strongly encourage you to tell stories about your early experiences with money, jobs and financial decisions with your children and grandchildren.

Talk about the jobs you had when you were young. You will be amazed at how interesting younger generations will find your past. Have these meaningful conversations now, while you can.

I share with my kids (ages 19-25) how I worked in high school, during college and the summers while I attended college, to pay for my own college education.

I share with my kids how I diligently paid my students loans every month for 10 years until they were fully repaid.

I share with them why our firm invests in the manner we do. I share with them the importance of establishing good credit, how to use credit cards responsibly and why they should start saving for retirement as soon as they start working after college.

Regardless of what ages your children or grandchildren are, once they understand the concept of money, they can be taught valuable lessons that hopefully will last them their lifetimes. Give them an allowance and tell them about the financial choices you are making, such as to save for their college education.

Talk about financial matters. Have conversations about money.

It may not be easy. You just need to take the initiative to start the conversation. It will be very worthwhile.

We are always available to discuss any of these financial matters with you and your extended family members.

Standing the Test of Time

We do not give advice just for today. Our advice must be successful over many years.

Over five years ago, in June, 2011, I wrote the following essay, in response to a prompt to provide advice to myself that I should give for the next five years.

I still think all of the following is just as applicable today as when I wrote this 5 1/2 years ago.

In June 2011: What advice would I give now, to myself, for 2016?

Provide financial advice to your clients that is always in their best interest.

Be sure that your clients have well diversified portfolios, based on their personal need, ability and willingness to take risk.

A portfolio of stocks should be globally diversified, which means that there should be a significant allocation to international stocks, emerging markets, small company stocks, as well as real estate. A diversified portfolio is not just the S&P 500 index fund.

Remember that over time, the vast majority of mutual funds and money managers do not beat their benchmarks.

Do not take risk with bonds. Only buy very high quality. Reaching for higher yielding, but less quality bonds, is not a good practice. Fixed income is the place to be very safe.

Expect the unexpected, and plan for it. Talk to your clients about bad markets as well as good markets.

Assist your clients in remaining disciplined, especially during down markets. If they do this, they will be well rewarded, after a market downturn, when the market rebounds.

It is impossible to accurately time the market. It is almost impossible to be right twice, as to when to sell (get out of the market) and then again (when to buy back into the market).

Rebalancing is crucial to long term success. When an asset class does well, sell some of it. Use the money to buy an asset class that has not done as well. This leads to buying low and selling high.

Plan with your clients (and have a simple written document), so your clients can achieve a sense of financial comfort and security.

Buy individual bonds or CDs of very high quality, only, which will work well if interest rates rise or fall. Bond mutual funds will not do well if interest rates rise.

Conclusion, today: We have utilized a rational and consistent investment philosophy since we formed our firm in 2003. What I wrote above in 2011 is still valid and applicable today, despite the constantly changing financial markets and the ups and downs the markets have experienced.

It should provide you comfort and confidence that our advice does stand up to the test of time.

Dow 20,000: The Implications

The Dow Jones Industrial Average (DJIA) crossed over and closed above the 20,000 mark for the first time in its history on Wednesday, January 25, 2017.

This is historic because it represents the continued increase in the worth of large, US companies and their respective stocks.

The DJIA has increased about 10% since the start of November (the election), while the broader S&P 500 has gained 7%. The DJIA’s first close above 19,000 was on November 22, 2016.

While the DJIA and US stocks have risen dramatically since the election, it is important to remember what causes stock market changes: real earnings and future earnings expectations. 

U.S. stocks increased after the election due to expectations of better future business conditions.

This week, we think the market increases are based more on actual earnings and company results. As companies have released their 4th quarter, 2016 earnings this week, they have reported solid results and positive future guidance about their earnings.

For example, despite whatever Washington has said or done this week regarding business or taxes, if most of the companies’ earnings reports this week had been below expectations or indicated future weakness in earnings guidance, the DJIA and other broader stock market indices would have gone down, not up.

What does this new high mean to you? With all the US major stock indices reaching new highs this week, we want to emphasize that we focus on long term global portfolios and your personal investment plan. We monitor your exposure to stocks and we will rebalance (sell or buy stocks) if your stock allocation increases (or decreases) significantly from our agreed upon stock allocation.

We recommend a globally diversified portfolio, which includes both US and non-US stocks, with an emphasis on small and value stocks.

In real terms, if you have a $3 million portfolio with a 60% stock allocation, your stock holdings target would be $1.8 million. If because of a stock market increase, your total portfolio grew to $3.4 million with $2.2 million in stocks, your stock allocation would now be 65%, which is more risk than we agreed was necessary. We would review and likely sell about $160,000 of stocks, to bring the stock allocation back to 60% (based on tax and other considerations). This is how we are disciplined and rational in our approach to investment management.

We encourage you to understand the perspective of the DJIA reaching this milestone. The DJIA is composed of only 30 stocks. The DJIA at times may perform similarly to the S&P 500, an index of 500 US based large companies, but these two major indices may perform differently for many reasons.

While the DJIA and S&P 500 performances are similar over the past 20 years, the S&P 500 has outperformed the DJIA by more than 30% since the 2008 market crash. Non-US market indices generally perform differently than US indices. International indices trailed US markets in 2016, but most International indices are outperforming the US so far in January 2017.

The DJIA gets a lot of media attention, so it is important for that reason.  However, the DJIA is calculated in an old-fashioned manner which is not considered an accurate representation of how investors are really doing.

The DJIA is calculated based on share price, not based on a stock’s market capitalization.  This means that an increase of $1 in the share price of Goldman Sachs, with a share price of around $236, is worth twice as much as a $1 increase in the price of Apple, even though Apple has a market capitalization which is 6X greater than Goldman Sachs.  Similarly, a price change in Goldman is worth 8X more than the price change of Cisco, which trades around $30 per share.

DJIA first closed over 10,000 in March 1999. It went back and forth 33 times above and below that 10,000 level until August 27, 2010, the last time it was around 10,000. This emphasizes the patience which is needed to reap the rewards of investing in stocks.

As the DJIA gets to even higher levels, we want to encourage you to put DJIA “headlines” in the proper perspective. With the Dow at 20,000, a 100 point increase or decrease is only a ½% move. A 250 point change is 1.25%. That is really not that significant. When the Dow was at 7,500, a 250 point daily change was over a 3% move. Please keep actual DJIA point moves in the proper perspective.

Stock market indices reaching new highs confirm our long term approach to investing, by maintaining consistent and appropriate allocation to stocks.

Sources: various Wall Street Journal articles, 1/26/27 (online).


Asset Allocation under a Trump Administration

With major changes in Washington, you may be wondering things like the following:

  • Where is the market going?
  • Is it the right time to invest more or should I get out of the market?
  • Should I make any major changes to my asset allocation or investment portfolio?

We all desire certainty, but we live in an uncertain world.

Based on who is President, we would not recommend changes to your investment strategy or plan. We didn’t recommend major portfolio changes when President Obama was elected and we are not recommending specific changes now.

President Obama was first inaugurated on January 20, 2009. The S & P 500 has been positive every year of his 8 years as President, from 2009-2016. Did you realize that?

While some were concerned about the country’s future when Obama was elected and some of his policy views, investors who remained patient have been very well rewarded. Others may now be concerned about the upcoming change in administrations. We want to stress the importance of trying to leave your political emotions aside from your investment actions.

Stock markets are efficient. Another way of saying this is that the market knows more than any one individual, firm or money manager. This means that professional money mangers cannot consistently outguess and beat the stock market, which is supported by years of industry performance data.

This is good news for you. It means we, and you, can focus on what you can control. It means you can capture good long-term returns without having to spend time and energy trying to forecast, predict or worry about the market or the future of specific stocks.

One of the most important things you can control is your allocation to stocks. This is the amount of risk you want to take, such as having a 40% allocation to stocks, versus having 70% of your portfolio invested in stocks.

We work with clients to determine an appropriate asset allocation between stocks and fixed income (such as bonds, CDs and cash) based on your personal needs, not necessarily on your view of the world or current events. Factors such as your age, need for future growth or your withdrawal needs, time frame and your goals impact this decision.

It is more important for you to establish proper expectations and an allocation you are truly comfortable with, which requires you to accept the volatility of investing in an uncertain world.

If you are in retirement and in the withdrawal stage of your life, we work with you to determine an optimal, appropriate allocation based on your withdrawal needs. We would review with you your assets, sources of income (Social Security, pension, etc.) and cash flow needs. We would discuss your need and comfort to take risk. These factors, and not who is President, drives our investment focus.

By managing your risk through your stock allocation and our belief in broad, global diversification, we can help you to handle the uncertainty which exists in investing.

Your confidence is important. As we adhere to a consistent and successful investment philosophy and we provide you with transparency about your investments, these should increase your confidence that our strategy will deliver upon its objectives.

We recommend a globally diversified portfolio, with an emphasis on small stocks over large stocks and value stocks over large company stocks. While this strategy has done particularly well since Trump was elected, this is not a new strategy for our firm and its clients. We have adhered to this strategy and our overall investment philosophy since our firm was started.

Unless there is convincing academic evidence to the contrary, we plan to continue our investment philosophy, as it works. We recommend that you base your asset allocation on your personal situation, not on who is President.