At 80, “Successful Ager” Jack Nicklaus Remains As Relevant As Ever

Golfing great Jack Nicklaus turned 80 last week. His drives aren’t as long anymore- Gary Player can now outdrive him.  Jack stepped away in 2018 from day-to-day operations of his companies which build golf courses all over the world.  You might think Mr. Nicklaus is slowing down.  But to hear Jack tell it, he got rid of the things he was tired of doing and is focusing on all the activities he likes; including public speaking engagements, occasional golf exhibitions, course design and fundraising with his wife.

Nicklaus started designing courses in 1969.  He’s completed over 300. He’s become a grandfather to the “kids” on the PGA tour such as Rickie Fowler and Justin Thomas. Rory McIlroy says that Nicklaus “has the best advice on how to play golf- not how to swing but how to play the game.”  Jack’s wife of 60 years, Barbara, is chair of the Nicklaus Children’s Health Care Foundation and together they have raised over $50 million for pediatric care in Ohio and Florida.  They just pledged to raise another $100 million over the next five years.  Yes, Jack Nicklaus remains relevant as ever and, by any definition, is successfully aging.

Much has changed since Social Security was started in 1935.  Back then, the average life expectancy was 61 years old.  In 1947, the poet Dylan Thomas encouraged the elderly: “Do not go gentle into that good night, old age should burn and rage at close of day.” It’s starting to happen. With greater longevity and medical advances, it’s no surprise that the term “successful aging” has grown in popularity over the past few decades.  Back in 1987, John Wallis Rowe and Robert Kahn published a book entitled “Successful Aging.”  They felt there were three key factors: 1) being free of disability or disease, 2) having high cognitive and physical abilities, and 3) interacting with others in meaningful ways.

Now comes a new NYT bestseller; Dr. Daniel Levitin’s “Successful Aging; a neuroscientist explores the power and potential of our lives.”  Today more people who are in the last quarter of their lives are engaged with life as much as they’ve ever been, immersed in social interactions, spiritual pursuits, hiking and nature, charitable work and even starting new professional projects.  Dr. Levitin remarks:  “They may look old, but they feel like the same people they were 50 years ago and this amazes them.”

Successful aging involves focusing on what is important to you, and being able to do what you want to do in old age. While successful aging may be one way to describe how well we age, the concept of meaningful aging might be another important way to consider how to age well.   Certainly, some of our faculties may have slowed, yet “seniors” are finding strength in compensatory mechanisms that have kicked in – positive changes in mood and outlook, punctuated by the exceptional benefits of experience.  Baby boomers and their elders may process information more slowly than younger generations but they can intuitively synthesize a lifetime of information and make smarter decisions based on decades of learning, often from their mistakes.

Combining recent developments in neuroscience and psychology, “Successful Aging” presents a novel approach to how we think about our final decades. The book demonstrates that aging is not simply a period of decay but a unique time, like infancy or adolescence, which brings forth its own demands, surprises and happiness.

Until about thirty years ago, older people in the workforce were forced/encouraged to retire; a tremendous economic and creative loss.  However, since the 1990s, the tide has been turning for seniors. Employers and organizations are awakening to the eastern idea that the elderly may not only be of some value but may provide superior enhancements to a group.   New medical advances and positive lifestyle changes can help us to find enhanced fulfillment that previous generations may not have been able to do.

Research now shows, for example, that fending off Alzheimer’s disease involves five key components:  1) a diet rich in vegetables, 2) moderate physical exercise, 3) brain training exercise, 4) good sleep hygiene, and 5) an appropriate regimen of supplements.  In addition, research shows that social stress can lead to a compromised immune system. We don’t need to be victims; we just need to take advantage of modern medicine and make some lifestyle changes.

When older people look back on their lives and are asked to pinpoint the age at which they were the happiest, what do you think they say? The age that comes up most often, according to Dr. Levitin, as the happiest time in one’s life is 82. And, that number is rising.

At DWM, we work with clients from 0 to 96.  As total wealth managers, we understand life cycle planning, financial and investment strategies and proactively provide value-added services.  Of course, we focus on making sure our clients have enough money for their entire lives.  In addition, and as important, we pay particular attention to helping them experience the best life possible with the money they have.  Their fulfillment is our fulfillment. Their happiness is our happiness.

Jack Nicklaus’s longtime PR man Scott Tolley says Jack still only operates at two speeds, “go and giddy-up.”  Gary Player calls retirement a death warrant.  It doesn’t need to be.  Successful aging is getting easier and more fun and fulfilling.  C’mon baby boomers- let’s giddy-up.

https://dwmgmt.com/

MLK Would Have Loved Finland

We hope everyone enjoyed the Martin Luther King, Jr. holiday on Monday. We hope you spent at least a few minutes thinking of Dr. King and his legacy. His stirring words and writings remain as relevant today as they were 50 years when he was alive. I am always moved by his comments, particularly on equality, such as:

  • “We may have all come on different ships, but we’re in the same boat now,”
  • “We must learn to live together as brothers or perish together as fools,”
  • “The time is always right to do what is right,” and
  • “In some not too distant tomorrow the radiant stars of love and brotherhood will shine over our great nation with all their scintillating beauty.”

As I thought about these quotes, it made me think of Finland, recently deemed a “Capitalist Paradise” by the NYT and lauded by the Economist for slashing homelessness while the rest of Europe is “failing.”

As many of you know, my maternal grandmother was Finnish and Elise and I spent a wonderful homecoming in Finland this past summer, meeting relatives and experiencing life first-hand in Finland. Dr. King certainly would have loved a country like Finland that provides a real-life example of a system that works to provide equality and happiness to all.

Finland hasn’t been operating independently all that long. Located between Sweden and Russia, Finland was under Swedish rule from 1250-1809. In 1809 it became a Grand Duchy in the Russian Empire until it declared its independence in 1917. In 1918, Finland experienced the Finnish Civil War; the “whites” were primarily Swedish descendants who were anti-socialists and the “reds” who supported Russian socialism. The whites won and established a republic. World War II saw Finland under attack from Russia and ultimately joining forces with Germany.

After WW II, Finland did not want to become a socialist country. Its capitalists cooperated with government to map out long-term strategies and discussed these plans with unions to get workers on board. Finnish capitalists realized that it would be in their best interests to accept progressive tax hikes. The taxes would help pay for new governmental programs to keep workers and their families healthy, educated and productive. Fast forward to today, the capitalists are still paying higher taxes and outsourcing to the government the responsibility of keeping workers healthy and educated.

The NYT article “A Capitalist Paradise” was authored by a couple who moved from Brooklyn to Helsinki two years ago. Both are US citizens, experienced professionals and enjoyed a privileged life in the States. However, they were both independent consultants with uneven access to health insurance, and major concerns about funding for day-care, and education, including college. What may come as a surprise to some, is that they have experienced since the move an increase in personal freedom.

In Finland, everyone is covered by taxpayer-funded universal health-care that “equals coverage in the U.S. but without piles of confusing paperwork or haggling over huge bills.”   Their child attends a “fabulous, highly professional and ethnically diverse” public day-care that costs about $300 per month. If they stay in Finland, their daughter will attend one of the world’s best K-12 education systems at no cost to them, regardless of the neighborhood they live in. College would also be tuition free.

Many Americans may consider the Finnish system strange, dysfunctional or authoritarian, but Finnish citizens report extraordinarily high levels of life satisfaction. The World Happiness Report announced recently that Finland was the happiest country in the world, for the second year in row, leading Norway, Denmark, Switzerland and Iceland in the poll.

Finland has also become one of the world’s wealthiest countries and, like other Nordic countries, home to many highly successful global companies. A spokesman for JPMorgan Asset Management recently concluded that “The Nordic region is not only ‘just as business friendly as the U.S,’ but also better on key free-market indices, including greater protection of private property, less impact on competition from government controls and more openness to trade and capital flows.” “Furthermore, children in Finland have a much better chance of escaping the economic class of their parents than do children in the U.S.”

Finland’s form of capitalism has worked for businesses and citizens alike. Since Independence, Finland has remained a country and economy committed to free markets, private businesses and capitalism. Its growth has been helped, not hurt, by the nation’s commitment to providing generous and universal public services that support basic human well-being. Finland and the Nordic countries as a whole, including their business elites, have arrived at a simple formula: “Capitalism works better if employees get paid decent wages and are supported by high-quality, democratically accountable public services that enable everyone to live healthy, dignified lives and to enjoy real equality of opportunity for themselves and their children.”

This system works. Over the last 50 years, if you had invested in a portfolio of Nordic equities, you would have earned a higher annual real return than the American stock market according to Credit Suisse research. It’s not a surprise since Nordic companies invest in “long-term stability and human flourishing while maintaining healthy profits.” We made a similar point in our September blog “Reinvent Capitalism?”

Dr. King’s quotes resonate loudly today. We Americans are a country of immigrants- “We came on different ships, but we’re in the same boat now.” In a time of tribal politics- “We must learn to live together as brothers or perish together as fools.” However, since “The time is always right to do what is right,” let’s keep optimistic that “In some not too distant tomorrow the radiant stars of love and brotherhood will shine over our great nation with their scintillating beauty.”

https://dwmgmt.com/

Breaking News- How the SECURE Act Will Impact Retirement Plans

Happy New Year!! We hope everyone had a great holiday. Everyone at DWM certainly did. In late December, Congress’s year-end spending package was signed into law and it included the SECURE Act which has made some significant changes to retirement plans. It’s a mixed bag. Major items impacted are 1) “stretching rules” for IRAs, including Roth IRAs, inherited by non-spouse beneficiaries 2) age limits for IRA contributions and 3) Required Beginning Date (“RBD”) for Required Minimum Distributions (“RMD”) for retirees.

In the past, owners of IRAs and Roth IRAs could leave them to much younger heirs, including grandchildren, who could “stretch” the IRA by taking out the minimum distribution, typically until they were 85 years. This was particularly valuable for Roth IRAs, where the income tax had already been paid and the account continued to grow tax-free for 50 years or more. For example, a grandchild who received a $100,000 Roth IRA from her deceased grandparent at age 30, who invested the money and earned 6% annually and withdrew only the required amount each year, could eventually receive $741,000 in distributions over 55 years, all tax-free. The same applied to IRAs, except there would be taxes to be paid on the distributions each year. This was a great wealth succession strategy.

Now, the “Big Stretch” is gone. The distribution period has been reduced generally to 10 years for non-spouse beneficiaries. Surviving spouses are still covered by the old rules. However, a non-spouse IRA or Roth IRA heir can postpone any distributions until the end of the 10 years to maximize tax-free or tax-deferred growth. A surviving spouse who inherits a Roth IRA can put the account in his or her name, not take any distributions in their lifetime and then leave the accounts to younger heirs who get a 10 year stretch.

The Big Stretch is gone but Roth conversions can still make lots of sense, in the right circumstances. Here’s a real life example of a program we are just putting into place with clients. A Roth conversion is where you voluntarily move all or a portion of an IRA to a Roth account and pay income tax on the amount transferred. The Roth account is tax-free thereafter. Over a 10 year period one of our client couples is converting $1 million of traditional “pre-tax” IRA money to Roth. We do an installment Roth conversion each year, with larger amounts in the beginning. At the end of the conversion, using a 6% annual investment growth, their Roth accounts total $2 million. It has cost about $250,000 of federal tax (they live in a state with no income tax) to do the conversion. At that point, our clients are 70 years old. They have no RMD requirements on their Roth accounts and, assuming the second to die of the couple passes away at 95 years of age, the $2 million would have grown to $8.5 million over those 25 years. After that, the beneficiaries can allow the money to grow for 10 more years under the new rules and then take tax-free distributions on the roughly $15 million of Roth money. The effective tax rate on the conversion and growth was less than 2% tax ($1 million of IRA money eventually became $15 million of Roth money). Conversions don’t work for everyone but for the right situation, it is a key part of the legacy and wealth succession strategy, even without the Big Stretch.

Under the SECURE ACT, savers can continue to make contributions to a Traditional IRA past the age of 70 ½ (the age limit of 70 ½ has been repealed). Roth contributions were never subject to an age limit. They still have to meet the requirements of earned income to make contributions.

Lastly, starting dates, or RBDs, have been revised from 70 ½ to age 72 for RMDs. Obviously, people are living longer and many would prefer to start their RMDs later. Again, traditional IRAs have RMDs so that the IRS can finally start collecting tax on the money. The initial withdrawal rate is 3.6% and the withdrawal rate increases each year to 16% at age 100, for example. Roth IRAs have no RMDs for owners and their spouses. Now, if the owner reaches 70 ½ after 12/31/19, the first RMD year is the year in which the owner reaches 72. The RBD is April 1 of the year that follows the year in which the owner reaches 72 ½. Here’s an example, IRA owner was born in April, 1950. She will be 70 ½ in October, 2020 (after 12/31/19). So, she can take his first RMD either in 2022 or by April, 2023 (under the old rules she would have had a RBD of 2020 or April 2021.) However, if the first RMD is taken in April 2023, then the 2023 RMD for her will be taken that year as well. Doubling up may not be advantageous, as it may push you into a higher tax bracket.

Those are the key issues in the SECURE ACT. If you have any questions, please let us know. We love working with retirement plans, traditional IRAs and particularly Roth IRAs. Even with the new changes in the SECURE Act, there are still some great planning opportunities available.

https://dwmgmt.com/

The “Nastiest, Hardest Problem” in Retirement

Running out of money in retirement is, according to Nobel Prize winning economist William Sharpe, the “nastiest, hardest problem” in retirement. Professor Sharpe has spent his career thinking about risk. His work on the Capital Asset Pricing Model and systemic risk produced in 1966 the Sharpe ratio, which measures risk-adjusted returns. Now, he’s tackling a much broader subject, extremely important to everyone, about possibly outliving your money in retirement. Similar to the Monte Carlo analysis that DWM uses to provide a probability of success for your financial plan, Dr. Sharpe created a computer program with 100,000 retirement-income scenarios to calculate the probability of not running out of money. He’s published a free 730 page e-book “Retirement Income Scenario Matrices.”

In short, there are three key variables that impact your retirement income; your spending, your investment returns and your eventual age (when your plan “ends.”)

The first variable, spending, is the one you can most control. Your spending before retirement will generally determine how much money you accumulate while working. What you don’t spend becomes savings/investments and these annual additions and their appreciation increase your investment portfolio overtime. Your spending in retirement will determine how much you need to withdraw from your investment pot. As your earnings during the working years increase, you need to save a larger percentage of your income in order to accumulate an investment pot at retirement time that will support the lifestyle you’ve created. Withdrawals from your investment portfolio during retirement typically should not exceed 4% of the total investment pot. It’s an easy calculation. For example, if you determine you will need to withdraw $100,000 from the portfolio in your first year of retirement, you’ll need a portfolio of $2.5 million.

Now let’s look at investment returns. No one can predict the future. Historically, we know there is a relationship between inflation, asset allocation and returns. Hypothetically, let’s assume that a diversified fixed income portfolio over the long term would produce a return of 1% above inflation. The return above inflation is called the “real return.” Equities, because of their higher risk, have earned an “equity risk premium” of roughly 3 to 7% above the inflation rate over the long term. Again, hypothetically, let’s assume that in the long-run equities earn 5% above inflation. Alternatives have a shorter historical track record but are designed to produce returns comparable to fixed income returns over time. Therefore, a portfolio with 50% fixed income holdings and 50% equity holdings might hypothetically produce a 3% real return over time. If long-term inflation is expected to be 2.5%, the nominal return could be expected to be 5.5%. A larger allocation to equities will likely produce a larger real return and a smaller (more defensive) allocation of equities would likely produce a smaller real return.

Lastly, longevity. Certainly, we can look at actuarial tables, such as those used by insurance companies and social security, to calculate life expectancy. These charts show that a male age 60 might be expected to live another 22 years; a female age 60, another 25 years. However, we suggest you not use these actuarial tables. Harvard Professor David Sinclair‘s “Lifespan- Why we Age- and Why We Don’t Have To” shows that the increases in technology and medicine are going to give those individuals who want to live a longer and healthier life the opportunity to do so. It is very possible that many of our clients and friends will live a healthy 100 plus years and younger generations, such as millennials and Gen Z, may live to 110 or longer. Accordingly, we suggest using an eventual age of at least 100 when doing your financial planning.

Dr. Sharpe’s final section in the book is about advice. He indicates that many people will need help. He outlines the “ideal financial advisor” and compares a “good financial advisor” to a “fine family doctor” who has “deep scientific knowledge, can assess client needs, habits and willpower and is able to provide scientific diagnoses and can communicate results to the client in simple terms so that the best treatments can be applied.” We like the analogy, we use it all the time.

Yes, running out of money in retirement would be a nasty, hard problem. It’s doesn’t have to be that way. You need a solid financial plan based on realistic values for investment returns and longevity. You also need to focus on spending and savings.   And, you might need some help from a “good financial advisor” that operates like a “fine family doctor,” a firm like DWM.

https://dwmgmt.com/

DAFS, QCDS, ROTHS AND 2019 TAX PLANNING-2020 IS COMING

Hope everyone had a great Halloween. Now, it’s time to finish your 2019 Tax Planning. You know the drill. You can’t extend December 31st– it’s the last day to get major tax planning resolved and implemented. This year we will focus on three key areas; Donor Advised Funds, Qualified Charitable Distributions and Roth accounts. And, then finish with some overall points to remember.

Donor Advised Funds (“DAFs”). For charitable gifts, this simple, tax-smart investment solution has become a real favorite, particularly starting in 2018. The concept of DAFs is that taxpayers can contribute to an investment account now and get a current deduction yet determine in the future where and when the money will go.

The Tax Cuts and Jobs Act of 2017 increased the standard deduction (up to $24,400 in 2019 for married couples). Couples with itemized deductions less than the standard deduction receive no tax benefit from their contributions. However, they could get a benefit by “bunching” their contributions using a DAF.   For example, if a couple made annual charitable contributions of $10,000 per year, they could contribute $40,000 to the DAF in 2019, e.g., and certainly, in that case, their itemized deductions would exceed the standard. The $40,000 would be used as their charity funding source over the next four years. In this manner, they would receive the full $40,000 tax deduction in 2019 for the contribution to the account, though they will not receive a deduction in the years after for the donations made from this account.

Now, what’s really great about a DAF is that if long-term appreciated securities are contributed to the DAF, you won’t have to pay capital gains taxes on them and the full fair market value (not cost) qualifies as an itemized deduction, up to 30% of your AGI. Why use after tax dollars for charity, when you can use appreciated securities?

Within the DAF, your fund grows tax-free. You or your wealth manager can manage the funds. The funds are not part of your estate. However, you advise your custodian, such as Schwab, the timing and amounts of the charitable donations. In general, your recommendations as donor will be accepted unless the payment is being made to fulfill an existing pledge or in a circumstance where you would receive benefit or value from the charity, such as a dinner, greens fees, etc.

Many taxpayers are using the DAF as part of their long-term charitable giving and estate planning strategy. They annually transfer long-term appreciated securities to a DAF, get a nice tax deduction, allow the funds to grow (unlike Foundations which have a 5% minimum distribution, there are no minimum distributions for DAFs) and then before or after their passing, the charities they support receive the benefits.

Qualified Charitable Distributions (“QCDs”). A QCD is a direct transfer of funds from your IRA to a qualified charity. These payments count towards satisfying your required minimum distribution (“RMD”) for the year. You must be 70 ½ years or older, you can give up to $100,000 (regardless of the RMD required) and the funds must come out of your IRA by December 31. You don’t get a tax deduction, but you make charitable contributions with pre-tax dollars. Each dollar in QCDs reduces the taxable portion of your RMD, up to your full RMD amount.

For taxpayers 70 ½ or older, their annual charitable contributions generally should be QCDs and if their gifting exceeds their RMDs, they can either do QCDs up to $100,000 annually or, instead of QCDs,fund a DAF with long-term appreciated securities and bunch the contributions to maximize the tax deduction.

Roth Accounts. A Roth IRA is a tax-advantaged, retirement savings account that allows you to withdraw your savings tax-free. Roth IRAs are funded with after-tax dollars. They grow tax-free and distributions of both principal and interest are tax-free. Roth IRAs do not have RMD requirements that traditional pre-tax IRAs have. They can be stretched by spouses and beneficiaries without tax. They are the best type of account that a beneficiary could receive upon your passing.

A taxpayer can convert an IRA to a Roth account anytime, regardless of age or income level- the IRS is happy to get your money. A Roth conversion is especially appealing if you expect to be in a higher marginal tax bracket in retirement. Conversions make sense when taxable income is low or negative. In addition, some couples interested in Roth conversions make DAFs in the same year to keep their taxes where they would have been without the conversion or the DAF.

2020 is coming. You still have almost two months to resolve your 2019 tax planning and get it implemented. Make sure you and your CPA review your situation before year-end to make sure you understand your likely tax status and review possible strategies that could help you. At DWM, we don’t prepare tax returns. However, we do prepare projections for our clients based on our experience and knowledge to help them identify key elements and potential strategies to reduce surprises and save taxes. Time is running out on 2019. Don’t forget to do your year-end tax planning. And, of course, contact us if you have any questions.

https://dwmgmt.com/

Old Adages Die Hard: What Worked in the Past May Not Work Today!

More people are renting (not buying) houses, particularly millennials. The old adage that “paying rent is foolish, own your house as soon as you can” is no longer being universally followed.  Lots of reasons: cost of college education, student debt, relative cost of houses, flat wages, more flexibility and others.  Today we 327 million Americans live in 124 million households, of which 64% (or 79 million) are owner-occupied and 36% (or 45 million) are renter-occupied. In 2008, homeownership hit 69% and has been declining ever since.

It starts with the increasing cost of college.  Back in the mid 1960s, in-state tuition, fees, room and board for one year at the University of Illinois was $1,100.  Annual Inflation from 1965 to now has been 4.4% meaning $1,100 would have increased 10 times to $11,000 in current dollars.  Yet, today’s in-state tuition, room & board at Champaign is $31,000, a 28 times (or 7.9% average annual) increase.  Yes, students often get scholarships and don’t pay full price, but even a $22,000 price tag would represent a 20 times increase.

It’s no surprise that in the last 20 years, many students following the old adage “get a college education at any price” found it necessary to incur debt to complete college.  Today over 44 million students and/or their parents owe $1.6 trillion in student debt.  Among the class of 2018, 69% took out student loans with the average debt being $37,000, up $20,000 each since 2005.  And here is the sad part: according to the NY Fed Reserve, 4 in 10 recent college graduates are in jobs that don’t require degrees.  Ouch. In today’s changing economy, taking on “good debt” to get a degree doesn’t work for everyone, like it did 50 years ago.

At the same time, houses in many communities have increased in value greater than general inflation.  Elise and I bought our first house in Arlington Heights, IL in 1970 when we were 22.   It was 1,300 sq. ft., 3 bedrooms and one bath and cost $21,000.  I was making $13,000 a year as a starting CPA and Elise made $8,000 teaching.  Today that same house is shown on Zillow at $315,000.  That’s a 15 times increase in 50 years. At the same time, the first year salary for a CPA in public accounting is now, according to Robert Half, about $50,000-$60,000. Let’s use $60,000.  That’s less than a 5x increase.  Houses, on the other hand, have increased at 5.6% per year. CPA salaries have increased 3.1%.  The cost of living in that 50 years went up 3.8%. Wages, even in good occupations, have lagged inflation. Our house 50 years ago represented about one times our annual income.  Today the average home is over 4 times the owners’ income.  That makes housing a huge cost of the family budget.

In addition, today it is so much more difficult to assemble the down payment. We needed 20% or $4,200; which came from $3,500 savings we accumulated during our first year working full-time and a $700 gift from my mother. A “starter” house today can cost $250,000 or more.  20% is $50,000, which for many is more than their first year gross income.  And, from that income, they have taxes, rent, food and other expenses and, in many cases, student debt, to pay before they have money for savings. Saving 10% is great, 20% is phenomenal.  But even at 20%, that’s only $10,000 per year and they would need five years to get to $50,000.  No surprise that it is estimated the 2/3 of millennials would require at least 2 decades to accumulate a 20% down payment.

Certainly, houses can become wealth builders because of the leverage of the mortgage.  If your $250,000 house appreciates 2% a year, that is a 10% or $5,000 increase on your theoretical $50,000 down payment. But what happens when real estate markets go down as they did after the 2008 financial crisis?  The loss is increased.  Many young people saw siblings or parents suffer a big downturn in equity 10 years ago and are not ready to jump in.

Furthermore, young people who can scrape up the down payment and recognize the long term benefits of home ownership, may not be willing to commit to one house or one location for six to seven years.  With closing costs and commissions, buying, owning and selling a house in too short a period can be costly and not produce positive returns.

Lastly, many people want flexibility and don’t want to be tied to a house. They want flexibility to change locations and jobs.  They want flexibility with their time and don’t want to spend their weekends mowing the grass or perform continual repairs on the house. In changing states like Illinois, with a shrinking population and less likelihood of significant appreciation, their house can be a burden.  For them, renting provides them flexibility and peace of mind.

It’s no surprise then that the WSJ reported last week that a record number of families earning $100,000 a year or more are renting.  In 2019, 19% of households with six-figure income rented their house, up from 12% in 2006.  Rentals are not only apartment buildings around city centers, but also single-family houses.  The big home-rental companies are betting that high earners will continue renting.

Yes, the world has changed greatly in the last 50 years and it will keep changing.  When I look back, I realize we baby boomers had it awfully good.  The old adages worked for us. But today, buying a house is not the “slam dunk” decision we had years ago, nor is a college degree.  The personal financial playbook followed by past generations doesn’t add up for many people these days.  It’s time for a new plan customized for new generations and that’s exactly what we do at DWM.

Equity Trades are Free – But there is no Free Lunch

Broker price wars

Before 1975, brokers had it really good. Commissions were fixed and regulated-at very high levels. It would sometimes cost hundreds of dollars to buy 500 shares of a blue-chip stock. That changed in 1975 when the SEC opened commissions to market competition.   A young Chuck Schwab and others became discount brokers- often charging ½ or less of the old rates. Since then, fees have continued to fall and earlier this year, trades could be made for $5 or less. Now, Charles Schwab & Co. as well as TD Ameritrade, E*TRADE and others have cut stock and ETF trades to zero. Free trading of equities has arrived.   Please be advised, though, that there is no free lunch- brokers profit from you even if they don’t charge for equity trades.

Here are some the main sources of income for brokerage firms:

  • Trade commissions
  • Brokerage fee- to hold the account
  • Mutual fund transaction fee-charges when you buy or sell a fund
  • Operating Expense Ratio-an annual fee charged by mutual funds, index funds and exchange-traded funds (“ETFs”)
  • Sales load- A sales charge or commission on some mutual funds paid to the broker or salesperson who sold the fund
  • Uninvested cash- brokers become bankers and lend it out

Let’s focus first on uninvested cash. In 2018, 57% of Schwab’s income came from loaning out its customers’ cash. As is typical in the brokerage business, uninvested cash is swept to an interest bearing account. However, sweep accounts typically earn almost nothing- usually ½ to ¼ of 1% or lower to the investor.

Schwab had a total of $3.7 trillion of deposits, with about 7% of it ($265 billion) in cash earning nice returns for them. Assuming a return of 2.5 % on the uninvested cash, that’s a return of $6.6 billion. The cost of that money was likely ½% or about $1 billion, with Schwab netting about 2%. $5.7 billion of Schwab’s $10 billion net revenue in 2018 was earned on its customers’ cash. Virtually all the brokers use the same model with uninvested cash.

Robo- advisors generally use the same format. Virtually all of them charge lower fees but require a certain amount of cash, between 4% and 30% in their pre-set asset allocations. Yes, there is a small sweep account interest paid on those funds, but not much. And, this is all typically disclosed. The rate paid on clients’ cash “may be higher or lower than on comparable deposit accounts at other banks” is a typical warning.

The use of uninvested cash is income for the brokers and reduction in performance for the investors. Let’s say your portfolio has 10% cash generating a 0% return. If your annual return on the invested 90% in your portfolio is 6%, then the return on 100% of the account is only 5.4%. A huge difference over time. As an example, the difference between earning 5% per year versus 6% a year on $100,000 for 30 years is $142,000.

Now, let’s look at the operating expense ratio (OER). OERs are charged by mutual funds, index funds and ETFs. If a fund has an expense ratio of 1%, that means you pay $1 annually for each $100 invested. If your portfolio was up 6% for the year, but you paid 1% in operating expenses, your return is actually only 5%. The OER is designed to cover operating costs including management and administration.

The first mutual funds were actively traded, meaning that the portfolio manager tried to beat the market by picking and choosing investments. Operating expenses for actively managed funds include research, marketing and significant administration with OERs often at 1% or more. Index funds are considered passive. The manager of an index fund tries to mimic the return of a given benchmark, e.g. the S&P 500 Index. Index funds should have significantly lower operating expense ratios. Evidence shows that actively managed funds, as a whole, don’t beat the indices. In fact, as a group, they underperform by the amount of their OER.

Operating expense ratios, primarily because of increased use of index funds and ETFs to minimize costs, have been getting smaller and smaller. In fact, we have seen some funds at a zero operating expense ratio. However, for these funds, a substantial amount (10% to 20%) of cash is maintained in the fund.

Conclusion: Set a target of 1-2% cash in your portfolio. Stay invested for the long term.   In addition, the investments in your portfolio should have very low OERs, wherever possible. However, in selecting investments, you need to look at both the OERs and the typical cash position of the mutual fund, index or ETF. Even if the OER is zero and the security holds 10% in cash, your performance on that holding will likely only be 90% of the benchmark, at best. Remember, when equity trades are free, brokers will continue to look for ways to make money, often at your expense.

Climate Capitalists to the Rescue?

Record heat has hit the South. On October 1, it was 101 in Montgomery, AL. Record highs were hit in AL, TN, MS and KY. An acute lack of rainfall has dried out the Southeast as well and residents and farmers are hurting. Planet Earth continues to get warmer.

Look at the chart above showing the changes in temperatures from the 1850s until now. Each stripe is one year. Dark blue years are cooler and red stripes are warmer. The period 1971-2000 is the base line. At the same time, extreme events like Dorian are becoming more severe, more glaciers have died and seas and lakes are getting higher. The climate has changed.

The past century has seen major changes in the world. The Industrial Revolution has brought riches to some, higher standards of living to many, and the population has increased from 2 billion to 7 billion in that last century, and carbon dioxide (“CO2”) emissions have skyrocketed. Fossil fuels have been used to produce industrial power, electricity, transportation, heating, fertilizers and plastic. In 1900 about 2 billion tons of CO2 went airborne. For 2019, 40 billion tons per year will be emitted, with the biggest increase in the last 30 years.   Expanding use of fossil fuel and related increasing emissions of CO2 have gone hand in hand with the expansion of world growth. See the chart below.

GDP CO2

We humans also produce CO2, breathing and eating.  Trees and plants absorb CO2 and, with sunlight and water, convert it to food.   Compared to 1900, we have 5 billion more humans, expanded use of fossil fuels and, because of deforestation, we have less flora to absorb the CO2.

The first half of the 20th century scientists believed that almost all of the CO2 given off by industry and humans and not absorbed by plants would be sucked up by the oceans.  By 1965 oceanographers realized that the seas couldn’t keep with the CO2 emissions.   Climate change shouldn’t come as a surprise; we’ve known about it for decades.

There are lots of predictions about the impact of climate change in the future. No one can predict the future. But certainly, as our beloved Yogi Berra always said, “The Future is not what it used to be.”

The Economist recaps it this way: “Climate change is not the end of the world.”  Humankind is not poised teetering on the edge of extinction.  The planet is not in peril.”  However, climate change could be a dire threat to the displacement of tens of millions of people, it will likely dry up wells and water mains, increase flooding as well as producing higher temps and more severe weather.  The Economist concludes that “the longer humanity takes to curb emissions, the greater the dangers and sparser the benefits-and the larger the risk of some truly catastrophic surprises.”

Addressing climate change will also provide substantial business opportunities in the coming years.  Already some countries are abandoning coal to generate electricity. Britain, e.g., has developed a thriving offshore wind farm industry used to generate power. Germany recently announced that it will spend $75 billion to meet its 2030 goals to combat climate change, primarily in the transportation area with electric vehicles.

In addition, “climate capitalists” want to do good for the planet and well for themselves.  Elon Musk has invested billions into batteries and electric vehicles.   Chinese BYD’s Zhenzhen sprawling campus is a major provider of solar cells, electric cars, heavy machinery and other items needing energy storage.  Warren Buffet has invested $232 million into BYD.  American billionaire Philip Anschutz has spent a decade promoting a $3 billion high-voltage electric grid. Bill Joy, a co-founder of Sun Microsystems, is now backing Beyond Meat, a maker of plant-based alternatives to burgers.  Microsoft’s Bill Gates established a $1 billion company to bankroll technologies that “radically cut annual emissions.”  Even Pope Francis is using the Vatican Bank’s $3 billion fund to help fight climate change.

The UN’s one day climate summit last week concluded with a number of new announcements.  65 countries and the EU have committed to reach net-zero carbon by 2050.   Unfortunately 75% of the emissions come from 12 countries and 4 of them, India, American, China and Russia made no commitment.  However, certain businesses such as Nestle, Salesforce and have made commitments to reach net-zero by 2050 or before.

2050 will be here before we know it.  Yet, technological change can be adopted quickly, particularly when people are provided a better alternative.  In America, the shift from horse-drawn carts to engine-driven vehicles took place within a decade, from 1903 to 1913.  Let’s hope climate capitalists all over the world do well for themselves and good for planet as soon as possible and we humans and our countries do our parts as well.

 

REINVENT CAPITALISM?

Kraft Heinz (KHC) and Unilever (UL) have many things in common. Both companies own hundreds of global consumer brands- KHC includes not only Kraft foods and Heinz Ketchup but also Planter’s peanuts and Grey Poupon mustard. Unilever owns Dove soap and Hellmann’s mayonnaise, Lipton’s tea and Ben & Jerry’s ice cream. Both have been in business since the 1920s. Both employ tens of thousands of employees.

In early 2017, KHC offered to buy UL for $143 billion. UL’s then CEO, Paul Polman, fended off the takeover attempt because of a “corporate culture that couldn’t have been more different from Unilever’s.” Since then, KHC’s share price has dropped 70% and UL’s has increased about 35%. If we look at some of the differences between KHC and UL we will see why Mr. Polman didn’t want to merge with KHC and why he would like to see capitalism “reinvented.”

After receiving his M.B.A., Mr. Polman joined Procter & Gamble which provided the foundations for his leadership approach. In his recent NYT interview, Mr. Polman indicated that “P&G has enormous values that permeate all levels and all places in the world that it operates. Ethics, doing the right thing for the long term, taking care of your community is really the way you want a responsible business to be run.”

Fast forward to 2009. After 10 years of decline, UL hires Mr. Polman as CEO. Annual sales had dropped from $55 billion to $38 billion. Mr. Polman felt UL had good brands and good people but had become too “short-term focused.” A change was needed.

Mr. Polman brought back values from the 20s that were at the roots of Unilever’s success. He felt a more responsible business model was needed. He came up with a bold plan to double Unilever’s revenue while cutting the company’s negative impact on the environment in half. And, he committed his entire team to focus on the long-term, not the short-term, in solving important issues.

In short, Mr. Polman believes “We need to reinvent capitalism, to move financial markets to the longer term.”  He felt that “KHC is clearly focused on a few billionaires that do extremely well, but the company is on the bottom of the human rights indexes and is built on the concept of cost cutting.”

This long-term vs. short-term focus is at the heart of a recent best seller, “Prosperity” by Colin Mayer, a former dean of Oxford’s Said business school. Dr. Mayer believes that a great shift in businesses, here in the U.S. and abroad, started about 50 years ago with the overwhelming acceptance of Chicago economist Milton Friedman’s simple doctrine that “the one and only responsibility” of a business is to increase its profits for the benefits of its shareholders, as long as it stays within the rules of the game.” This has been a “powerful concept that has defined business practice and government policies and has molded generations of business leaders.” It has resulted in a huge emphasis on quarterly reporting and quarterly behavior.

Dr. Mayer believes, on the other hand, that the purpose of a corporation should consider its customers, employees, suppliers, and communities as well as its shareholders. Historically, family-owned businesses were cognizant of and responsive to all the constituencies that compose a business and focused on the long-term. Today, almost all corporations in the UK and many US corporations are no longer owned by the founders or their families. This change has accelerated due to the focus on short-term profits, often by simply merging and cutting costs. Dr. Mayer also pointed out that corporations can also have dual-class share structures (typically voting and non-voting shares) which can allow the founders and their like-minded successors to control the company and therefore focus on its long-term purpose rather than quarterly earnings reports. Ford, Google, and Facebook all have this structure. This is a positive trend.

Robert Reich’s new book “The Common Good”, sums it up this way, “In the corporate world, the single-minded-pursuit of shareholder value has displaced the older notion that companies are also responsible for the well-being of workers, customers and communities they serve.” “The common good is no longer a fashionable idea.” He defines common good as “consisting of our shared values about what we owe another as citizens who are bound together in the same society.” Regardless of political party, all Americans should embrace contributions to the common good.

For 50 years, there has been a huge focus on financial capital with less attention paid to human capital, intellectual capital, material capital and environmental capital. All five of these components of capital should be considered for the overall long-term growth and common good of America and the world.

Reinventing capitalism would require companies to focus on more than quarterly profits. Consideration of all of its constituents- customers, shareholders, employees, suppliers, communities and the environment for the long-term-could certainly benefit the common good and likely produce even better stock market returns in the long-run as well.

Dealing With Investor Anxiety: Think Long-Term

Stock prices reflect a mix of emotions, biases and rational calculations. The bond market reflects the economy. Historically, bond markets had done a better job in predicting recessions.

The two big bond stories last week were 1) the “inverted yield curve”- when interest rates on short-term bonds are higher than long-term bonds, and 2) yields below 2% on 30 year treasuries- indicating investors expect low inflation and a weaker economy for a long time.

We all remember the 2017 income tax cut that boosted the economy and produced stock markets returns of 20% or more in 2017. These tax cuts were supposed to lay a foundation for many years of high economic growth. Since mid-2018, however, the economic data has been confirming what many of us expected. The tax cuts provided a short sugar “high,” which is now over. Instead, we have trillion dollar deficits and lack of large promised business investments, including infrastructure, which never materialized. The economy has reverted to its pre-stimulus growth rate of near 2%.

This shouldn’t surprise us. No major economy is growing as fast as it was before 2008. In almost every country, the national discussion focuses on what must be done to revive growth and ignores the fact that the slowdown is happening everywhere. The working population is declining in 46 countries around the world, including Japan, Russia and China. Demographics are a key driver of economic growth. So, we can expect to see recessions (two quarters of negative growth) more likely in the future as working populations contract. BTW- the U.S. population is growing at less than 1% per year.

Over the next few decades, we will likely see more growth decline. Ruchir Sharma, author of “The Rise and Fall of Nations,” suggests that new benchmarks for economic success should be 5% growth for emerging countries, 3-4% growth for middle income countries like China, and 1-2% growth for developed countries like the U.S. and Germany.

Yes, there are uncertainties in the market, including US-China trade tensions, a weakening European economy, and concern about a recession. These produce a huge dilemma for U.S. business owners, trying to make plans for the future. So, there are lots of piles of cash, waiting for clarity. We may or may not soon have a recession. Yet all of this uncertainty produces increased volatility and anxiety. And studies show that a 3% down day, like last Wednesday, feels about ten times worse than a 1% down day. What’s an investor to do to reduce anxiety?

We understand it is difficult to think long-term, but we highly recommend it:

1) Recognize that equities will likely produce lower nominal returns in the future. However, with inflation also likely lower, the real returns of equities will likely outpace fixed income and alternatives. Equities will continue to provide the primary engine of growth.

2) Use all three asset classes. A diversified portfolio composed on equities, fixed income and alternatives has been shown to reduce risk and increase return.

3) Review your long-term financial plan and determine what rate of return you need to meet your financial goals. The expected return of your asset allocation must be sufficient to meet your goals or you need to revise your goals and plan.

4) Review your risk profile to determine your appropriate asset allocation. Using the assumption that equities could drop 40% and you can’t tolerate a loss of 10% or more in your portfolio, then your allocation to equities should not exceed 25%. Of course, this allocation would severely limit your upside.

5) Stay invested. Don’t try to time the market. A recent report from Morningstar shows that “low cost funds”, (like those used at DWM), “lead to higher total returns and higher investor returns.” First, for efficient markets, the active managers in the high-cost funds overall produce gross results equal to the benchmarks, but then the additional costs of 1% or more is subtracted. Second, studies show that active managers attempting to time the market have failed and this subtracts another ½% per year from performance. Even highly-paid active managers can’t time the market successfully.

Lastly, in this time of overall investor anxiety, fee-only total wealth managers, like DWM, are here to rescue you. Yes, we execute a detailed process to add value every day in the areas of investing, financial planning, income taxes, insurance and estate planning. Yet, one of our most important tasks we have is to protect our clients from hurting themselves in the capital markets. Investors overall have a very human tendency to do exactly the wrong thing at the worst possible moment.

We understand it’s hard to think long-term. Today’s world moves at a very fast pace. And, the news is often designed to instill fear. Don’t succumb to emotions. Reduce your anxiety. Allowing your portfolio to compound quietly over time can be boring, yet very successful.   If your allocation or the markets are making you anxious, let’s talk.