Handling Market Gains

The first few weeks of January, 2018 have begun with strong gains in nearly all global stock asset classes. This follows the significant gains of US and International stock markets in 2016 and 2017. These gains have rewarded many investors.

We want to remind you of some important statistics and how we handle market increases for our clients.

Over the long term, it is normal for the S & P 500 (large US stocks) and many other markets to decline more than 20% in 1 out of every 5 calendar years.

  • However, the S&P 500 has not had a down calendar year since 2008. So there certainly has not been a 20% decline in the past 5 years. While we recommend a globally diversified portfolio which owns many more asset classes than the S&P 500, this data is still very useful for informational purposes.
  • This does not mean that we expect a major decline in the near term, but we want you to be prepared for such a decline.
  • A major decline, such as 20% or more, is not an “if”…. it is a matter of “when” the next large decline will occur.
  • Historically, these declines are temporary, as the markets eventually climb higher.

It is historically normal for the S & P 500 (large US stocks) and many other markets to decline approximately 14% at some point during most calendar years. This is called an intra-year decline.

  • While the market may rise for a calendar year, there is usually a peak to bottom decline averaging 14% at some point during most years.
  • There has not been such a decline since early 2016.
  • We cannot predict if there will be such an intra-year decline in 2018, but we want you to be prepared for it.

We provide advice to our clients for the long-term. We determine your individual stock allocation based on your personal goals, as well as your need, ability and willingness to take risk.

By having a stock allocation suitable to your circumstances, we enable you to benefit from the gains of the stock market as well as limit the downside risk of exposure to losses. Further, through the discipline of rebalancing, we do not allow the gains of the market to dramatically increase your risk. We feel this is a significant differentiator of our firm, on your behalf.

For example, if we agree that your target stock allocation should be 50% of your portfolio, we would invest 50% of your portfolio into globally diversified asset class stocks funds. As the markets increased, we would not allow the stock percentage of your portfolio to increase far beyond your desired stock %, such as to 60-70%, or even higher, keeping in mind tax and other personal considerations.

We saw clients of our past CPA firm whose advisors permitted their stock allocations to grow unrestrained during the late 1990s (we were not yet investment advisors at that time). People would not sell their hot tech stocks and allowed their stock allocation to grow far beyond what they intended (or what was really in their long term best interest). Then they faced huge declines in the early 2000s, when these stocks plummeted.

To allow your stock percentage to grow unchecked would be subjecting you to more risk than we agreed was necessary. We are very disciplined and unemotional about this concept. As the market gains increase the value of your portfolio, we monitor this and gradually recognize gains by selling the best performing stock funds and invest those proceeds into fixed income (generally less volatile investments).

This is a major advantage of investing in mutual funds over individual stocks. It is frequently difficult for people to sell individual stocks, as they get very emotionally attached to them. When is the right time to sell Netflix, Apple, Amazon or any other stock? Who knows? How can anyone consistently know the right time to sell an individual stock?

We discuss with our clients that we cannot predict the future. We accept this as a reality. We cannot accurately time the market. We do not believe anyone else can successfully predict both the top and bottom of the stock market, consistently and accurately…. over the long term.

But we do accept the reality that the general trend of US and global stock markets is up. So if you put these concepts together (we don’t try to time stock markets and the general trend of stock markets are up), these work to your long-term advantage.

To put it simply, you are far better off having been invested in stocks over the past number of years, at whatever stock allocation made sense for your personal situation, than not having been in the market because you had “concerns” or you were “waiting for a correction” (decline) which has not occurred.

Five years ago, the S&P 500 was around 1,500. Today, it is almost 90% higher, at around 2,840. When (not if) the markets do decline from these or even higher levels than now, and even if it is a temporary decline of 20% or more, you would still be way ahead of where you would have been years ago if you had not invested in stocks. Again, we recommend investing in a globally diversified portfolio of stock funds and not just the S&P 500, so this is not an illustration of our performance.


This week’s takeaway: You will be a more successful long-term investor by being disciplined and generally sticking to a pre-determined stock allocation. When the market increases significantly, and your stock allocation grows, it is best to rebalance back to your stock allocation percentage (usually by selling some stock funds). This is a winning long-term strategy.

Interest rate changes: what you should know and do

Interest rates have been very low for years. But meaningful changes are occurring.

The 2 year US Treasury note yield increased from 1.20% at the end of December, 2016 to over 2% last week. On a relative basis, that is a huge increase.

According to the Wall Street Journal, this is the first time the 2 year Treasury note has been above 2% since 2008.

This means that you should no longer be satisfied with having significant money in the bank earning .01% or some ridiculously low interest rate close to zero.

You can now earn interest on short term bonds or certificates of deposits that should be somewhat meaningful to you.

Importantly, you should make sure that you do not have significant cash that is not earning interest, or hardly any interest, such as in a bank checking or savings account.

If you have money in an account that is earning nothing or next to nothing, you should contact us to discuss whether we can help you to earn more on this money.

Money market fund returns, or accounts where you have immediate access to your money, are still very low. However, we can provide you with alternatives that offer liquidity within a few days on conservative fixed income investments.

Sometimes small numbers, even 2%, can have a material impact. For example, if you have $200,000 earning nothing, you could gain thousand of dollars of interest income per year.

Give us a call and let’s talk.

The general consensus is that the Federal Reserve will increase short term interest rates 3-4 times this year, .25% at a time. This would likely mean that short term rates will be .75% to 1.00% higher a year from now.

The yield curve is flattening, meaning the difference between short term rates and long term interest rates is decreasing.  Currently, the 2 year US Treasury Note yields around 2%, whereas the 10 year US Treasury Note yields 2.55%, a premium of 0.55% for the longer maturity.  We do not know if this will continue, but for today, it means that if you are a borrower, we would still recommend keeping a mortgage and generally not pre-paying your mortgage payments.

If you are in the market for a new house or mortgage, we still consider mortgage rates to be very low historically. We feel that taking a mortgage today at these rates will prove to be an excellent financial decision for the long term.

The tax law that was enacted at the end of 2017 did make some changes to home related borrowing. Home equity loan interest is no longer deductible for 2018 and beyond, even if the loan was obtained prior to the law. If you are considering borrowing money for home renovations, a car purchase or other reasons, we would still recommend considering a home equity loan, as the interest rate may be better than other loans. We also recommend you to have a home equity loan, if you do not have adequate emergency cash reserves, just to be prepared.

Further, the new law limited mortgage interest deductibility to interest on the first $750,000 of a mortgage loan. Depending on your personal circumstances, we may still advise you to borrow more than $750,000 on a mortgage, as rates are historically low.


This week’s takeaway: Financial advice must be given based on the current environment and the factors involved never remain constant. That’s why you should talk with us before you make financial moves, as interest rates and tax laws are always changing.

5,000, 30, 5 and 2: what do they mean?

The Dow Jones Industrial Average (DJIA) increased by over 5,000 points during 2017, from 19,762 to 24,792 at the end of December, 2017.

Of this 5,000 point gain in 2017, only 5 stocks accounted for over 50% of the increase. Yes, you read that correctly, 5 companies caused the majority of the 2017 rise. The DJIA index consists of 30 large US companies.**

Boeing, Caterpillar, UnitedHealth Group, 3M Co and The Home Depot, in that order, were the 5 largest contributors to the index’s rise, accounting for nearly 2,600 points.  Boeing itself accounted for almost 1,000 points, or 20% of the increase.

As the media places so much importance in reporting on the Dow’s ups and downs (though there have been few down periods in the past 18 months), it is important that you understand how the DJIA works and how certain figures and facts can be meaningful, as well as tricky or misinterpreted.

The DJIA index is calculated in an unusual method, which emphasizes the actual price change of the highest priced stocks in the index. It is not based on the percentage change of each company and the companies are not equally weighted. For example, Caterpillar stock gained almost twice as much as UnitedHealth in 2017, but in terms of DJIA points, they contributed 446 and 416, respectively. Not even near double, is that?

When you realize that only 5 stocks caused the majority of the 2017 increase, it can also mean that a few stocks could cause a large decline in the index. As the DJIA has only 30 component stocks and so few of them can have such a big impact on this index, you should realize why the stocks (asset class mutual funds) in the portfolios we recommend may perform quite differently than indexes like the DJIA.

Think of your portfolio as a massive high-rise building, with a huge, 2 city-block wide foundation at the base and is a full city-block wide at the top. Structurally, it is sound and has many types of support. Your portfolio is not the Dow. The DJIA can be compared to a different high-rise, but this one would be much smaller, not even 1/5 of a city-block wide base and much shorter. It may be strong, but it is dependent on fewer beams for support and may be harmed much more by a specific type of event (or for the DJIA, economic events) than the portfolio we recommend.

As we recommend globally diversified portfolios which may contain thousands of stocks in many industries and geographic areas, your portfolio is intentionally structured to perform differently than a limited index, like the DJIA or even the S & P 500, which is comprised of 500 large US companies. Your portfolio is much more diversified, which has significant long term benefits in terms of reduced risk and greater expected return over time.

The Impact of large numbers

Pretend headline: The Dow increased 200 points today. The Dow dropped 350 points yesterday. Those sound big, but they are actually changes of .8% and (1.4%), based on the DJIA’s current level of around 25,500.

As the DJIA is now much higher than it was years ago, numerical moves of the index maybe less meaningful, when viewed as a change in numbers only, and not on a percentage basis. But the media does not usually report percentage changes.

When you hear that the Dow increased by 1,000 points, from 24,000 to 25,000 recently, it is meaningful, but should be viewed in perspective.

When the Dow was at 10,000 in 2009, a 1,000 point increase was 10%. When the DJIA was at 15,000 in April, 2013, a 1,000 point increase was 6.7%.

Facts about the recent rise of the DJIA from 24,000 to 25,000:

  • The gain was a 4.2% increase. That is still positive and impressive, but not as much in percentage terms as a 1,000 point rise earlier in time.
  • 629 points of the 1,000 point gain were attributable to 8 of the 30 Dow stocks.
  • United Health and 3M were the 2 largest point losers in the DJIA move from 24,000 to 25,000.
    • This may seem surprising, as these were 2 of the biggest point gainers during 2017. **
    • Who would have predicted that? This is another example of why we adhere to the investment philosophy which we use and do not pick individual stocks.

Today’s Takeaway: As in other aspects of life, it is not always a great goal to strive to keep up with the Joneses. As the DJIA is an index of 30 US based companies, you should focus on whether your portfolio is helping you to meet your goals, not on how you are doing compared to the DJIA. You will likely be much better off in the long term.



** Source for the specific stock data in this blog post are from:Wall Street Journal, print edition, page 1 chart, January 5, 2018

Disclosure: We are not making any type of positive or negative recommendation about any of the individual companies which are mentioned in this blog post. The companies which are mentioned in this blog post may be owned in the diversified mutual funds which we recommend for our clients. We generally do not recommend individual stocks for our clients.

The January Effect: Myth or Reality?

The first few days of January, 2018 have been positive for financial markets. What does that mean for the rest of the year?

There are some who believe that as January goes for the S&P 500 (an index of 500 large US companies), it may be a signal whether that index will rise or fall for the remainder of the year.

In other words, the theory suggests if the return of the S&P 500 in January is negative, this would predict that a decline in the general US stock market for the remainder of that year, and vice versa if returns in January are positive.

Has this been an accurate and reliable indicator in the past?

Exhibit 1 shows the monthly returns of the S&P 500 Index for each January since 1926, compared to the subsequent 11 month return (from February-December). A negative return in January was followed by a positive 11-month return about 60% of the time, with an average return during those 11 months of around 7%. So, no, this is not an accurate indicator, at least when January is negative.

What other observations can be made from this data? The lessons of patience and discipline are clear.

January, 2016 was a good example of this. The first two weeks of January, 2016 were the worst ever for the Index, down (7.93%). The full month of January 2016 ended down (4.96%), the 9th worst January since 1926. However, the return of 18% for the next 11 months of 2016 resulted in a positive calendar year 2016 return of almost 13%.

Over the past 20 years, 10 of the January’s were negative. In 15 of these 20 years, the succeeding 11 months of the year were positive, not negative.

We do not believe that sound investment policy should be based on “indicators” such as this. You should not make investment decisions for a year, or the long-term, based on the market movements of any one month.

Over the long-term, the markets (both US and overseas, and across various asset classes, as we recommend) have rewarded investors who are patient and disciplined, who can look beyond indicators such as this.

Frequent changes to your portfolio or investment strategy can hurt performance. Rather than trying to beat the market based on your emotions, hunches, headlines or indicators, investors who remain disciplined, patient and calm can let the markets work for them successfully over time.

We are here to provide you with sound, reliable guidance and advice, so you can meet the financial goals of you and your family. And not just in January!


Source: Dimensional Fund Advisors LP