Blog #488

Cost of NOT staying in the market

We have often talked about the importance of staying in the market. Think long-term. Stick with it, through the good and bad markets, to reap the long-term benefits that investing in stocks can provide.

It can be hard to remain invested in stocks (appropriate to your personal stock allocation), especially when stocks are declining. It can be particularly difficult to remain invested in stocks during periods of great uncertainty, such as in the spring of 2020, at the onset of the Covid pandemic, or in 2008-09, during the Great Financial Crisis.

We want to share some thoughts and data with you, while markets are good….so you can be mentally prepared the next time markets decline significantly in the future.

Missing only a few days of strong returns can drastically impact your overall investment performance.

While we recommend a global and broadly diversified allocation mix of stocks, for purposes of this discussion, we are using the S&P 500 Index, from January 1, 1990 – December 31, 2020. Note that the companies in the S&P 500 Index are primarily US Large companies, and the companies in the Index change over time, as the economy changes, as companies grow, merge, are bought or their financial performance declines and they are removed from the Index.

As the chart below reflects, if a hypothetical $1,000 was invested in the S&P 500 in January 1990, it would have grown to $20,451 by the end of 2020. The increase over this 30 year period, including all kinds of economic and societal changes, most of which could NOT have been anticipated in advance.

  • Staying invested and focused on the long term would help you to better capture the benefits that the stock market has to offer.

However, if you had missed only a few of the best performing days during this 30 year period, the growth of the $1,000 would be dramatically less. If you had missed the best 25 days over the last 30 years, $1,000 would have only grown to $4,376, which is only 21% of what you would have had if you had left the money in the S&P 500 the entire period. Let’s review the results**:

There is no proven way to time the markets – trying to target the best days and to get out of the markets to avoid the worst days. History argues for staying put through the good times and the bad.

We further reviewed the best 15 days of the last 30 years of the S&P 500, which are provided in chronological (date) order, in the table below. There are a few key lessons to be learned from these large daily increases:

  • The significant daily gains all occurred during times of great uncertainty and fear among investors, during periods of great volatility.
  • They occurred in three groups, days in 2002 (during the tech meltdown and during a number of corporate scandals, including the Enron crisis), 2008-09, and in the spring of 2020, at the onset of the Covid-19 pandemic.
  • None of the top 15 days occurred during times of relative calm for the US stock markets.
  • None of the top 15 days occurred during times when markets had been rising for a few years.
  • Some of the days were during bursts of market rebounds, shortly after a bottom had been reached (but few would have known it was the real the bottom at that time).
  • However, a number of the days occurred during huge downturns, but the markets continued to decline even further after these large gain days, before they eventually recovered.

Financial history teaches us that is important to be patient and stay the course during times of economic crises, when stocks are falling, to reap their long-term benefits.

We do not know when financial markets will next incur a significant decline. Hopefully reviewing data like this, when we are not in the midst of a scary period of stock decline, will provide you with the mental fortitude to adhere to your planned stock allocation when future downturns occur.

 

Talk to us. We want to listen to you. we want to assist you, your family members and friends.

Source and disclosures:

** “The Cost of Trying to Time the Market”, can be found at this link Dimensional Fund Advisors, www.dimensional.com, 7/6/21. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 Index at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

***Information provided to WWM by DFA.
As noted above, WWM generally invests in globally diversified portfolios for their clients, which would include various US, International and Emerging Market asset classes, not just US Large Companies, as represented by the S&P 500 Index. The use of the S&P 500 Index in this article is for illustrative purposes only. The Index does not reflect the expenses associated with the management of an actual portfolio, including any advisory fees that WWM would normally charge.

If you would like to read our previous blog posts, click here.

Let us know what you think. If you would like to contact us, please email or call Brad Wasserman (bwasserman@wassermanwealth.com) or Keith Rybak (krybak@wassermanwealth.com); or 248-626-3900 (or visit the Contact Us section of our website).

 

~ Developing Relationships by Doing the Right Thing ~
Wasserman Wealth Management, 31700 Middlebelt Road, Suite 130, Farmington Hills, MI 48334

 

Inflation: Our thoughts

Blog post #485

The headlines are everywhere….inflation is rising.

The US Labor Department reported on Thursday that consumer inflation climbed “strongly in May, surging 5% from a year ago, to reach the highest annual inflation rate in 13 years.”*

We want to address a few of the issues surrounding inflation and the impact this issue may have on your financial future:

  • What is happening with inflation and how does it compare to the past?
  • What should we (as your advisor) and you do about this, as it relates to your investment portfolio?
    • What is the impact on your stock portfolio?
    • What is the impact on fixed income investments?

What is happening with inflation and should you be concerned?

Clearly, prices of most or all categories of consumer goods are increasing, but perspective is needed. It is not surprising that prices are increasing over last year, as prices were depressed a year ago, as the US and world were in the midst of pandemic shutdowns. Most of the consumer price increases have been in the energy, used vehicles and transportation services sectors.

The automobile sector is having a very significant impact on the inflation. Prices for used cars and trucks increased 7.3% in May, from April, 2021, which accounted for 1/3 of the overall May inflation index increase. Much of this is likely temporary, as car makers are not able to ship certain vehicles due to computer chip shortages, which is putting price pressure on used cars.

It is not surprising that inflation has increased from a year ago, given the pandemic impact. It is not surprising that gas prices at the pump were down last spring and summer from 2019 levels, as most people were driving much less than normal a year ago.

Let’s look at the price per barrel of oil (which correlates with the price of gas at the pump) over the past two years, which I think is a key perspective.  The price per barrel of oil, as reported by WSJ.com, shows over the past two years a huge increase from 2020, but a much more reasonable increase from pre-pandemic level of June 2019, as follows:

Oil per barrel:

June, 2019                    $57-60

June, 2020                    $37-40

June, 2021                    $68-70

In an excellent WSJ article** on Monday, economics reporter Jon Hilsenrath wrote about the importance of a two-year time perspective for viewing inflation and other economic data (including corporate profits), versus making conclusions based on only 2020 data.  He feels that using pandemic-related data (the 2020 base) will distort many economic statistics, including inflation.

While the May inflation increase of 5% in certainly large, as the accompanying chart reflects, “the consumer price index rose 3.5% every two years during the decade before the Covid-19 crisis. That was within a range between 5.8% in 2012 and .8% in 2016. In April this year, the index was up 4.5% from two years earlier.”**

 

Hilsenrath wrote Monday, prior to the release of the May inflation data, “the message from this perspective (taking a two-year view) is that inflation is trending a bit higher than usual but not exceptionally so as of April.” **

We think that future inflation is something that should be monitored, but it does not seem like we are headed towards a period of hyper-inflation, where prices are increasing anywhere near the inflation levels of the 1970s. During that time, inflation increased many years above 6% annually and there were 3 years above 12%, including 1980.

 

 

 

What is impact on your portfolio of these inflation concerns?

One of the best long-term inflation hedges that you can have is investing in stocks and maintaining your long-term stock allocation. That is what we recommend you continue to do. As the data below shows, concerns about inflation is more of a reason to be invested in stocks, not a reason to sell stocks, as the long-term performance of stocks has far outpaced the cumulative rate of inflation.

S & P 500 annual return, 1926-2020 :                                                  around 10%

Many other asset stock classes, such as small and value:                 greater than 10%

Long term Consumer Price Index (CPI):                                              little less than 3%

 

While we believe in broadly diversifying among many stock asset classes, both in the US and Internationally, the S&P 500 provides a good illustration of the benefits of long-term stock ownership, as a solid hedge against inflation.  Since 1960, the S & P has increased by more than 71 times, while inflation has increased by only 9X. Over a very long term period, and certainly with many ups and downs, owning stocks has provided an excellent way for your money to grow at a rate that far surpasses the rate of inflation, so you are not losing spending power due to inflation.

S & P 500,    1960:                   58

S & P 500, June, 2021:                        4,200+   That is an increase of 71X

Inflation,   1960:                      30

Inflation, June, 2021:                          268        That is an increase of 9X

 

Stocks may be impacted by higher inflation, as pricing pressures throughout the economy impact companies and their earnings. There is no way to predict this, especially in the short-term. We cannot predict the future rate of inflation, nor how long inflationary pressures will exist above the Federal Reserve’s 2% long-term inflation target.

We focus on your long-term goals. We don’t make major changes in client portfolios based on things that we cannot predict, as well as things we cannot quantify or know their duration.

Inflation can have an impact on your fixed income portfolio, if inflation causes interest rates to rise. However, due to Federal Reserve actions over many years, even before the pandemic, interest rates remain very low on a historical basis. For example, the US 10-year Treasury Note remains around 1.50% today, while it was at 1.745% on 3/31/21. It has increased from under 1% at the beginning of 2021 but is still far below the 2.8% – 3.2% range in the second half of 2018.

It is particularly interesting that the 10-year rate has declined from 3/31, from 1.745%, to around 1.50% today, as inflation concerns have increased recently. If bond traders thought inflation was going to continue to increase significantly over the long-term, one would think a 10-year Note interest rate would be increasing, not decreasing. This is why we don’t make interest rate bets, but would rather build diversified fixed income portfolios for our clients, with varying high quality investments and maturities.

 

We have structured your fixed income portfolios to be defensive, by holding short term bonds and bond funds/ETFs. Generally, most fixed income investments that we recommend will have maturities that range from a few years to a duration of 6 years (the shorter end of intermediate maturities). We do not recommend holding longer term fixed investments, say 10 years or longer, due to inflation and interest rate risk. We have also added, and will be continuing to evaluate, adding other inflation protected fixed income investments to certain portfolios, as considered appropriate.

 

We hope that this information is beneficial to you, as you read and hear about increased inflationary pressures on various segments of the economy. We remain optimistic about the future of corporate earnings, as successful companies are always innovating and dealing with change.

 

Talk to us. We want to listen to you. we want to assist you, your family members and friends.

 

If you would like to read our previous blog posts, click here.

 

Let us know what you think. If you would like to contact us, please email or call Brad Wasserman (bwasserman@wassermanwealth.com) or Keith Rybak (krybak@wassermanwealth.com); or 248-626-3900 (or visit the Contact Us section of our website).

 

~ Developing Relationships by Doing the Right Thing ~

 

 Wasserman Wealth Management, 31700 Middlebelt Road, Suite 130, Farmington Hills, MI 48334

 

Sources:

*“U.S. Consumer Prices Rose Strongly Again in May,” Gwynn Guilford, June 10, 2021, 8:54 am, WSJ.com.

** “For Inflation, Looks Can Be Deceiving,” Jon Hilsenrath, June 7, 2021, Wall Street Journal print edition, page A2.

Investing at Market Highs

Blog post #482

At the end of April, 2021, most US stock market indices are near their all-time highs.

What does that mean for your current, and future, investments?

As Exhibit 1 below indicates, when the S & P 500 has reached highs in the past (for data from 1926-2018), the S & P 500 went on to provide positive average annualized returns over the one, three, and five years following new market highs. And those returns were significant, averaging over 14% during the subsequent one year and around 10% over the subsequent three and five year time periods.

Please see Exhibit Disclosures below.*

What does that mean for you today? It means there is justification, based on historical financial data of almost 100 years, that new market highs today are NOT a sign of negative returns to come over the next 1-5 years, on average. While none of us can predict what will occur in the next few weeks, months or years, this type of rational optimism is the basis for remaining invested for the future.

We believe in broadly diversified portfolios, investing in much more than just the S & P 500, which represents only large, US based companies. However, we feel this data should give you confidence to remain invested for the long-term, with a stock allocation that is appropriate for your personal circumstances and time frame.

While some asset classes are at high levels, other asset classes may not be at highs or have valuations which are significantly below the valuations of US large stocks. This is where our discipline and planning can benefit you.

When you begin as a client with us, we develop a target asset allocation plan, based on your personal goals and time horizon, say 65% stocks and 35% fixed income. As stocks have increased, your stock allocation may have grown from 65% to near 70%. As this occurs, we are disciplined. We would review your account and consider selling some asset classes of stocks to bring your stock allocation back to 65%.

This is called rebalancing. It is the discipline to sell when stocks increase and buy when they decline. We review this on an overall basis, on a US and International level, as well as at each asset class level. We balance the tax ramifications of selling versus the increased risk of allowing your stock allocation to grow way higher than the risk target level we planned with you.

As stocks have recovered since March 2020 and are now significantly higher, in general, we are actively reviewing client accounts that need to be rebalanced. This is the discipline and one of the values we provide to you. We will take profits and keep your stock allocation in line with your asset allocation target.

In addition to our rebalancing discipline, we want to remind you about expected volatility that is normal with investing in stocks.

You should expect that in most year’s there will be a decline of around 10% in stock values, from a peak. This does not mean that the full year will be negative, it just means that at some time during most years there are declines of around 10% and then recoveries. This is the normal volatility we must endure to reap the longer-terms rewards of investing in stocks.

In other periods, usually every 3-5 years, there are major stock market declines of more than 30%. These may be fast or take a few years to go down and many years to recover. These are normal and should also be expected.

A few mornings ago, the CNBC screen read something like: Analyst: brace for 10-20% decline. I thought to myself, investors in stocks should always be prepared for that type of decline. It is normal. We just don’t know when it will occur. Remember, declines are temporary on the long-term upward trend of stocks. 

If you can handle the volatility, the positive news is that you don’t need to be able to time markets to have a good investment experience. Over time, capital markets have rewarded investors who have taken a long-term perspective and remain disciplined in the face of short-term noise.

By focusing on the things you can control (like having an appropriate asset allocation, being diversified and managing expenses, turnover and taxes), you can be better positioned to make the most of what global stock markets have to offer.

Talk to us.  We want to listen.  We want to assist you, your family members and friends.  

*Exhibit 1 Notes:

In US dollars.  Past performance is no guarantee of future results.  New market highs are defined as months ending with the market above all previous levels for the sample period.  Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations.  There were 1,115 observation months in the sample.  January 1990–Present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only.  Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the managment of an actual portfolio.  There is always a risk that an investor may lose money.

Source:
“Timing Isn’t Everything”, Dimensional Funds, July 1, 2019

If it’s too good to be true….

Blog post #481

Bernie Madoff, who ran one of the largest Ponzi schemes ever, died this week in jail at age 82. He defrauded investors of almost $65 billion in paper losses, which came to light in 2008 during the Great Financial Crisis.

There are lessons to be learned from the Madoff incident, as well as how the regulatory system which governs investment advisory firms like ours changed for the better.

Madoff bilked many wealthy families, in NY and Florida particularly, as well as charities, institutions and endowment funds in the US and globally. They were lured by his years of positive returns and reputation as a leader on Wall Street.

The key lesson is that Madoff “reported” years and years of only positive returns to his clients. They became more confident of his firm and referred others. Madoff never reported down periods once his Ponzi scheme got going in the 1990s. That is not realistic.

We often talk about when you invest in stocks there will be frequent time periods that your investments will go down. We all know that, but these very wealthy individuals and institutions kept believing that Madoff was so good that he never lost money.

Our advice to you is that if returns are too good, or seem consistently too good, you should look at that investment concept/manager/advisor very carefully and with lots of skepticism.  No one can invest in the stock market and always generate positive returns.  No investment only goes up and never goes down (that we know of).  This is advice that you should always remember and discuss with your family, especially your kids or grandchildren, as they learn about investing.

After the Madoff scandal, the Securities and Exchange Commission (SEC), which governs our industry, encouraged Registered Investment Advisers (RIAs) to place their clients’ assets in the custody of an independent firm (like Fidelity or Schwab), unlike Madoff did. This is what is referred to as the custody rule. WWM does not have custody of your assets. When you open an account with our firm or make a future deposit, you write a check payable to the custodian (or wire funds directly to the custodian). You will never write a check to WWM. The funds are paid directly to the custodian, such as Fidelity Investments or Schwab. Madoff did not use an independent custodian like Fidelity, which is how he was able to pull off the Ponzi scheme.

When you want a disbursement of your assets, the custodian will never write a check to WWM.  The funds are only disbursed to the account holders, their bank account or if you want a check sent to another party, multiple forms are required for security purposes.  When you open an account, want to link your bank account to your custodian or get check writing privileges, there is always lots of paperwork.  All these steps, documents and requirements are to prevent a Madoff-like scenario from occurring again.

For nearly all of our client relationships, WWM is considered to not have custody over these assets. The assets are held at an independent custodian (Fidelity or Schwab) and WWM has no control or withdrawal privileges over these accounts.

There are situations where RIAs such as WWM can have “custody” rights for certain clients, at the client’s request. For example, WWM (or the firm principals) have been named as Trustee for several client accounts, at their request or in their estate planning documents. In these situations, we still use an independent custodian, but we are considered to have custody, or control of client assets. Because of the SEC custody rules, we must annually disclose these accounts to the SEC. WWM is then subject to an annual surprise exam by an independent CPA firm, to protect the investors’ assets and verify that those assets actually exist. This surprise examination provides another set of eyes on the clients’ assets, thereby offering additional protection against the theft or misuse of funds.

We take our responsibility to invest and safeguard your assets very seriously. We want you to know that we are diligent about adhering to our regulatory obligations. We know that Fidelity and Schwab work hard to maintain their custodial relationships with you very carefully.

We hope that a Madoff-like scandal never occurs again, but we know there will be other fraudulent incidents in the future. There are constant cyber-security threats ongoing all the time. We must all be careful and diligent.

We work hard to build our trust with you. And we plan to keep that trust.

Talk to us. We want to listen. We want to assist you, your family members and friends.

 

 

Lifetime advice

Blog post #477

The advice is simple. Living it is much harder.

You should remain invested in the stock market for the long-term, regardless of what is happening in the world, in a diversified manner, at a level that is consistent with your need, ability and willingness to take risk.

This means you should not get out of the stock market in a significant manner or go mostly to cash, no matter what is happening in the stock market, economy, politics or other factors.

This means that if you are in the accumulation phase, when you have money to invest and have a long-term time perspective, you should keep investing in stocks on a regular basis, irrespective of what else is going on. This is what we do.

In general, you should only change your stock allocation when your financial or life circumstances change. This means that your stock allocation will likely change as your wealth grows and as you get older, but not due to external factors.

Why are we writing this? Because regularly investing in the stock market and sticking to your stock allocation, through good and bad, is some of the most important advice we can convey to you as financial advisors.

Some people struggle with these concepts. They may get very nervous during a downturn and want to go to cash. Others are hesitant to invest in the stock market now or at other times because they think the market is “overvalued,” at a peak, or for some other reason (like a “potential” oncoming recession or the fear of higher future taxes).

We feel you need to have a guiding set of investment principles and stick to them. For our firm, remaining invested according to your long-term plan is one of these core principles.

But sometimes, should we make an exception to our own core principles?

Last year was one of those times when we challenged our long-held belief. When the pandemic began and started spreading outside of China during January and early February, I became increasingly concerned about Covid. I began questioning if this was a time to sell or reduce client stock allocations. As Covid started spreading in the US in late February 2020, Keith and I talked about this extensively, for hours, over many days.

Was the onset of Covid a reason to try to time the markets? After much consideration, we determined that there was no way that we could time the markets successfully, as you need to determine when to sell (February 2020) AND be able to determine when to buy back into the markets. We had no way to rationally figure out when to buy back into the market. We knew this downturn was different than most prior downturns, but we also knew that most prior major downturns seemed unexpected and unique at that time. We decided to adhere to our core philosophy and recommended that clients remain invested.

  • In hindsight, we made the correct decision by staying in the markets. Instead of selling in February/March 2020, we recommended that clients should gradually begin buying stocks after the markets had dropped significantly.

We knew from past financial history that markets generally rebound way before “the all-clear signal” is readily visible. Stock markets tend to be very forward thinking. By the time it eventually seems “safe” to get back into the markets, the markets have usually already advanced much higher from their bottom.

This is exactly what occurred in late March, which was the approximate bottom for the S&P 500. The stock market rebound began when lockdowns in the US were just starting and Covid had not even reached its worse impact, medically or economically. We made the proper decision not to temporarily get out of stocks due to the Covid pandemic, as US and global markets have strongly rebounded since March 2020, to higher levels few would have predicted a year ago.

To be a better investor, you should try to understand the following concepts:

  • No one is consistently able to accurately predict the future of the stock market. Market timing does not work.
  • The long-term path of the stock markets, US and globally, are upwards.
  • Declines in the stock market are temporary. The long-term historical path for the stock market since the 1920s has been upwards, with declines along the way that have been temporary. We do not see any change in that long-term pattern.
  • Peaks in the stock market are temporary, as they are exceeded by higher highs. This means that at some point in the future, the highs of today will be replaced by higher levels.

So you are prepared in advance, we want to remind you what normal declines are in the stock market when you own a broadly diversified portfolio.

  • It is normal for stock markets to decline at least 10% during almost every calendar year, from top to bottom, at least once during a year.
  • It is normal that stocks will drop a lot, like 20%-30%-40%, or more, every 3-5 years.

Addressing these issues of market timing and continuing to invest on a regular basis are some of the most important services that we can provide in our relationship with you.

  • If these are concerns or issues for you, we would be pleased to discuss this with you. We can listen to each other and work through your concerns, so we can determine an appropriate stock allocation for you and your family for the long-term. That stock allocation should enable you to have the ability to remain invested and learn to get more comfortable, so that your money can work for you and to help you reach your life and financial goals.

We want to work with you to develop a financial plan that includes an asset allocation to stocks that you can live with, when markets are rising and when they are dropping. That is how you can be a more successful long-term investor.

Talk to us.  We want to listen.  We want to assist you, your family members and friends.

 

Source:  *27 Principles Every Investor Should Know, by Steven J. Atkinson (Illustrations by Dan Roam) July 2019

Why do we……?

Blog post #476

While many of you have been clients for well over a decade, some of you are newer to WWM and our investment philosophy. We want to help you to have the best chance to reach your financial goals. We hope this post provides you with a summary of why we adhere to certain philosophies and practices.

Why do we use mutual funds and ETFs, rather than individual stocks?

To provide you with the best chance for financial success, we believe it is better to own diversified mutual funds (or ETFs, exchange traded funds, which are used interchangeably in this post), and not a portfolio of individual stocks. Investing in only a few companies is much riskier, in general, than investing in the markets as a whole. It is also difficult to pick which stocks will outperform the market over the long-term. We believe that it is very difficult to identify successfully, in advance and consistently over a long period of time, which individual stocks will outperform the markets.

We strongly believe that investors should be well diversified in many respects (by size of companies, by industry sector and geographically), which mutual funds and ETFs can provide. For most of our clients the core of your portfolio should be in mutual funds or ETFs, even if you want to invest in a handful of individual stocks as well.

Why do we use “passive” stock strategies and not “active” managers? And what about index funds?

There are huge amounts of academic and financial data that show money managers who “actively” try to pick and choose stocks to buy and sell generally underperform their asset class peers over short- and long-term periods of time. These “active” funds tend to be much more expensive, which is a hard hurdle to overcome. They trade more, which adds to expenses and causes more taxes, compared to a buy and hold approach. See these past blog posts, 10 Things You Should Know and 10 (or more) Things You Should Know, where we provide more details on how few active managers have been able to outperform their respective benchmarks.

Thus, when developing a strategy to strive for long-term financial success, we follow the data that “passive” money managers generally outperform “active” managers. It is very difficult to identify successfully, in advance and consistently over a long period of time, which money managers and mutual funds will outperform. Active managers may have some hot years of outperformance, but very few consistently outperform their peers or benchmarks over long time periods, such as 5 or 10 years or more.

The funds we utilize are similar to index funds but different. Index funds must track a specific index and they have little flexibility. A passive approach allows for the diversification and buy and hold benefits of indexing, with additional flexibility, such as not being strictly tied to an index. For example, if an index fund had owned Gamestop in the past few weeks, the index fund would not have been able to sell, as they need to hold the stocks in the index they track. A passive fund would have the flexibility to sell Gamestop, as they don’t have to strictly adhere to a specific index.

Why do we believe in utilizing so many different asset classes?

We make many of our investment decisions based on historical academic data and investment research, along with our own investment experience. We recognize that no one can accurately predict which type of stocks (asset classes) will outperform another asset class over the long-term.

To structure a portfolio to reach your goals, whether your goal is to grow your portfolio or to be able to feel secure and maintain your lifestyle, we apply these concepts. We want your portfolio to be very diversified, as that reduces individual stock risk. Being diversified does not eliminate the risk of investing in stocks, but it reduces the likelihood of incurring huge mistakes that are hard to overcome.

Financial research shows that the following applies, over varying long-term time periods, some back to 1926:**

  • Small stocks outperform large company stocks, both in the US and Internationally
  • Value stocks outperform growth stocks, both in the US and Internationally
  • International stocks and Emerging markets stocks (of undeveloped countries) have outperformed US Large Caps during many time periods.

We tilt most portfolios toward these factors, while remaining broadly diversified. While this data may be true over long-term periods, say over 10 years or more, it does not mean these trends (“factors”) will apply all the time or every year.

What this means to you is that we do not invest in only the S&P 500, as other asset classes have outperformed the S&P 500 over long periods of time. Financial research shows that a broadly diversified portfolio should do better over the long-term than owning just the S&P 500, so we do that.

Why do we believe in global diversification?

We recommend investing globally for the same reasons. Financial research shows that over the long-term, a broadly diversified portfolio, which includes US and International stocks, as well as large and small company stocks, with both value and growth, has outperformed owning just the S&P 500.

For example, from the period 2000 – 2010, a globally diversified portfolio would have far outperformed the S&P 500, as that index did poorly for those 10 years, while many other asset classes did quite well. In recent years, the opposite has been true, as the S&P 500 has outperformed International stocks. But as the world is constantly changing, no one can know what sectors or regions will do best over the next 5-10+ years.

Thus, we recommend some International exposure for most clients.

Talk to us.  We want to listen.  We want to assist you, your family members and friends.

 

 

** Source: DFA 2020 Matrix book, with data through 12/31/19, as well as other information.

Market Update – January 2021

Blog post #475

As 2021 begins, the US and the world are very different than they were a year ago.

Financial markets continuously change in response to new information and unexpected events. Stock and fixed income prices move on earnings and future expectations.

What are we seeing and what are we doing?

The way that we manage your investments and strive to help you reach your financial goals are consistent and disciplined, with the flexibility to change as needed.

As uncertainty always exists, we recognize that no one, including us, can accurately and consistently predict the future. For example, no one could have predicted Covid in December 2019. Even if someone had predicted the Covid pandemic, we doubt that they could have predicted and accurately timed the rebound and strong gains in nearly all asset classes since the onset of Covid. Similarly, we cannot predict the continued impact of Covid, how successful/fast the vaccination process will be, or the impact of new Covid strains.

We remain committed to key investment principles, such as broad diversification across many asset classes, utilizing investments with very low costs, and active tax management (as applicable). These are all things that we can control and should benefit our clients.

Stock update:

Asset classes that are performing well so far in January 2021 are many of the same asset classes that performed well late in 2020 (see index definitions below). Over recent months, many asset classes are outperforming US Large stocks, as defined by the S&P 500, which is a reversal of US Large stocks outperforming most other asset classes during recent years. For illustrative and informational purposes, below are selected asset classes and return data for their respective indices that we recommend to clients:

Consider the significant gains in the sample of asset classes provided above, which have occurred since November 1. If we recommended getting out of the market or significantly reducing your stock exposure before the election, or shortly after the election, when many political changes became more likely, you may have missed out on these gains. This is why we encourage you to adhere to your asset allocation plan and focus on the longer-term, not on political proposals.

We do not make investment policy decisions based on political matters, such as potential tax increases or the size of the Federal deficit.  Financial markets, which include the stock and bond/credit markets, very quickly incorporate all known information into prices and valuations. The financial markets clearly know about the potential for personal income tax increases on high-income taxpayers and corporate tax increases, even though no one knows what proposals will become enacted or when they will be effective.

We will provide our clients with advice about these tax and other changes, as they affect each person or family. However, we do not recommend basing your long-term investment strategy on political matters, as the stock market has done well under both Republican and Democratic Presidents. There are so many other factors that impact the direction of stocks beyond just who is in the White House or what party controls Congress.

Given the significant gains in many asset classes since last March, and particularly in recent months, we are reviewing client portfolios for rebalancing (selling some stocks) for those clients whose stock allocations have exceeded their IPS (Investment Policy Statement) stock targets. This is the disciplined implementation of buying low (which we encouraged you to do starting last spring) and selling high, after significant stock increases.

We also want to remind you that stocks have increased almost straight up since early November. There has not been a significant decline in the markets (of 10% or more) since the major decline last February-March. We are not predicting a near-term decline but reminding you that 5-10% declines are normal. They frequently occur when you least expect them. You must always be emotionally prepared for these types of pullbacks, which are temporary, not permanent, and a part of investing in stocks.

We hope that information like this is helpful for you to adhere to your asset allocation plan, despite whatever uncertainty and changes are occurring in the world.

Talk to us.  We want to listen.  We want to assist you, your family members and friends.

 

 

*Indices used for the above asset classes are:
US Large stocks: S&P 500
US Large Value stocks: Russell 1000 Value
US Small Cap stocks: Russell 2000
US Small Cap Value: Russell 2000 Value
International stocks: MSCI EAFE NR USD
International Value: MSCI ACWI ex USA Value
Emerging Markets: MSCI EM NR USD
Disclosure: This data is provided for illustrative purposes only and do not represent actual mutual funds or ETFs, or actual client portfolios. We recommend more asset classes to clients than is provided above. These indices represent asset classes, which do not have fees. The actual mutual funds or ETFs would have internal expense ratios, which would reduce the returns provided above. These figures also do not include the deduction of WWM advisory fees.

 

Why this is so important

Blog post #474

One of the most important services that we provide for clients is preparing a written Investment Policy Statement (IPS) for them.

Developing a written Investment Policy Statement, along with a diversified portfolio, are critical for making the investment process more disciplined and systematic, and less emotional. For most long-term investors to meet their various financial goals and objectives, they need to be able to stay in the financial markets.

Having a written Investment Policy Statement can increase the likelihood that you will adhere to your plan (during both good and bad markets) and give you a better chance of attaining your financial goals.

An IPS document means you have a target for your asset allocation plan. You don’t just have a bunch of investments that are randomly thrown together. You have a written investment plan based on your current situation, your goals, needs, time perspective and tolerance for risk. This provides both you and us, as your advisor, with discipline to act rationally in a world full of unknowns and uncertainty. 

The IPS that we develop for each client states their overall asset allocation target, such as 70% stock / 30% fixed income, or 40% stock / 60% fixed income. It states what % of the stock allocation would be invested in the US and Internationally. It then identifies target allocations for various asset classes, such as US Large stocks, US Large value, US small and small value stocks, as well as for International asset classes and Real Estate.

For clients of our firm, having an IPS may seem logical as we have always used them.  However, some other brokers or financial advisors may not develop IPS documents or asset allocation plans for their clients.  If you don’t have a plan or target, how can you properly monitor the risk of your portfolio?

An IPS may sound like an impersonal document. But behind this Policy Statement is our understanding of your personal, family situation and your goals. We talk with you to learn and understand your objectives and concerns, before we prepare your IPS. Everyone is different and unique. Two people of the same age and assets may likely have different IPS’, as they are unique with different past experiences and different future goals. While the IPS is an unemotional document, preparing an IPS for each client is a very personal process.

Having an IPS allows us to manage portfolios in a rational manner. This means that we are not reacting to current events with guesses and predictions. We act and provide guidance in a disciplined manner. For example, during the onset of the Covid crisis last winter and spring, IPS’ provided us and our clients with the structure to buy stocks when markets fell, as we worked to maintain their stock allocations in the desired range. This enables us to help our clients maintain their stock exposures during times of great uncertainty and volatility, when your emotions may be telling you it’s time to get out of stocks.

Having an IPS with target asset allocations prevents your stock allocation from getting either too high or too low. When markets or specific asset classes go down, we would review buying more. This was mid-2020. When stocks increase, such as they have done very strongly in past months, we review client portfolios to see if their stock allocations have grown to exceed their target stock exposure. This is what we are doing now and have been doing over the past few months. This provides the discipline of buying low and selling high.

Your IPS would also clearly state that there will be times when your diversified portfolio will vary from major stock market indexes, such as the S&P 500. A diversified portfolio is very different than an index which is comprised of just US Large stocks. This means there will be periods, which could be months or years, when a diversified portfolio will underperform or outperform a major market index. We talk about this likelihood for portfolios to be different than major US indices with our clients in advance, to manage their expectations.

Your IPS can be revised. This is generally done because of changes in your financial situation over your lifetime, not usually due to changes in current financial markets. The goal is that the IPS is a long-term document that is not influenced by short-term ups and downs of the stock market. It is impacted (and modified) by changes in your life, your finances and your goals.

Isn’t the goal of investing to help you reach your financial goals? Then working with a financial advisor that uses a written Investment Policy Statement should be an important part of your financial planning.

 

Note: As a reminder, the blog will be emailed to you every other Friday going forward.

 

Talk to us.  We want to listen.  We want to assist you, your family members and friends.

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.

 

 

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.