At this time of Thanksgiving, we are thankful for wonderful clients and associates like you.
Your business and referrals have helped us to grow over the years and we are grateful for your support.
There are plenty of reasons for caution. So far, the rise that started in the stock market in March 2009 has lasted 56 months and produced gains of 166%. Margin debt has risen to record levels, investor sentiment is quite upbeat (55% bullish and only 16% bearish) which often foretells a correction, and warnings are coming from the likes of Warren Buffet and Carl Icahn.
Let’s put this in perspective. The S&P 500 is valued at 16 times projected 2013 earnings and 15 times estimated 2014 earnings. According to Barron’s report on Saturday, those price/earnings (P/E) ratios are about equal to the long-term average. Equities are currently trading at 2.5x book value- far below the peaks of prior bubbles. P/E ratios were 23, 30, and 17.5 before the bubbles popped in 1987, 2000 and 2007.
Perhaps a better measure for valuation other than P/E is CAPE. CAPE or cyclically-adjusted-price-earnings ratio is the brainchild of recent Nobel Prize winner Robert Shiller. Instead of focusing on one year of earnings, it averages the past 10 years, and adjusts them for inflation using CPI. Inflation is a powerful force that is often ignored when looking at nominal all-time highs. Dr. Shiller used CAPE valuation in his book “Irrational Exuberance” published in March 2000 which demonstrated how markets were overvalued during the internet boom. The dotcom bubble burst the same month.
Today, CAPE is at 24. The long-term average is 16. Dr. Shiller cautions against using CAPE to time crashes and make short-term trades. Rather, CAPE is more useful in predicting longer-term returns. Looking at stocks today, Dr. Shiller recently said: “The market is somewhat high, but it’s not a time when I would be writing ‘Irrational Exuberance’”. He continued: “Stocks are merely expensive, rather than bubbly.”
What Dr. Shiller does say, though, is that high CAPE historically produces lower returns in the following three years than years following low CAPE amounts. That’s understandable- it’s the old “reversion to the mean”. Good to reflect upon after such a banner year in stocks in 2013.
Perhaps a better question to ask, other than “Are we in a bubble,” is “Am I comfortable with how my portfolio would perform if there is a significant correction in stocks?” As we pointed out in our seminars last month, it’s all about stress testing your financial plan and your portfolio and focusing on what you can control.
Let’s say you have a balanced risk profile and have an asset allocation of 50% stocks, 25% fixed income and 25% alternatives. If there is a 15% stock market correction, what will be the likely short-term impact on your portfolio? Based upon what happened in 2008, the impact might be a decline of 5%-10%. Of course, past performance is no guarantee of future results. Can you live with such a decline? The answer should be yes for someone with a balanced risk profile.
We can’t tell you whether we are in a bubble or not. We do watch the markets very carefully but we can’t control them. What we focus on is making sure every client’s asset allocation is consistent with their risk profile. We also focus on the components within each asset class, rebalancing the investments on a systematic basis in an effort to produce enhanced performance. That’s the way we protect and grow our clients’ net worth and legacy and give them peace of mind.
Generally, the earliest you can collect social security is age 62. However, if you are making more than $15,120 per year, social security will withhold $1 of benefits for every $2 in earnings above the limit. In addition, there is a 25% reduction in benefits for taking them early. Current “full retirement age” is 66. You can also wait until age 70 to start collecting. Social Security provides a “guaranteed” 8% increase per year if you wait to age 70.
So, many financial advisers do a simple calculation and conclude that you should wait to age 70 and get a slightly larger monthly check. I believe they are missing four key factors in analyzing this important decision.
Here’s an example on how this works and why I think it is worthwhile to take the money. Let’s assume a person reaching full retirement age of 66 could receive $2,500 per month now. Alternatively, they could wait until age 70 and receive $3,400 per month then. If they take the $2,500 per month at age 66, invest it at 5% and get a COLA adjustment of 3% each year, their monthly benefit when they reach 70 is $2,813. In addition, they will have accumulated $136,000 in four years. Yes, if they waited four years, the monthly payment would be $587 more. However, it will take another 24 years (age 94) before the person waiting until 70 will have as large a pot of money (or economic benefit) as the individual starting at age 66.
Secondly, there are going to be changes in social security. If they introduce means testing, many of us will have our social security benefits reduced or eliminated. Let’s take the money now. If they push out the “full retirement age” that could mean fewer years of payments. Furthermore, none of us knows our “eventual age”. Hence, while many of us hope and expect to live beyond age 94, there is no guarantee that we will. When we die, our benefits die as well.
We’ve done the same calculations for people who want to start collecting early, at age 62. Again, this doesn’t apply if you still have earned income above $15,120 per year. Similarly, taking benefits at age 62 instead of age 66 or 70 is likely advantageous. In addition, there are still some very nice strategies that couples can use to maximize their social security benefits and still start early. Of course, everyone’s situation is different and it is possible that delaying social security may, in some cases, be better. Working with sophisticated software programs such as www.maximizemysocialsecurity.com and an experienced financial adviser like DWM can be quite helpful in customizing this analysis for you.
Don’t delay collecting social security. The gravy train may be slowing down soon.
We just wrapped up our fall seminar series and based upon feedback it was a great success. Both venues – the Wolfe St Playhouse in Charleston and Emmett’s Brewery in Palatine – served as great places to not only deliver an important financial presentation but also as a great place to just hang out and visit with one another.
In case you missed one of the October seminars entitled “Rising Interest Rates: Should I Be Concerned?“, here is a quick recap of what you missed:
The Bond bull market may be over.
Bonds still play a vital role within an overall portfolio as do all of the asset classes.
Traditional and major index (like Barclays Aggregate) bond funds may not be the best way to go. Make sure to ‘get under the hood’ of your bond portfolio and ‘check the fluids’.
Use of multiple asset classes lead to non-correlation benefits that ultimately lead to better long-term results.