Interest Rates and Your Financial Future

Blog post #462

Interest rates have been quite low for over a decade and are not likely to increase in the next few years. This has important implications for all investors.

The 10-year US Treasury bond yield has been below 4% since 2008, in the 2-3% range for most of 2009-2019, and has been well below 1% since the Covid pandemic hit in March of this year. (see the chart below).

The Federal Reserve on Wednesday provided forward guidance that they project short-term interest rates to remain near zero well into 2023. Eventually they predict short-term rates of around 2.5%, but they do not provide any guidance as to when that may occur. While their forward guidance (projections) have generally not been accurate, they are basing these predictions on the impact of Covid on the economy and the lack of current and expected future inflation.

What is the impact of continued low interest rates mean to you?

When we do investment planning for you, one of the most important decisions is how much to allocate to stocks and how much to allocate to fixed income (bonds, CDs, bond mutual funds, cash, etc.).

This high level asset allocation decision is based on several factors, which include your need and willingness to take risk, how much growth you need from your investments to meet your financial goals and your investment timeframe.

As we review these items with you, that will guide our recommendation of how much of your portfolio should be in stocks and how much should be in fixed income.

The key concept that we want to stress is that even though interest rates are very low, and may remain that way for a while, this should not significantly change how much you should allocate to fixed income. 

Why? Shouldn’t the prospect of continued lower interest rates make someone want to increase their stock allocation, as the fixed income returns will be very low? Let’s look at some examples and discuss this further.

If you are in your 20s or 30s and have decades of work and savings ahead of you, we may recommend a stock allocation of 80% or even more.

If you are in your 40s or 50s and need growth from your portfolio to provide for the retirement you desire, your asset allocation may be 60-70% in stocks, with the remainder in fixed income.

If you are in your 70s or 80s and have saved enough so that you can live comfortably, your stock allocation may be well below 50%.

We don’t think the prospect of continued very low interest rates should materially change your overall asset allocation plan because most people don’t want to significantly increase their stock market risk more than they need to.

If you feel that because of expected continued low interest rates you should decrease your fixed income allocation and increase your stock exposure, you must be prepared for the increased volatility (short term risk) that comes with owning more stocks.

Fixed income provides you with some income, but we view the fixed income allocation primarily to provide stability to your portfolio. Thus, you don’t have as much temporary volatility that comes with owning stocks. If you have the stomach to own more stocks, and can handle the swings and volatility, then your expected returns could be much greater over the long-term, say 10 or more years. But for most investors, they need the ballast of fixed income in their portfolio.

As we remind clients, it is normal for stock markets to decline at least 20-30% every 3-5 years. That is the type of temporary volatility that is to be expected in order to earn the long-term rewards of owning stocks.

  • If someone had a $2 million portfolio with a 50% stock / 50% fixed income portfolio, they would have $1 million invested in stocks. If that portfolio incurs a 35% decline, as happened in the S&P 500 earlier this year, the stocks would decline by $350,000.
  • But if the stock allocation had been increased to 75% because of lower expected interest rates on the fixed income allocation, they would have had $1.5 million invested in stocks. If a 35% stock market decline occurred, the temporary decline would be $525,000, which is far greater than the $350,000 temporary drop of a 50/50 portfolio.

The question you must ask yourself: Is the additional volatility of the stock market worth the increased exposure to stocks? Will you be able to maintain a higher stock market exposure through the down periods? This is so important, because the worst result would be to increase your stock market exposure now, then panic when a major stock market decline occurs.

We plan to remain consistent with our long-term principles regarding fixed income.

  • We will only invest in high quality fixed income, as the return of your principal is most important.
  • We will not reach for yield by buying junk bonds. If a bond fund says high yield, that means it is holding less than investment grade securities, which have a much greater chance of defaulting. We don’t recommend junk or high yield bond funds for our clients.
  • Diversification is vital in fixed income. For those who invest in municipal bonds, we recommend holding bonds of many states, not just your home state.
  • We regularly monitor your fixed income holdings of corporate and municipal bonds for any downgrades or credit risk exposure. We would rather sell today than take the chance on a default in the future.

The financial world is continuously changing. We are here for you, if you have any questions about this or other financial matter. 

We would be pleased to assist you, your family members and friends.

Source:

 

 

It’s Hard to Stay on Top

Blog post #460

The Covid outbreak has caused each of us to adapt and change.

Adapting and dealing with change is not a new concept. In order to succeed over a long time period, organizations and companies must adapt and change to remain on top.

Very little stays constant. We know that change happens over time. Sometimes change is gradual and sometimes it’s sudden. Change can happen for many reasons.

Companies that are successful over long periods must be able to adapt and change, or they will be less successful or less profitable or shrink and possibly even go out of business.

The chart below shows the top 10 US stocks based on market capitalization by decade from 1930 to 2020. The data is based on their overall stock market value at the end of the calendar year, preceding the decade. For example, for 2020, Apple was the largest stock based on market cap as of December 31, 2019 (see the far right column, at the top).

Suggestion….if you can look at this chart on a device where you can enlarge it, the chart is much more informative.

Key takeaway: While some companies remained in the top 10 list for decades, this chart shows how much change there has been over the long term and how hard it is to remain in the top 10.

Based on this past evidence, it is hard to know with confidence if a top 10 stock today will be a top 10 stock in 2030 or 2040.

Exhibit 2, from DFA Article, “Large and In Charge? Giant Firms atop Market Is Nothing New”.

Some observations from this chart:

  1. From 2000, only 2 stocks that were in the top 10 are still in the top 10 as of the beginning of 2020. That is a significant amount of change in 20 short years. What 2 companies do you think these are? Think about this.  The answer is at the bottom.
  2. Apple was not in the top 10 until 2010. It is now #1.
  3. Of the top 10 in 2020, 5 of those companies were not in the top 10 at the beginning of 2010. That is an amazing amount of change in 10 years. And since the beginning of the year, JPMorgan would be out of the top 10 today, and either Tesla or Walmart would be #10. Tesla was far from the top 10 at the beginning of the year.
  4. What decade did Amazon begin in the top 10? The answer is at the bottom.
  5. What stock was in the top 10 every decade from 1930 through 2010, was #2 at 2000, but dropped out after 2010 and is now only about 110-120th largest as of June 30, 2020? General Electric.
  6. The chart by decade shows how the economy and world have changed significantly.
    • Energy stocks were 5 of the top 10 in 1980. There are no energy stocks in the top 10 now.
    • There were 5 technology stocks in 2000 (Microsoft, Cisco, Intel, Lucent and IBM) and 5 technology stocks on the list at the beginning of 2020. However, only Microsoft remains on the list from 2000 to 2020. And none of the other 4 stocks have done well in the 20 years since 2000, compared to the S&P 500 index.
      • Today’s leaders may not be the leader’s a decade or two from now.
      • To show how hard change is, Cisco was #3 in 2000. Its current price is still lower than it was at December 31, 1999. In 2007, Cisco purchased a company called WebEx, a web conferencing start-up. In 2011, a VP of Engineering pitched an idea for a smartphone-friendly conferencing system to Cisco executives. They rejected the idea and Eric Yuan left to establish Zoom Video Communications, which is now worth over $100 billion. Cisco is worth about $174 billion but could be worth so much more.
    • Since 1990, it appears that change is even more frequent, or that is even harder to remain in the top 10 list. At the beginning of each decade, these are the number of companies that appear on the list for the first or only time:
      • 1990:  4 companies
      • 2000:  5 companies
      • 2010:  1 company
      • 2020:  5 companies

While many of the current top stocks have performed extremely well in recent years, you should remember that expectations about future operational performance of a company should already be reflected in it current price. Positive developments that occur in the future that exceed current expectations (such as Covid’s positive impact so far on Amazon and Walmart) may lead to further gains in its stock price. However, unexpected changes are not predictable.

Historical data on the performance of the top 10 stocks following the year in which they joined the list of the 10 largest firms shows much less positive results. As Exhibit 3 below shows, these stocks outperformed the total stock market (this is not compared to the S&P 500) by 0.7% per year in the subsequent 3-year period. Over the subsequent 5- and 10-year periods, these stocks underperformed the total stock market on average by greater than 1% per year. This data was compiled for each calendar year between 1927-2019, not just by decade in the prior chart.

 

 

The only constant is change and this clearly applies to the dominant stocks in the market. It remains impossible to systematically predict which large companies will outperform the stock market and which will underperform it. This reminds us of the importance of having a broadly diversified portfolio that provides exposure to many companies and industry sectors.

Answers from above:

1. Microsoft (#1 in 2000, and #2 at the beginning of 2020) and Walmart (#4 in 2000 and #9 at the beginning of 2020).
4. Amazon was not in the top 10 in 2000 or in 2010. The first decade that Amazon appears in the top 10 was in 2020, ranking #3 at the beginning of 2020.

 

Source:

Where do we go from here?

Blog post #456

It’s early August, 2020. In the US, this marks the beginning of the 6th month of dealing with Covid-19, which really started to impact the US in March.

What are we thinking about in terms of investing and financial planning now, and going forward?

What are the lessons of the past 6 months and how should we apply them moving forward?

Markets react quickly and unexpectedly: Stock markets in the US and globally reacted quickly as countries shut down due to the pandemic. Then, unexpectedly, beginning in late March, markets recovered strongly.  Investors looked at the longer term view of recovery and how companies can adapt. However, companies and sectors that continue to be greatly affected by Covid-related challenges are still far off their pre-Covid price levels.

Stick to your asset allocation and financial plan: The rapid recovery of many stocks re-emphasizes why it is so difficult to time and predict the stock market. This is why we are strong believers in developing a long-term financial plan and adhering to that asset allocation.

We work with you to develop a financial plan, based on your goals, your need to take risk and your time frame. We don’t try to time the markets and we don’t base our advice on guesses and predictions.

There is still a long way to go: While there has been great progress in Covid treatments and initial vaccine development, a return to pre-Covid life is still likely to be many months, if not a year or two or even more into the future.

There is no way to know how long vaccine trials will take. We don’t know how many of the potential vaccines will be successful. Even when some are determined to be viable, distribution and receiving vaccines will take time, likely much longer than many now realize. And no one knows how effective any new vaccines will be.

Because of all these medical unknowns, we think it is important for each of us to be realistic and develop a long-term mentality related to this new Covid environment. We need to be resilient. How can you better adjust and adapt? As Covid issues will likely be with us for awhile, are there additional things that you can or should do, to help you and your family cope with this new world?

Is there anything you want to discuss with us, to help you cope?

How your investments will adapt: We focus on developing a very broadly diversified investment portfolio for you, as part of your investment plan. Even more today, we think being very diversified is vital and beneficial.

Your portfolio has growth and value companies, as well as large and small companies. We recommend investments both in the US and Internationally. Diversification, both in stocks and your fixed income holdings, has many benefits. The most important benefit is that you should not be materially impacted by any one industry or company.

As Covid continues in the future, we do not know which countries or companies may be more successful than others. Thus, broadly diversify. As my wife asked the other night during a walk, what will happen to stocks and companies that have hugely benefitted from Covid? Won’t they go down at some point? Will they be considered way overvalued in the future, as Covid is dealt with? We don’t know the answers, which is why a broadly diversified portfolio holds all types of companies, in varying amounts.

No company, industry or geographic region should cause a decline in your retirement lifestyle or your ability to reach your financial goals. Broad diversification provides this.

We want to stress the importance of thinking long-term, even though that means different things, depending on your age.

If you are in your 20s, 30s, 40s, or 50s, you have a very long life expectancy. You should not be focused on what is happening in the markets now. You should primarily focus on saving and investing. That is what I have done and will continue to do, regardless of what the markets are doing. I keep investing, every month, into the same funds and investments we recommend to our clients.

You need to have a positive mental attitude that our country and companies, both in the US and globally, will continue to evolve, grow, adapt and succeed. I believe that years and decades from now, the earnings of public companies will be greater than today, as the world and economies expand. I don’t know which stocks will be the best performers decades from now, which is why we believe in asset class investing as a core principle.

We are concerned about the impact of Covid on small businesses, industries and people that have been greatly affected by Covid, but that does not influence the long-term investment strategy of either our firm or me personally.

As you near or are in retirement, we stress the concept of a “fixed income foundation.” By this we mean that our goal for you is to have many years of your annual withdrawal needs in various fixed income investments, such as bonds, CDs, bond funds or cash.

For example, if you have $1 million of your $2 million portfolio in fixed income investments, and you withdraw $50,000 annually, you have a fixed income foundation of 20 years worth of withdrawals ($1 million divided by $50,000 = 20) and that assumes no interest on the fixed income.

If you have have many years of a fixed income foundation, then mentally we hope that you can focus on that, as your standard of living is not directly impacted by short term declines in the stock market.

Remember, regardless of how old you are, declines in a broadly diversified stock portfolio are temporary, and eventually give way to a more permanent uptrend in the growth of stock prices.

The harder concept for people to grasp, due to human nature, is that lower stock prices mean better value for stocks going forward. It is like a sale at a store (or online!). The store sales seem like a good bargain. Try to think of temporary stock declines like a sale at a store.

We see that periods of market turbulence or stock price declines cause great companies to react, adapt, adjust and add value for the long term. The companies that will succeed will figure out a way to do so, however they are able.

This is why we invest in all types of companies, because you can’t predict who and how they will succeed, and which will have better future stock market returns. For example, while growth companies have excelled, many companies that are now considered value companies trade at a fraction of growth companies’ valuations. Many of today’s cheap companies will succeed, and they will likely have strong stock market returns when we look back, 5 or 10 years from now.

Plan for the future.

Be resilient.

Be positive.

Wear a mask.

How to Deal with Lower Interest Rates

Blog post #452

The Covid pandemic has caused already low interest rates to move even lower. 

Throughout much of 2018, the 10-year US Treasury Note yielded around 3%. During 2019, it dropped from the 3% to 2% and since Covid hit, the US 10-year yield has hovered around 0.6% – 0.7%. It is worse overseas, as Germany’s 10-year notes pay 0.09% and Japan’s are at zero or negative.**

The implication of much lower interest rates are important to you as an investor. Going forward, at least for the next few years, it is likely your fixed income allocation will yield even less than it has been. As each fixed income security that you own matures, it will likely be reinvested at a much lower interest rate.

What are the choices that you have, and we face as your investment advisor, regarding very low interest rates? 

We could recommend some of the following, but that is not likely. We could….

  • Extend maturities
  • Invest in lower credit quality fixed income, to reach for higher yields
  • Invest more in stocks and reduce your fixed income allocation
  • Invest more in alternative investments

For most clients, we are not likely to recommend most of the above, at least not without extensive analysis and conversations with you.

Extending maturities means buying individual fixed income investments or bond mutual funds that are beyond what we are buying now, which is generally 5 years or less. The markets are not paying much more interest to hold longer maturities, so it does not make sense to us.

We view fixed income as your foundation, the safe part of your portfolio. When stocks drop, we don’t want your fixed income to crash as well. We don’t buy high yield (or junk bonds) for this reason. Risk and reward are tied together. If an investment grade 5-year corporate bond is yielding 2% today….and another one yields 6% or 10% for the same 5-year maturity, this means that there is much more default risk in the 6% or 10% bond. We want to try and ensure that you will get your principal back.

For some clients, we may review your stock to fixed income allocation, as fixed income is paying so little. For clients who are younger or can emotionally handle the volatility and greater risk in stocks, it may make sense to maintain a greater stock exposure than we would otherwise recommend. For older clients getting close to retirement or in a withdrawal mode, this may be a difficult decision. We will need to evaluate where you are in terms of your need to take risk, and your willingness to handle more risk. If you are comfortable and have adequate assets, the downside of greater stock exposure is probably not worth it.

We have not found any alternative investments that we are comfortable recommending. We have reviewed many, but they must provide benefits to you through performance track records that add value to your portfolio (and not just expected to add benefits), as well as provide liquidity, be understandable to us and have reasonable or low internal costs. As of now, we prefer to stick with our long-term investment philosophy that we are very comfortable with and not try other investment vehicles.

What does this mean for your future?

We focus on meeting your financial goals and the long-term total return of your portfolio.

  • We are not going to reach for additional yield if it means increasing the risk of defaults on fixed income. Although you will receive less interest income for the foreseeable future, we place greater priority on the return of your principal.
  • We will likely use more investment grade bond mutual funds in the near term, due to the very low interest rates, as they may hold higher yielding investments than we can purchase today. This also provides even greater diversification, which reduces your risk further.
  • We may need to work with you regarding Social Security planning, as we discussed in an earlier blog post, Social Security Projections and Impacts for all, dated May 14, 2020. If inflation remains low for many years, then future Social Security benefit increases will be lower or non-existent.
  • If you are in good health and feel you have a longer life expectancy, delaying Social Security benefits until age 70 may be a strategy that is recommended more in the future. There is a huge annual increase in benefits by waiting until age 70, rather than starting to receive Social Security benefits at your normal retirement age of 65-66.
  • We will continue to carefully monitor the credit quality of your current fixed income investments, as we do when we purchase new investments. We avoid low-quality fixed income investments, in both corporate and municipal bonds. We avoid some sectors entirely which have higher historical default risks.
  • Some clients may face difficult decisions, if interest rates remain low for an extended time period. The future is always uncertain, and things can change. Some may have to reduce their spending expectations or work longer, before they retire.
  • You should review your mortgage and see if refinancing makes sense. Rates are around 3% and even lower, depending on where you live and the length of your mortgage. I thought my refinance at 3.50% a few years ago would be my last, but I will likely refinance it again to lock in these lower mortgage rates.
    • For others, we may recommend paying off your mortgage sooner, which is something that we generally do not recommend. Please discuss these mortgage alternatives with us, as the recommendations are very specific to your individual circumstances.

We know the financial world keeps changing. This is what makes our role in your life valuable, as we will continue to provide you advice that is relevant and appropriate. We take this responsibility very seriously.

Talk to us. We want to help you, and your family, deal with change, today and tomorrow.

Source: **WSJ.com, July 9, 2020.

Is there a disconnect?

Blog post #451

The 3 months that just ended June 30th was terrific for nearly all asset classes, both in the US and Internationally.

The financial markets have been volatile, as one would expect, given the onset of the Covid-19 crisis. The 34% decline in the S&P 500 for the 33 days up to March 23rd was the fastest decline from an all-time high. But this rapid decline was then followed by one of the best 50 days in the history of US stock markets.

Markets are unpredictable. If the above market moves don’t teach you that, then nothing else will. This is why we emphasize the importance of staying in the market, because you don’t know what tomorrow will bring.

Early this week was another good example of the difficulty of predicting what the markets will do.

  • Over the weekend, Covid cases were rising and states were moving toward more closings, not openings. The news was bad both medically and for the economy.
  • With no new positive medical or vaccine developments on Monday and Tuesday, and Covid cases increasing, the markets went up on Monday and Tuesday.
  • You can’t predict that. Just stay in the market for the long-term. Be disciplined and take the long view.

How can large US company stock indices be down by only single digits for the first 6 months of the year, despite the Covid outbreak, widespread shutdowns and huge unemployment?

Many people have asked this question, wondering if there is a disconnect between the stock market and the actual economy. They are right and wrong.

The stock market looks into the future and values long term future expectations for publicly held companies. Thus, these large company indices that many view as “the market” are representing the future prospects and expected future cash flows for large companies like Apple, Delta, Amazon, Costco, Facebook, Marriott and many more. These large indices, such as the Dow Jones and S&P 500 are heavily impacted by a handful of the largest companies, as these indices are market weighted. This means the largest companies by stock market valuation have the greatest impact on the indices. And remember, the DJIA consists of just 30 stocks.

The stock market does not directly reflect the many small, private companies that are hurting or have already gone out of business. The market does not directly factor in the restaurants and stores near each of us that have already closed or are struggling. They are private, so they are not traded as stocks. But these privately held businesses are, or were, most likely customers or have relationships with many larger, public companies, and their owners and employees all shop at public companies. All this information should be factored into the current value of publicly traded stocks.

Thus, “Main Street” and “Wall Street,” if I can use those terms, are different.

The question that we cannot ever answer is about the future. As we often say, we don’t have a crystal ball.

What will the eventual impact of the stress on these smaller businesses be on the larger economy?

Will unemployment continue to go down? How fast or slow?

How will Covid impact consumer spending and will it affect the purchases of Apple products? When will people begin traveling again in large numbers and restore those related businesses and workers?

Will Target, Costco and Walmart feel the brunt of high unemployment? Will consumer spending drop or increase over the next 3 or 6 months, or longer, due to all these Covid effects?

Apple, Target, Costco and Walmart stocks are each near their 5 years highs. What the market is saying about these companies right now, based on their stock prices, is that they will succeed in the future. This helps to explain why these indices are at the levels they are at.

Other public companies, which are facing the negative brunt of the Covid impact, are still crushed, even if they have rebounded from their lows. Airlines, hotels, travel and leisure, and energy companies are far off their pre-Covid levels.

How do we handle and process these issues?

From an investment standpoint, we have a choice of how to approach all these issues. As a firm, we have taken the path that says that we will hold a diversified portfolio of many stocks, mostly in the US, as well as around the world.

But we have chosen not to play an expensive and most likely, unsuccessful guessing game to try and determine the answers to all the above questions, because no one really knows any of the answers.

We are not going to try and guess which stocks will outperform others over the next 1, 5, 10 or 20 years. That would not be our primary focus to help you to reach your financial goals.

We want to focus on the key things that matter to you most. We want to make sure you have adequate funds for your needs, both in the short term and the long term.

This is why we work with you and talk to you about the importance of developing an appropriate investment allocation between stocks and bonds that you can live with, especially during market downturns.

We hope this makes sense to you. This approach should provide you with comfort and clarity.

We want to wish you and your family a happy 4th of July weekend. We hope that you stay safe, and socially distance.

As we said above, we don’t have a crystal ball. However, we do believe in science. We do believe in the benefit of wearing a mask when in public places. In our humble opinions, we believe that if more people would wear a mask, we (and the stock market) would be better off in the long run.

Our firm will be closed on Friday, July 3rd, in observance of the 4th of July holiday.

Blog post 450: A Milestone Interview

Starting in mid-June, 2014, I committed to writing these posts weekly, which we have done for the past 6 years. Since 2009, this is the 450th blog post we have written.

We hope these blog posts are helpful to you, as we strive to provide you with guidance, timely information and clarity, as you deal with a constantly changing financial world.

What have you learned from the last few months, from the pandemic and the financial markets?

The most important lesson confirmed what we already knew, that financial markets cannot be timed and predicted. One of our firm’s guiding principles and beliefs is that you can’t successfully time the markets….that you can’t successfully try to time when to get out of the stock market and then accurately figure out when to get back in. It is too hard to be right both times, getting out and getting back in.

No one could have predicted the strong stock market recovery since March 23, 2020. The stock and bond markets move on news that is unexpected. In other words, new information that is not already known. The Federal Reserve’s strong and sweeping actions could not have been predicted or timed in advance. They have done much more, and acted much faster, than they did during the Financial Crisis of 2008-09. That has had a major positive impact on the bond market, and thus, the stock market.

When unexpected progress is announced on vaccines or treatments, it is likely the markets may increase. However, there remains great uncertainty about future cases, the ability to control Covid, how the economy will react and future governmental and Federal Reserve responses.

Nearly all of our clients have adhered to their long-term plans. They have remained in the stock market. We plan and determine each client’s asset allocation to be appropriate for their risk tolerance, time frame and their need and ability to take risk…. your need for stock market exposure. We want each client to have an appropriate stock market exposure so you can emotionally handle the downturns.

What are some of your earliest investing memories and lessons?

I didn’t make any real investments until I was in my late 20s or early 30s. My first financially related memory was working at my local public library during high school, when an older gentleman advised me to read the Wall Street Journal every day. I have been a Wall Street Journal subscriber and reader since my first year of college, for almost 40 years now.

The summer after my first year in college I worked as a busboy at a resort in Wisconsin, putting myself through college. Chrysler was near bankruptcy at the time. I wanted to buy $500 or $1,000 of Chrysler stock and called my mom to discuss it. She had no investing experience, as my parents were divorced and we lived paycheck to paycheck. She said I needed to save the money to pay my college tuition and not to risk it on Chrysler stock. I would have made a lot of money if I had bought that stock, but she was clearly right. I had no business even thinking about buying Chrysler stock, as that was critical money that I needed for the coming year of college.

The lesson is that money needs to be considered in various buckets, based on your time frame. I needed the money for tuition and housing for the next year. Money invested in the stock market requires a long time frame, at least 3-5 years or much longer.

You need to think about your investments based on your time horizon. If you are saving for a retirement that may last decades, what happens today is not as critical. We are planning and focusing on providing you with enough capital for an income stream that will last you for decades.

What are some of the important decisions that you have made and why?

The decision to adopt the investment philosophies that we did in 2003, and still believe in and adhere to today. These guiding principles enable us to have a set of beliefs that give us confidence and a foundation for investment policy and the decisions that we make. We believe this gives our clients confidence and comfort, despite financial uncertainty.

My decision to ask Keith to be my partner in 2008 was critical. I will forever be thankful for his trust in me and leaving our prior firm, a week after his 4th child was born. While we have very different styles and personalities, we analyze things well together and complement each other. We feel that one plus one equals three, which is the basis for a strong business relationship.

The decision to be fee-only financial planners and not to accept any commissions is vital. We act as fiduciaries and put our clients’ interest first, always. If our clients do well, so do we. If they lose money, our income declines as well.

We have made several major investment policy decisions that we feel are proper in the long run. We believe in global asset allocation and broad diversification. While certain asset classes have performed below US Large stock indices for a number of years, we know these periods of underperformance often turn around. Over the long-term, meaning decades, a globally diversified portfolio has outperformed a US-only portfolio. We expect that to be true going forward.

We got out of commodities after 2010. We did this because we did not think commodities provided an effective hedge against inflation, which was the original purpose of buying commodity funds. This had been a good decision, as commodities have done very poorly since then.

We have avoided alternative investments and hedge funds. We believe in using very low costs investments, which we can understand and provide daily liquidity. Most alternative and hedge funds don’t meet these criteria. We invest only in high quality fixed income investments. We review different investments regularly, and have modified portfolios and investments over time, but new investments must meet our foundational criteria.

How does writing this blog fit into the firm? Why do you do this every week?

As founder of WWM and author of nearly all of these 450 blog posts, writing these weekly blog posts represents our commitment and discipline to effectively and timely communicate with you, our clients.

We want you to know that we care. We want you to know that we are always thinking about our constantly changing world and how it impacts you. We want to be unique as a firm. By writing each week, we can inform you and provide our thoughts to you in real time.

Writing a blog post every week means we are constantly looking for relevant topics to write and communicate about. Finding topics in the past months has NOT been a challenge. We feel this process makes us better Advisors for you. We listen to your questions and issues, as those frequently become future blog posts topics.

I want to thank the other members of our firm, and Michelle Graham in particular, who works with me each week to produce the blog and deals with my many editing changes. We must research and meet various compliance regulations, which takes time. We spend hours per week on each blog. It is a firm-wide effort.

There are very few independent financial advisors that make this type of commitment to their clients to produce their own, original content on a weekly basis. We hope you find this valuable and helps you to be a better and more successful investor.

What do you see for the future of the firm and its clients?

In the near-term, we will be working with clients on a virtual basis and we are well prepared for that.

WWM has grown at a steady, moderate rate over the past decade, and we hope that continues. We want to add clients, but only at a pace that will enable us to provide excellent service to all of our clients, new and continuing.

We are particularly pleased that we are working with multiple generations of client families. We have many clients where we work with grandparents, their children and even grandchildren. We work with parents and they are now introducing us to their children. We have helped many clients deal with life transitions, such as those who have had a spouse die or have gotten divorced. These can be difficult times for people and having a firm with this expertise that can assist you through those times can be critical to your well-being.

We are looking forward to engaging clients in a Wealth Analysis and planning processover the next year, and beyond. We are using a top of the line, comprehensive financial planning software that will enable us to interact and plan with you in a new way. Brad Newsome, an Associate Wealth Advisor who we hired last summer, is very experienced with this software program. He will be leading this implementation and the related client discussions. This process will address long-term financial planning and projections, goal setting, Social Security decisions and projections, college funding and many other areas. If you are interested in starting this process, please let us know.

We are committed in providing you with excellent financial advice, a dedication to client service and to be lifelong learners in many areas of financial and investment matters. We are committed to listening to your questions and concerns, and to invest in people and technology to provide the level of service, advice and long-term financial results that you deserve.

We plan to remain disciplined and stick with our commitment to communicate with our clients regularly via this blog, as well as through phone and Zoom calls. Hopefully in the not too distant future……meetings with you, wherever in the country you live.

Thank you for reading.

And thank you for being a loyal client!

Dealing Thoughtfully with Uncertainty

Blog post #447

For this week’s blog post, we encourage you to watch this short video.

David Booth, Founder and Executive Chairman of DFA (Dimensional Fund Advisors) shares his thoughts on the importance of having an investment plan that you can stick with, uncertainty and how to think about the future.

I didn’t know what the word “clairvoyant” means. It means to have the ability to predict the future.

As Booth states at the beginning of the video, we don’t have the ability to predict the future; humans are not clairvoyant.

We hope you find this few minute video worthwhile.

David Booth on Dealing Thoughtfully on Uncertainty

We help you plan. We help you with a strategy to reach your goals. We consider your goals and risk tolerance.  We help you make good decisions.

Just as we strive for your relationship with our firm to be beneficial for you, we hope this video is helpful.

Uncertainty can create opportunity. Please feel free to forward this blog post and video to others you know who could benefit from our firm’s approach to financial planning and investing.

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.

 

 

Thoughts on Where We are Now and Headed

Blog post #441

As we near the end of April 2020, we thought it would make sense to step back and consider the past few months, as well as approaches for the future.

  • As we have stated many times in the past, one of the basic concepts that we have told our clients is that we do not have a crystal ball and we cannot predict the future. No one can accurately predict the future, repeatedly and successfully.
  • This is why we work with you as a fundamental building block to develop a personalized asset allocation strategy developed for your personal circumstances and needs.
    • Throughout this crisis, and many others that have preceded it, having an Investment Policy Statement (IPS), or asset allocation plan, has enabled clients to remain invested and in the long term, be able to continue and reach their financial goals.
    • We can’t control or predict the financial markets. But we can control your plan and how you are invested, to meet your short-term withdrawal needs and your long-term financial goals and objectives.
      • Thus, we recommend continuing to adhere to the strategy of maintaining your personal Investment Policy Statement (IPS), or asset allocation, especially in this very unpredictable period.
  • Despite a decline in your account value, which you could view as temporary, a key question to ask is: has this decline directly impacted your ability to have the financial resources that you need today, or within the next year?
    • While none of us are happy that account values have declined, the answer for all of our clients should be that they have the financial resources that they need for the short to intermediate term, for the next number of years. This positive answer is due to proper planning.
  • The stock market is not the economy.
    • Remember, the stock market tends to look into the future and may not reflect what the economy is doing right now. The stock market can be driven by many factors, such as cash flow and profit/loss projections, predictions and emotions.
  • Fed Chair Powell has done a terrific job so far.
    • The Federal Reserve has been strong, responsive and acted swiftly when needed, especially in March and early April. This is one of the key reasons that the stock market has recovered significantly from its March lows.
    • The Fed’s actions have helped to solidify the fixed income markets and has enabled many public companies to sell bonds during this crisis, to help them to have the liquidity to get through the shutdown period. The Fed’s decisions to purchase bonds of companies that were credit worthy prior to this crisis, and then expanded to less than investment grade debt, has also helped to stabilize the credit markets.
  • Diversification works, for both stocks and fixed income
    • We are strong believers in diversification at all levels, as are the mutual funds that we use to invest in.
      • The past few months has not changed our minds about this. If anything, during a crisis, diversification again has proven to be very important. 
    • While our client accounts have been volatile, there has not been the huge destruction of your investments compared to if we held a portfolio that had been concentrated in certain sectors, say for example…..lodging and travel, aerospace, airlines, retail, entertainment and energy. We have not had overall 40%-50%-60% declines, though these sectors are held as part of a diversified portfolios.
    • We don’t place bets on individual stocks or focus on sectors. The asset class funds that we use strongly believe in diversification and have guidelines across industries and companies, as well as geographic regions, for International and Emerging Market funds.
    • While we still believe in our core investment beliefs, that does not mean that we don’t make changes. We have modified our portfolios over past months, prior to and during this crisis, to reduce some exposure to small value holdings in both the US and internationally. We did this for the long term, as we wanted to increase exposure to small cap asset classes that were not strictly small value.
      • In the short term, this has been a positive move. Again, this was made to increase diversification further and should benefit clients over the long term, as we cannot predict which asset class will outperform, or when.
    • In fixed income, we have always been well diversified, and we are taking steps to strengthen your holdings, and add even greater diversification.
      • Due to the economic impact of the Covid crisis and the plunge in oil prices, certain companies that previously were investment grade or not at risk of near-term bankruptcy, are now potentially more at risk.
      • We have been proactive in selling bonds of companies that were previously much stronger financially. We would rather sell these bonds now, prior to their maturities, and not put your investment principal at further risk with these types of companies.
      • We are reviewing clients’ fixed income holdings very carefully, as we always have, for exposures to sector and financial risk.
      • We are using large and well-established bond funds with excellent track records, processes and methodologies, more than we did in the past, so your fixed income holdings will be even more diversified.
      • We will be more carefully monitoring the impact of this crisis on municipal bonds, as state and local revenues have been impacted. We already know that some of the strict purchasing guidelines we have in place, and have had since we started our firm, are still valid today, and have helped us avoid municipal bonds which are related to single sector issuances, like airport or certain single source building projects.
      • We want the fixed income “Foundation” of your portfolio to be as financially sound as it can be, even during this period of greater financial uncertainty.
  • Expect the unexpected
    • This certainly has been the case over the past few months. However, even with all this uncertainly, and there could be more in the future, we want you to have a sense of financial comfort.
  • We will continue to act and make rational decisions, not emotional ones. We are not going to place bets on when a vaccine will be discovered or how fast the economy will recover…..as no one knows those answers. We do know that sticking to a philosophy works, over the long-term. We will continue to do the following:
    • Regularly review and rebalance your accounts.
    • Place tax loss trades as appropriate, which will save you tax dollars.
    • Adhere to your financial asset allocation plan and modify that if your circumstances have changed.
    • Having a strong fixed income foundation and ample cash and liquid assets for those regularly withdrawing money.
  • We have again been reminded why we avoid certain types of investments.
    • We don’t invest in investment funds or products that are considered illiquid or restrict your right to redeem your money to a certain percentage a quarter or annually.
      • Many of these types of investments are not permitting withdrawals or severely restricting investors’ access to their money. We don’t want your money to be restricted, so we don’t use these types of products.
    • We don’t invest in high yield or junk bonds, as they have the greatest risk of default, and many of them declined significantly in value during past months. The higher interest rate that they offer are not worth it, if you don’t get your principal back.
    • We don’t invest in stocks primarily due to high dividend yield, as those companies tend to be the riskiest, like junk bonds. This does not apply to all companies, but those paying a very high dividend yield is often a sign of some type of underlying risk in the company. And usually the risk is not worth it, especially if the dividend is later cut or eliminated, or the price of the stock eventually declines significantly. This is what has occurred to many energy stocks. While the funds we utilize hold energy stocks, the exposure is quite small.
      • Bottom line….don’t reach for yield…..if the interest or dividend yield is far above the market average, there is usually a good reason…it is much more risky.

 

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