What is NAPFA?

NAPFAElise recently helped me change the artwork in the office. Added some, moved some, and removed a couple. The best addition was a map of Sanibel Island signed by our kids and grandkids, and now, thanks to Elise’s help, it includes pics of everyone. Sanibel has always been a special vacation place for our family. Great memories.

Another nice addition was my NAPFA acceptance letter, related Fiduciary Oath signed by me, and the recent Accredited Investment Fiduciary (AIF®) certification I received. Brett has these three items in his office as well. We’re often asked by clients and others for more information on NAPFA and AIF® so we thought it might be worth an explanation.

NAPFA (pronounced ‘Nap-Fah’) stands for the National Association of Personal Financial Advisors. NAPFA and its members are all about bringing integrity, honor, and trust to its clients and to investors in general. Its members are strictly fee-only, independent, Registered Investment Advisors just like DWM. NAPFA vets its candidates very carefully, including credentials, experience, peer review of a sample comprehensive financial plan, and signature and adherence to NAPFA’s Fiduciary Oath.

The AIF® designation is awarded by the Center for Fiduciary Studies, the standards-setting body for fi360, the first full-time training and research facility for fiduciaries in the country. AIF® is a very select group. There are only 6,000 AIF® designees currently, as compared to 70,000 CFP® certificants. AIF® designees are the only recognized professionals trained to perform fiduciary assessments, which measure how well investment professionals are fulfilling the fiduciary duties required of them by the applicable investment legislation, case law, and regulatory opinion letters. AIF® designees, like Brett and myself, are able to use the knowledge and resources they have gained through their training to better organize, formalize, implement and monitor their processes and procedures. Studies show that a prudent process improves investment results.

There is a tremendous investor movement away from large brokerage firms to smaller, fee-only independent firms such as DWM. In my opinion there are two key reasons for this: results and trust.

According to the WSJ, “Investors are Fleeing Active Stock Managers.” Actively managed stock and bond mutual funds are the building blocks used by many large institutional wirehouses. The operating expense of an actively managed mutual fund is generally a minimum of 1% more per year than a passive, low cost mutual fund or ETF. Actively managed funds have a lot of expenses a passive fund doesn’t have. These can include research (to try to beat the market), trading, marketing, upfront fees, sales fees and others. Of course, the institutions that promote these actively managed funds to investors receive part of those operating expenses as “revenue sharing.” The investor comes out the loser in this format, since studies have shown time and time again that actively managed stock and bond funds over time don’t “beat the market”, but rather they consistently underperform the benchmark indices. And, that underperformance is usually by about 1% or more, just about the same amount as the “excess fees” over passive investments. The extra 1% in expenses goes right to the bottom line, especially these days when diversified stock returns are more likely in single digits than double digits. A 1% drag on a $1 million portfolio would reduce the appreciation over 20 years by $600,000 or more. It’s no surprise that many large institutions don’t even provide performance results with their statements. The reports can be 100 pages long and yet there is no performance data provided (i.e. time-weighted return calculations). The WSJ article puts it this way, “U.S. active managers destroyed the trust of individual investors and financial advisers, neither of whom want to pay up for active management that can’t beat an index.”

So, many large brokerage institutions have tried to gain the public’s trust (and their money) by advertising themselves as fee-only and fiduciaries. While there may be a small portion of their offering that does qualify to use these terms, their overall business model is generally focused on making money for the institution and its employees. They may charge a client a percentage of asset fees for managing money. That’s not all they get. They often receive “revenue sharing” from mutual fund companies they promote to clients and receive commissions for selling annuities and life insurance contracts.

Have you seen the recent Charles Schwab “Why” TV Commercial? The ad revolves around a boy who quizzes his father about the real value the family’s financial advisor provides. It suggests that most children can see that the wirehouse business is stacked in favor of the advisor, not the client. These days, both children and their parents are really questioning what they are getting and paying these brokers. True fiduciaries put their clients’ interests first and disclose any potential conflict of interest. They hold themselves accountable for results and make full disclosure to their clients. And, they provide additional value-added services and transparency. The general public, I believe, is recognizing that the wirehouses just don’t do that.

NAPFA and its members are gaining a lot of traction. Investors looking to move from the old wirehouse paradigm can contact NAPFA and use its website www.NAPFA.org, to find vetted financial advisers in their area who might be a good fit for them. DWM gets communication, prospects, and ultimately clients from our association with and link to NAPFA. No money changes hands between us. Like DWM, NAPFA is all about doing the right thing; bringing integrity, honor and trust to its clients and investors in general. That’s why we are proud to be members of NAPFA® and AIF® designees.

Get Real- Focus on Real Returns

signCould we be on our way to join the “Deflation Club?” Yes, our U.S. inflation rates continue to drop. It’s now 0.8% on an annual basis after the Consumer Price Index (CPI) declined 0.4% in December. CPI is at zero for last nine months.

For those of us who remember buying cars and getting home mortgages between 1979-1981 when inflation was 12-13%, it’s hard to comprehend. For the last thirty years, inflation has averaged about 3% per year and since 1970 about 4% per year. Hard to believe inflation is now at 1%. Yes, someone moved our cheese again.

And, it’s not just us. It’s all over the world. The Eurozone and Switzerland both recently slipped into deflation. The U.K. isn’t far off. Japan, which imposed a large sales tax increase in mid-2014, suddenly has the highest annual inflation rate in the developed world at 2.4%.

Market expectations of inflation over long periods have a huge impact on asset valuations in four major ways.

  • Price valuations. When inflation is high (think 1979-1981), buyers are willing to pay almost anything for an asset, since it appears the item is just going to keep getting much more expensive. In low inflation or deflationary periods, buyers wait because the price may be coming down and secondly, because their take home pay may be stagnant or non-existent.
  • Economic growth. The Fed has targeted 2% inflation as the rate at which the economy can grow at a sufficient level without overheating or going into recession. As we have discussed in detail in prior blogs, continued low inflation or deflation can cause low GDP growth or recession. Last week, the World Bank reduced its prediction for global growth in 2015 from 3.4% to 3%.
  • Riskless government debt rates. At the close of business last Friday, the 10-year U.S. Treasury note was 1.84% and 30-year 2.44%. The European 10-year government bonds are even lower- Germany at .45%, France at .63% and Switzerland at -.13% per year.
  • Consumer confidence. The huge drop in oil prices, caused primarily by plentiful supply, should be a real boon for families. Yet, the VIX, a measure of expected volatility called the “fear index” jumped on January 14th. Major changes and uncertainty make investors skittish.

Hence, unusually low market expectations of inflation have a huge impact on investment returns. To begin with, the risk/reward principal applies to most any investment. You need to be rewarded for the amount of risk you incur. Since U.S. treasuries are considered “risk-free”, other investments must provide the likelihood of a great return in order for an investor to risk their money. This “risk premium” is the return for the investment over treasuries.

Historically, since 1970, stocks have grown at the rate of almost 9% while inflation has been a little more than 4% per year. Hence, there has been a 5% real return obtained by risking money and investing in stocks. For the same time period, bonds returned about 6% per year, 2% more than inflation. This represents a 2% real return.

So, mathematically, if inflation is 2%, it is very possible that expected returns on a diversified equity portfolio over a long period of time might be 7% and returns on a diversified bond portfolio might be 4%. If inflation is 1%, the nominal returns might be 6% and 3% respectively. And, if low inflation or deflation persists, economic growth can stagnant which further impacts price valuations.

Of course, no one can guarantee future performance. Furthermore, there have been periods of time in the last 40 years when real returns of equities were far greater than 5% and periods where real returns were negative. From 1968-1982, the average annual equity nominal return was 6% while CPI was up 8% per year, resulting in a minus 2% real return. From 1982 to 2000, the equity return was an 18% nominal return annually and a 15% real return per year on average.

Our clients know that we have recently been modifying our DWM/MoneyGuidePro financial plans to reflect this current reality. Inflation is no longer 4.22% per year and expected returns of a balanced portfolio that historically were 7.5% are not likely when inflation is 1% a year. The focus needs to be on real returns. Depending on the allocation of the portfolio, a real return of 2%-5% over inflation for a diversified portfolio of equities, fixed income and alternatives may be a reasonable expectation in today’s investment environment.

So, our cheese actually moved two ways. Both inflation and nominal investment returns have declined. However, real returns should continue in similar historical patterns over time unless low inflation or deflation cause economic growth to stagnate or decline which could further reduce both the nominal and real returns.

So Many Numbers: Which Ones Are Important?

stock-photo-old-typeset-166120136Our world is full of numbers. They’re everywhere. Our calendars just moved from 2014 to 2015. We get bombarded continually with numbers representing time, temperature, and, yes, stock market reports. NPR’s Eric Westervelt last week called numbers “the scaffolding that our economy, our technology and huge parts of our life are built on.”

For this blog, I thought it would be interesting to look at the origin of our numbers and then highlight five key numbers that are of real importance to your financial future.

Mr. Westervelt was interviewing Amir Aczel who has written a new book “Finding Zero: A Mathematician’s Odyssey to Uncover the Origins of Numbers.” Mr. Aczel believes the invention or discovery of numbers “is the greatest intellectual invention of the human mind.” We use Hindu-Arabic numerals. Before that, there were many other systems including the Mayans, the Babylonians, and, yes, the Romans. The big problem with the Roman number system is that it had no zero. The numbers didn’t cycle and hence multiplication or division was almost impossible. Five (V) times ten (X) is 50 or L in the Roman system. Each value was unique in the Roman system whereas in our system, numbers can cycle. Two with a zero after it is 20. And, zero is very important. Without it, numbers couldn’t cycle. It’s the reason that 9 numbers plus a zero allow us to write any number we want. Pretty amazing.

stock-photo-old-typeset-166120136Our world is full of numbers. They’re everywhere. Our calendars just moved from 2014 to 2015. We get bombarded continually with numbers representing time, temperature, and, yes, stock market reports. NPR’s Eric Westervelt last week called numbers “the scaffolding that our economy, our technology and huge parts of our life are built on.”

For this blog, I thought it would be interesting to look at the origin of our numbers and then highlight five key numbers that are of real importance to your financial future.

Mr. Westervelt was interviewing Amir Aczel who has written a new book “Finding Zero: A Mathematician’s Odyssey to Uncover the Origins of Numbers.” Mr. Aczel believes the invention or discovery of numbers “is the greatest intellectual invention of the human mind.” We use Hindu-Arabic numerals. Before that, there were many other systems including the Mayans, the Babylonians, and, yes, the Romans. The big problem with the Roman number system is that it had no zero. The numbers didn’t cycle and hence multiplication or division was almost impossible. Five (V) times ten (X) is 50 or L in the Roman system. Each value was unique in the Roman system whereas in our system, numbers can cycle. Two with a zero after it is 20. And, zero is very important. Without it, numbers couldn’t cycle. It’s the reason that 9 numbers plus a zero allow us to write any number we want. Pretty amazing.

Now, knowing a little more about our number system and with numbers seemingly everywhere, where do we focus our attention? Here are five key numbers that have a big impact on your ability to meet your financial goals:

Percentage of your paycheck that goes to savings/investments. This may be the most important decision in your life. By saving early, you can have a portion of earnings grow in a compound fashion for decades. Furthermore, by “paying yourself” off the top, you limit the amount available for everyday living expenses during your working years. This discipline helps you in two major ways to obtaining early financial independence- first, by creating the fund for “retirement” and second, by reducing the expenses you will likely have during “retirement.” BTW- there is no magic percentage. Everyone’s circumstances are different. Consider an amount of 10-20% of your gross pay.

Your Annual Living Expenses. Monitor your expenses for last year and group them in three categories- needs, wants and wishes. Review the data from a long-term perspective. Spending a considerable amount now on wants and wishes will obviously reduce the amount available in future years. It’s all about choices and accountability. For the most part, you alone can determine and control your level of expenses.

The Asset Allocation of Your Portfolio. This is one of your most important investment decisions. Based upon your risk profile you need to determine how best to split up your investment funds between stocks, bonds and alternatives (which can include real estate). Studies show that 90% of your investment returns are the result of your asset allocation.

The Net Returns on Your Portfolio. Research shows that fees really matter. A $1,000,000 portfolio that earns 5% net per year will grow to $4.3 million in 30 years. The same portfolio that earns 4% net per year will grow to $3.2MM. The difference is $1.1 million- a 26% reduction. Over long periods, loads, commissions, high operating expenses and management fees can be a significant drag on wealth creation. Low cost passive investments are best for stocks and bonds. Make sure you understand and monitor all fees charged to your portfolio. Make sure you are getting real value for all the fees. And certainly, know what your net returns have been, are expected to be and how they compare to the appropriate benchmarks.

Your Effective (average) and Marginal Tax Rate. Tax costs on earnings, investment returns and other income can be huge, particularly as a result of the increases caused by the Affordable Care Act. You and your advisors should know your tax rates and use them as a key factor in decision making and investment strategy. Furthermore, proactive planning designed to minimize taxes is a must for you and your advisors.

Over the last 45 years, I have worked with clients of all ages, income levels and circumstances. A common thread among those who have achieved or are achieving their financial goals is that they all knew of and monitored these five key numbers regularly, making adjustments as appropriate. And, of course, they use objective, proactive, value driven advisors like DWM to help them as well.

Why not make it a New Year’s Resolution to know and monitor these five key numbers for your financial future? It could change your life.

DWM 4Q14 & 2014 Market Commentary

brett-blogDiversification. We talk a lot about it. It’s basically our religion when applying reasoning to investing. Diversification is a technique that reduces risk by allocating investments among various financial asset classes, investment styles, industries, and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-term financial goals while minimizing risk. As great as “diversification” is to CFA Institute practitioners, it might be just a long winded word to someone that doesn’t enjoy the occasional financial periodical. In fact, to that someone, diversification may seem pretty silly in a year like 2014 where really only a couple areas of the market stood out and made everything else seem trivial.

What am I talking about? Well, if you haven’t heard by now, the S&P500 just racked up another double-digit year, gaining 13.7% in 2014. However, the rest of the equity markets, weren’t close to this. In fact, the average US stock fund was only up 7.6% and the average international stock fund was down 5.0% for 2014. In other words, besides a few dozen mega-cap stocks that powered the market-cap-weighted S&P500, most stocks were up for the year, but only modestly.

Frankly, like I’ve said before, the S&P500 is not the best benchmark for a diversified investor. A better barometer or benchmark may be the MSCI ACWI Investable Market Index which captures large, mid and small cap representation across 23 developed markets and 23 emerging markets countries. With 8603 constituents, the index is comprehensive, covering ~99% of the global equity investment opportunity set. For 2014, this index was up 4.16%.

Changing gears, let’s talk about bonds. Like equities, developed international exposure didn’t help much shown by the Barclays Global Agg Bond Index only posting a 0.59% return on the year. Here in the US, it unexpectedly turned out to be a decent year for bonds with the average taxable bond fund notching a 2.8% return. Long-term US Treasuries, which everyone was afraid of going into this year, did really well (+5.1% for the Barclays US Total Treasury Index) because interest rates went down instead of up as almost everyone was predicting. In fact, the yield on the 10-year Treasury Note started 2014 right at 3.0% and just dipped under 2.0% at the time of this writing! One should not expect a marked rise in US rates any time soon and the basic reason is a lack of inflation. Remember the days when we fought inflation?! Well, now it’s looking like central banks around the world need to worry about deflation. Case in point: the US has not been able to get to its 2% CPI inflation target, the biggest culprit being oil down over 50% from its June 2014 peak. New Fed Head Janet Yellen has laid the groundwork for the central bank to raise interest rates around midyear 2015, but she’ll need the economy to keep cooperating to do so.

Liquid Alternatives were a mixed bag this year. Real estate securities had a great year as most real estate related funds were up well over 10%. Managed Futures also were a bright spot with our fund of choice AQR Managed Futures, up over 9% for the year. If you were long-only commodities, it was a terrible year with energy down big with the oil drop. And some hedge fund type strategies that employ a very active approach had difficult times. For example, a manager betting on rising rates and increased inflation going into 2014, most definitely was a loser. Like any other actively managed investment, the liquid alternative managers need to be monitored closely. Again, alternatives are a prudent part of someone’s overall portfolio because of the extra diversification it brings to the table. For the record, the Credit Suisse Liquid Alts Beta Index was up 3.6%.

Turning the page to 2015, we can only truly count on one thing: increased volatility. Volatility has been very low the last few years and that most likely will change as this bull market which started in 2009 has created equity prices in the US that are above historical fundamental standards. And whereas the US economy is now on a roll – evidenced by the best hiring stretch since the 1990s boom, record auto sales, unemployment falling to 5.8%, job openings near a 13 year high, and the number of Americans working surpassing its prerecession high – there are also significant headlines our global economy still faces. Some of these concerns include China’s slowing growth, Europe’s flirtation with recession, Russian instability, a US labor force participation rate that is near the lowest since the 1970s, US wage growth which remains weak, and US part-time workers that want, but can’t find, full-time work.

We would also like to point out how there is a relation to inflation and returns. When inflation is higher, expected returns are higher and vice versa. Inflation has averaged over 4% per annum over the last 40 years, e.g. a “balanced” portfolio with a historical nominal return may be around 7.3%, but adjusted for inflation, the real return is actually 3.1%. We are in a hugely different inflation environment now where inflation is much lower, hence expected returns will also be lower. Our clients know first-hand that it is the real return that is they key and what it used for their planning scenarios.

In conclusion, now perhaps more than ever is a good time to be working with a wealth manager to keep you on track to reach your long-range goals and to prevent you from taking on unnecessary risk, like loading up in any one stock or investment style. Investing is like a marathon. You want to be well prepared, resilient, disciplined and focused in order to complete the long race. Sprinting, like short-term investing or investing in the latest fad, is really a different sport entirely, and for a lot of people, a way to quickly hurt themselves. Just as a marathoner in training benefits from a good running partner or coach, your long term results can be enhanced with the right financial advisor.

Here’s to an excellent 2015.