Adapting and Investing – Part I

Blog post #446

To be successful at almost anything, you need to be able to adapt. This applies to individuals, families, companies and countries.

In the past months, we have all been forced to adapt and change. Going forward, we will all need to continue to adapt, innovate and change.

Though there has been tremendous loss of life, if you step back with a broader view, individuals and societies around the world have adapted incredibly quickly, in various ways and with differing levels of success, to the Covid pandemic.

If I had told you on February 1st that most of us would be working from home (and staying home!) during March, April, May and even into the summer, you would have not thought that would be possible or could work. Now, many companies are realizing that a certain percentage of their employees can successfully work remotely, and they are innovating to meet the challenges of the Covid era.

Our firm adapting

We hope working remotely is not a permanent requirement, but a choice that people and companies can make. For many years, we have had a team member, Michelle Graham, who has worked for us remotely very successfully, after she started with us an in-office employee.

As a firm, we had steps in place, which had been tested for many years so we would be prepared to work remotely, if needed. Fortunately, we have been able to handle this difficult situation very well, from an operational standpoint. We have received phone calls, done Zoom and phone meetings, placed stock and bond trades and managed your portfolios all from remote locations. With no problems or glitches.

Our firm: core principles

We continue to believe in many of the core investment principles we adopted nearly two decades ago, but we have also adapted and made changes throughout the years, as well as in response to this crisis.

In terms of fixed income investments, we have adapted and reacted quickly to change.

  • Our role is to purchase the optimal type of fixed income investments that we feel would be safe (you should be repaid the principal upon maturity), pay the best interest rate for a given maturity and we monitor the security while it is in your portfolio.

Covid and Fixed Income Impact

When the Covid crisis severely affected the credit markets in mid-March, we had a conference call with fixed income executives of our primary mutual fund company. As a result of that call, subsequent analysis and decisions, we sold many individual corporate bonds of companies that were previously considered safe, but in this new world, appeared much riskier. We did not need to act in a panic. We did not need to sell due to a need for cash or because we, or our clients, had used margin or leverage. We waited until prices improved. Over a period of weeks, we sold bonds that were held which the Covid crisis has impacted the most, mostly in the retail, hotel and energy sectors.

While we still believe in buying and holding individual investment grade corporate bonds, we reacted with thoughtfulness and conservatism. We decided to sell the bonds of companies whose financial situation appeared to be the most impacted by this crisis, especially where there was no real visibility of how or when these companies would recover. We hope these companies do recover. But given the changed circumstances, we thought our clients should be holding better quality fixed income securities. We adapted quickly and decisively, for you, our clients.

Municipal bonds and bond funds – other changes

Usually, municipal bonds are only purchased for those in the highest tax brackets (incomes above $520,000 or $625,000, single or married), and only for their taxable accounts. Municipal bonds are debt issuances of state and local municipalities, as well as colleges, hospitals, water and sewer systems, and other projects. The interest is not taxable by the US Government, which enables the issuers to generally pay lower interest rates than corporate bonds or bank certificates of deposits (CDs).

It is our responsibility to monitor and adapt to what the financial markets provide. Recently, in a major change, some high-grade municipal bonds are paying higher interest rates than CDs and investment grade corporate bonds.

  • If this anomaly continues, it is possible that we will be purchasing municipal bonds for clients in all tax brackets, not just for those in top tax bracket, which is something that we have rarely done in the past.
  • This is a decision that we will make based on what the financial markets are offering at a given date, which constantly changes. It is our role as your financial advisor to adapt to the financial markets and do what is in your best financial interest.

While we have generally used mostly individual bonds and CDs for larger clients in the past, another way that we are adapting to the new, Covid world is likely to be a greater use of bond mutual funds within your fixed income portfolio. We have always been strong believers in diversification in both fixed income and stocks….and we continue to believe this. Due to the greater credit risk that now exists in the economy, we feel that adding bond mutual funds, in addition to other types of fixed income investments, will provide clients with greater security and more diversification.

  • If you add to your portfolio or have other fixed income investments that mature, if we invest those funds into an existing bond fund, that may provide a greater return than if we buy a new individual fixed income security.

These are just a few of the ways that we are adapting and evolving, as we always have, to changes in the world and changes in the financial markets.

We know that the world has changed dramatically.  We are committed to adapting, which means continually evaluating our business, principles, investments and practices.  When needed or when it makes sense, we will adapt and change, if we feel that would be in your best financial interest.

As always, we are here for you, and family members or friends who could use our guidance and assistance during the crisis.

Thinking about risk

Blog post #445

I never know where the ideas for these blog posts will come from. That can be a little risky, as I need to develop an idea every week.

Early Wednesday morning I was on a phone call with Delta, to cancel a flight for a trip we were supposed to be taking for a family event that was to occur this weekend.

I was fortunate that my call was answered quickly and a very nice Delta employee was able to process the cancellation, which we had been unable to do online or via their app. As she was processing the cancellation, the woman asked how me, and my business, were doing. I told her how bad I felt for her, Delta and the other Delta employees, as they didn’t do anything wrong to cause the crisis they are now facing.

Then I realized that many Delta employees at all levels (executives, pilots, phone representatives, etc.) are likely facing a huge double whammy problem right now that could have been avoided.

  • Many of them likely didn’t manage their risk properly. Many of them likely took on way too much single stock risk, by owning lots of Delta stock.
  • This could have been avoided with proper advice and planning. At the same time when many of them could lose their income due to Covid-related job losses (or have their incomes reduced, if they are able to keep their job), they have incurred huge losses in their Delta stock ownings, which has been crushed. Double whammy of loss!! Ouch!

This got me thinking about risk. 

Some risk can be avoided. Some risk can’t be prevented.

Some risk can be minimized. But risk is always there.

Your risk needs to be managed properly.

Dealing with risk is vital. Helping you to deal with financial and emotional risk is one of our main roles and can be of great value to you.

We often talk about diversification and its importance. The examples below are real world and should be evidence of why you should not own a huge amount of any one stock, and especially if it is your employer. We have seen unexpected issues arise in the past that severely impacted one company, or an industry, or now with Covid, are impacting many different industries.

Delta: Is now down 63% from its 2020 high and was down 72% at its 2020 low.

Marriott: Is now down 40% from its 2020 high and was down 69% at its 2020 low.

JP Morgan Chase: Is now down 40% from its 2020 high and was down 69% at its 2020 low.

These are Covid related losses, and likely would not have occurred if not for this crisis. But there are many examples of companies and industries that have suffered great losses for all kinds of reasons, due to technological changes, bad decisions, product failures (think of the Boeing Max), or lack of keeping up with societal trends. Think of GE, Boeing and many large retailers. Some have succeeded, others have not.

The energy sector has been hurt over many years, which worsened due to the Covid pandemic this year. There are many far worse examples than this, but Exxon Mobil is down 53% from where it was trading in 2016, dropping from $95 to around $45 now.

What are the lessons from this?

  • Be diversified. Do not own too much of one stock and definitely not too much of your employer’s stock. Our globally diversified portfolios eliminate the risk of a concentrated portfolio, by providing lots of diversification. Our clients are very well diversified, both in stock and fixed income holdings, in numerous, structured ways.
  • People don’t think single stock risk or the lack of diversification will actually impact them. But it happens. Remember Enron? Lehman Brothers? Some “unexpected event” could cause a huge financial crisis at almost company.
  • Reaching for yield is a significant risk. If a stock or bond is paying a dividend or interest rate that is far above market yields, then there is much greater risk involved.
    • We have seen people buy stocks for the “great” dividend yield and then something happens to the company….and the dividend is cut or even eliminated…and usually the stock price has dropped as well.
    • This is why we focus on your goals and your overall portfolio, not on dividend paying stocks or the yield of your stock portfolio.
  • Overconfidence and not expecting risk to show up. You always need to be prepared for unexpected events and risk to show up, as we have experienced with the Covid pandemic.
    • You need to be prepared emotionally for stock market declines of 10%-20% within every year.
    • You need to be prepared for occasional major declines in stocks of 30-50%, which could take several years to recover.
    • This is why we focus so much on your overall asset allocation, on the mix of stock and fixed income, based on your specific needs, risk tolerance and time frame…so you will be able to handle these types of declines.
  • With the current Covid crisis….there is still a significant amount of risk (and unknowns) that remain. 
    • While segments of the stock market have made major recoveries from the March lows, there are still many unknowns related to the pandemic.
    • Will there be future waves of Covid-19 that return in the fall or winter, or later? How will localized outbreaks impact manufacturing, food production and other aspects of our lives?
    • What will unemployment look like going forward? How quickly or slowly will those now unemployed return to jobs, and at what income levels?
    • When will an effective vaccine be released that is proven to be effective on a mass basis, in the US and globally?
    • What new programs will the US and other governments introduce to provide income and help people, companies, and state and local municipalities to help bridge the financial gap? What further actions will the Federal Reserve take, to continue to provide the financial markets and companies with support?
    • How quickly will people return to restaurants, stores, large events? How fast or slow will that be? Months? Years?
    • When will people return to traveling and tourism, both in the US and globally?
    • As these unknowns gradually get answered or resolved, risk and market volatility will likely remain high. No one can provide answers to these questions. The markets will react suddenly to good news, as well as to disappointments. You need to be prepared for both. 
  • Even the smartest make mistakes and even repeat them.
    • Warren Buffett has just repeated one of his biggest mistakes. He wrote in the 2007 Berkshire Hathaway shareholders letter about buying US Airways preferred stock in 1989. It quickly stopped paying the high dividend he was expecting. He eventually sold the stock at a gain in 1998, but he said that owning airlines was like a “bottomless pit.”
      • He wrote in the 2007 letter: “Now let’s move to the gruesome. The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers.”
      • After swearing off airline stocks forever, he and his team started to load up on airline stocks in the fall of 2016, and by December 31, 2019, Berkshire Hathaway had invested more than $6 billion, owning close to 10% each of the top 4 US airlines. After the Covid crisis crushed the airlines stocks in March 2020, Buffett announced that they sold their airlines holdings during April 2020, at significant losses. He no longer thought the risk of owning the airlines was worthwhile. He never anticipated a pandemic type risk when he considered buying these stocks in 2016.

Risk of loss will show up again. What seems like unexpected risks, like 9/11 or the Covid pandemic, are always there, but we do not focus on them until they become known events. Other seemingly “unexpected” events will certainly happen again in the future. We just don’t know what the source of the major event, or risk, will be….and what its impact will be in the future. As none of us has a crystal ball or can predict the future, we as your advisors have a key role in helping you to manage your risk. And we take that responsibility very seriously.

We want to help you manage your risk, so that you and your family can reach your financial goals, whatever they may be, knowing that there are known and unknown risks that will impact you in the future.

If we are able to help you reach and maintain your financial goals and help you to effectively deal with all the risks that will show up along that journey, then we will consider our relationship a success.

We hope that you and your family are healthy, and enjoy this Memorial Day weekend with appreciation for your health, and the sacrifices of many who have come before us, so that we are able to live and enjoy the benefits of our country. Even during this pandemic, we have much to be thankful for.

As always, we are here for you, and family members or friends who could use our guidance and assistance during this crisis.

If you know of someone who may benefit from this blog regarding single or company stock risk, please forward this blog to them and let them know we are open to speaking with them.

 

 

Social Security Projections and Impacts for All

Blog post #444

Based on preliminary estimates, there may not be any increase in Social Security benefits to recipients next year, for 2021.**

Social Security benefit increases are based on annual changes in the consumer-price index (CPI) and are announced each year in October. CPI data from January – April would indicate no increase for 2021, per a policy analyst of The Senior Citizens League.**

The 2020 increase was 1.6%. Over the last decade, cost of living (COLA) increases in Social Security averaged 1.4%. These are much lower than the 3% average increases in the preceding decade, between 2000-2009.

While these increases have been minor, costs of food, housing, utilities and health care still seem to rise at a much greater pace. Since 2000, Social Security COLA benefits have increased by 53%, but prices of what a typical retiree spends grew by almost double, by 99.3%. In a report by The Senior Citizens League, this has resulted in lost buying power of Social Security benefits of 30% since 2000. 

This raises the importance of maintaining your purchasing power, or of having your other assets grow at a rate that is greater than inflation, which will be discussed further below. 

Social Security is still a vital benefit for most people, and we think it will continue to be for the long-term. For example, if a couple is receiving benefits of $20,000 per year, per person, that is $40,000 per year. Using what was considered a historically safe withdrawal rate of 4% from a diversified stock and fixed income portfolio (which is based on data with much higher interest rates than we have experienced for more than a decade), that $40,000 income flow would be the equivalent of having $1,000,000 of assets. If you are receiving more than $20,000 per year, or your future projection is to receive more than that, the equivalent asset base would be much greater than $1 million. That is not insignificant, especially as the benefits are risk-free and are not subject to any financial market volatility.

As interest rates have been very low since around 2008, the value of that income stream is actually now much greater. If you were to invest $1 million in an all fixed income portfolio over the past few years, you may only generate $10-20,000 per year, not the $40,000 as described above in Social Security benefits.

What are the implications of this information? 

Social Security benefits are not likely to increase much next year, or in near future. However, most costs are likely to keep going up. In the near term, gas will be less, and you may spend much less on travel, but we all hope that once a vaccine is discovered, some normalcy will return.

The key is that over the long-term, you must earn more than the rate of inflation on your overall investment portfolio, so that you can maintain or increase your purchasing power. The only place to do that for most people, to earn more than inflation on an after-tax basis, is in stocks or other riskier investments.

Although stocks have declined in 2020 and there has been heightened volatility in recent years, you must focus on the long-term benefits of having a diversified portfolio. We provide and plan for a solid “fixed income foundation” to provide stability for your near-term financial needs, for your next 5-10 years of spending, if you are in or near retirement.

Though it can be difficult, patience and discipline are required to maintain your stock allocation, but it has been rewarding to do so over the long-term. And your focus must be on the long-term, not on the next few months or years, but on the rest of your life, and that of your spouse and other family members.

A globally diversified portfolio goes through ups and downs, but over the long-term, a globally diversified, balanced portfolio can provide returns that are far in excess of inflation. For illustrative purposes, the Vanguard Star Fund has returned 6.76% per year over the past 15 years, and 9.16% per year since its inception in 1985.**** This fund generally has a 60% stock and 40% fixed income allocation, with diversified holdings in the US and significant International exposure. This is not a fund that we recommend, so this is not performance data of our firm. But I think this information is relevant for illustrative and informational purposes, to reinforce the long-term benefits of staying invested in stocks and being well diversified.

Social Security planning

If you are not yet receiving Social Security benefits, or are years from receiving Social Security benefits, you should verify your projections regularly at SSA.gov. Check your earnings and projected benefits every few years.

Even if your income goes down this year, due to the Covid crisis, you should know that benefits are based on a 35-year average, which is weighted toward your later years of earnings. Also, it is important that you, and a spouse/partner, earn credits for as many years as you can. For example, for 2020, you earn one credit for each $1,410 of earnings, up to 4 credits per year. You need to earn 40 credits, or 10 years of work, to be eligible for retirement benefits.***

Even if you or your spouse only work part-time for a significant number of years, there is still a long-term benefit of earning some amount of money, to earn these credits, and the resultant years of Social Security benefits later in life.

Focus on the long-term.

Adhere to your plan. Or talk to us about your planning.

Be positive.

As always, we are here for you, and family members or friends who could use our guidance and assistance during this crisis.

 

Sources:

** “Social Security recipients may be in for a rude awakening later this year,” Alessandra Malito, Marketwatch.com, published May 13, 2020.  Social Security statistics in the first 4 paragraphs are from this source.
*** Data per Social Security website, SSA.gov.
****Per Morningstar.com, May 14, 2020, for Vanguard Star, VGSTX. The returns cited do not include any advisory fees, such as our firm would charge a client.

Credit Card/Grocery Tips and Thoughts about Buffett

Blog post #443

Get more credit card benefits for grocery, restaurant and delivery purchases

As we are all buying or ordering more groceries, as well as using delivery services due to the pandemic, a number of premium credit cards have significantly increased their rewards for grocery purchases and food delivery services, either from grocery stores or restaurants.

Chase and American Express recently announced that for many of their premium credit cards, they will be offering up to 5X points or cash, on grocery store purchases. For some credit cards, this now includes grocery delivery services like Instacart.

Each credit card may have different benefits, and differing time frames (some through May 31, some until July 31), so you should check on each credit card’s specific benefits.

This may not be huge money, but if you can get 5% back, rather than 1%, that can make a difference to you and your family.

Other related items:

  • Some Chase credit cards are offering rewards for restaurant delivery services, like Door Dash. If you have these cards, take a look at their rewards or search for this on the Internet.
  • If you have normally charged all your purchases to accumulate airline or hotel points, you may want to consider using other credit cards that offer cash or points that are redeemable in other ways, especially if you already have lots of airline and hotel points, and don’t plan to travel in the near future (though we certainly hope that travel can resume sooner rather than later).
  • Instacart has become a popular grocery delivery service.  After using Instacart, I was very surprised with a recent purchase from a local grocery store (which is not a chain). While we thought this was a great service, there was a 12% mark-up on the food, plus a delivery fee, service fee, and we paid a tip as well.
    • In later reviewing the grocery store’s website, I learned that purchases through Instacart were marked up 12% (and ours was actually more), in addition to the other fees. Each grocery store’s relationship with Instacart is likely different.
    • While grocery delivery services are important these days, you should be aware of this cost, as it can be significant. We are more likely to pick up groceries that the store can pack, which will still be safe, and save a lot of money.

Thoughts on Warren Buffett’s virtual Shareholder meeting

This Saturday afternoon, Warren Buffett spent a few hours on a virtual live stream for Berkshire Hathaway’s annual meeting, providing a financial history of the US and the stock market, as well as discussing how Berkshire Hathaway and his team have handled the pandemic.

He announced that they sold all their airline stocks in late March and April, at significant losses. They had accumulated up to 10% stakes in the 4 largest US airlines in past years (Delta, Southwest Airlines, United Continental and American). He said, “the airline business has changed in a major way and the future of airlines is much less clear.” He said he made a mistake in buying them, as he believed the airline earnings would continue to increase, but that has changed now due to the pandemic.

The other major news was that Berkshire has not made any large stock purchases or deals in 2020.  This is quite different than in the financial crisis, when Berkshire made major investments or provided financing to many companies, including Goldman Sachs, Bank of American and others.

Buffett discussed the current situation as still having many unknowns, but the variance in possible outcomes is less than it was in March. He gave huge credit to Fed Chair Powell and the committee for their swift actions in March, 2020, and implied that the financial markets and the economy would be far worse now without their many programs and steps.

Our observations about Buffett/Berkshire’s actions and non-actions:

Buffet/Berkshire’s decision to sell all their airlines stock holdings, at or near a market bottom, could be viewed as startling or surprising, as he generally holds for the very long term. Buffett stressed in his comments that the sales should not be interpreted as his view on the overall stock market, only in relation to the airline sector.

Buffett is decisive, which is commendable. He acts quickly, when he buys, sells or makes transactional decisions. He is also confident enough in himself that he can admit a mistake and walk away from a loss.

This is just my assumption, but he must have thought that the other Berkshire companies would earn more with the proceeds from the airline stock sales than had he left the money in airline stocks. Or he thinks the airline stocks will decline much further or not recover for many years.

This is something to consider, as does he think that it will take many years for the airlines, and thus, hotels, travel and other leisure companies to get back to “normal,” or pre-pandemic earnings levels? This would be one of the many unknowns he referred to indirectly throughout the introduction and during his Q & A.

That Berkshire has not made any major stock purchases or provided financing to major corporations as they did in the Great Financial Crisis, or at other times in the past, is indicative of several factors, but should not be overly concerning to individuals as long-term investors.

  • Interest rates are very low and the Federal Reserve has taken strong action that has allowed large corporations to borrow huge sums in the credit markets recently (billions), which many were unable to do in 2008-09.
    • For example, Boeing is facing a severe cash crunch, due to their Max plane problems, and now the lack of demand for planes, due to Covid 19.
    • Last Thursday, Boeing borrowed $25 billion in one of the largest bond offerings ever. There were many different maturities, but the 10-year maturity paid 5.15%, or 4.50% more than the 10-year US Treasury bond. Boeing is rated just above junk status, as a very low-grade investment quality company, right now.
    • But instead of having to go to Buffett, and pay say 10-12%, which he may have been willing to entertain, other institutional investors (likely bond mutual funds, insurance companies, etc.) were more than eager to buy these Boeing bonds. As Buffett is not going to loan money to risky companies at 4-5-6% interest, he has not made these types of deals right now.
      • Just like we are not going to buy these Boeing bonds as investments for our individual clients. We would agree with Buffett that the risk is much greater than the reward. We are fine to pass on these.
  • Similarly, as the stock market dropped a lot very quickly and then has made a significant recovery, Buffett/Berkshire did not jump into the stock market to make any major purchases.
    • His view as a very patient, generally long-term investor has not changed. He wants to buy when he feels he is getting a bargain, or he perceives value. He views taking no action is an action.
    • Berkshire likely has more than $200 Billion already in many individual stocks. The top 5 holdings from 12/31/19 were Apple, Bank of America, Coke, American Express, and Wells Fargo. His holdings in these and other financial stocks have dropped significantly, due to less credit card usage, as well as increased default risk, if the pandemic crisis worsens or continues longer than expected, and there is not further governmental financial support. But he has not sold any of these major holdings, or anything else.
      • While Buffett clearly did not pound the table Saturday and say stocks are under-valued, he remains optimistic about the long-term prospects for stocks.
        • He provided clear caveats, and important reminders for stock investors, that stocks may not always perform well and there may be long periods without a recovery.
        • He said to be an investor in stocks, you must be prepared for significant declines, sometimes as much as 50%.
        • Buffett: “I don’t believe anybody knows what markets are going to do tomorrow, next week, next month or next year. Anything can happen. You need to be careful about how you bet simply because markets can do anything (in the short-term). Nobody knows what’s going to happen tomorrow.”
        • Buffett: “Equities (stocks) will outperform US Treasuries over the long term.”

Berkshire Hathaway and Warren Buffett are very different than you, our clients, and how we manage your portfolio. We feel it is important to listen and learn from Buffett and his team.

However, we are managing your portfolio so that you can meet your goals, and those of your family. Buffett is managing Berkshire Hathaway as a public company with a multi-generational mindset, and for stockholders, not to meet your personal spending and savings needs.

We share Buffett’s concerns and the many unknowns about the future. We have often stated that the future is unknown, because it is, but there are even more unknowns now than normal.

We are confident that we have structured your portfolio to be able to handle the unknowns of the future, by providing you with an appropriate amount of conservative fixed income “Foundation,” based on your personal circumstances. 

We remain confident long-term investors, for ourselves and for you.

As always, we are here for you, and family members or friends who could use our guidance and assistance during this crisis.