Ask DWM: What Does the Fed’s Decision Last Week Mean?

FED logoThat’s a very important and good question.

Last week the Federal Reserve decided to hold rates steady. The uncertainty as to when they will raise rates has been extended to at least October and, if not then, to December or beyond. A Fed rate hike has been in the air since March when the Fed removed the word “patient” from its press release, signaling it could increase rates for the first time in nine years. Rates were reduced to zero in 2008 during the financial crisis and haven’t moved since.

This uncertainty has made markets very skittish. After a January and February when all asset classes were up, March through July was flat overall. Since the week after July 4th, the S&P 500 has alternated between weekly declines and gains for 11 consecutive weeks. China’s devaluation of the yuan in August (see the DWM blog) and the related concerns about its growth and that of emerging markets, caused a 6-7% pullback in stocks in August.

As we have pointed out previously, investors hate uncertainty. It’s interesting though. History shows us that equities typically do well during the tightening cycle (raising of rates by the Fed) and a year after the initial rate rise. (This is based on results in seven different time periods from 1983 to 2004). Hence, the uncertainty may be more disruptive to the markets than the actual tightening (raising of rates).

It’s valuable to look at the Fed’s decision and related statements in greater detail. They did acknowledge the U.S. economy is expanding at a “moderate pace” with “solid job gains and declining unemployment.” There is concern, however, about global growth. China, which has been growing at double digits, is now expected to be 6.8%. And other emerging market countries are struggling, particularly those whose income comes from oil and commodities. A decade ago, China accounted for 9% of the world GDP, now it’s 16%. Emerging markets overall now account for 57% of world GDP, up from 46% in 2004. We’re all interconnected, so lower worldwide economic growth impacts business earnings and stock valuations.

The other key factor is that inflation has failed to reach the 2% Fed target the last three years. Furthermore, the Fed doesn’t expect it to get there until 2018. What the Fed is trying to do is gradually raise rates at just the right time(s) before inflation hits 2% such that there will be a nice “soft landing” near 2% without the economy heating up and pushing inflation up too much and too quickly. At the same time, if the Fed raises rates too quickly and causes the economy to cool down, inflation could decline or even move to deflation, which we want to avoid.

Based upon the statements from the Fed officials last week and other recent data, it appears likely we may have lower worldwide economic growth and low inflation for at least a few years. Plus we will need to continue to endure the uncertainty of when the Fed will raise rates. October? December? Next year? What does all of this likely mean for investment returns?

First, nominal investment returns are likely continue to be lower than historical values. Historically, since 1970, stocks have grown at an annual rate of almost 9% while inflation has been a little more than 4% per year. Hence, there has been a 5% real return earned by risking money and investing in stocks. For the same time period, bonds returned 6%, or a 2% real return.

Mathematically, therefore, if inflation is 2%, it is very likely that a diversified all-equity portfolio might earn 7% and returns on a diversified bond portfolio might be 4%. And, if economic growth is low or stagnant, that pushes valuations down and lowers returns as well.

Nominal returns for all of us are under pressure from three sources; low inflation, slowing global growth and Fed uncertainty. We can’t control any of those. What we need to do is focus on real returns, not nominal returns. And, we need to make sure our financial planning and investment return expectations for the next few years are based on lower inflation and lower nominal returns.

We’re happy to chat about this important topic at any time. Give us a call.

Fed_lady_cartoon

How Would You Rate Your Life?

happiness prosperity healthWe hope you had a wonderful holiday weekend. Perhaps some time with the family, a barbeque, some physical activity and maybe a great beverage or two. Labor Day is one of my favorite holidays. It marks the end of summer and start of fall, including kids returning to school and another season of college and NFL football games. It’s also a reflective time, when many people take a look at their life and review where they are and where they want to be.

A couple of weeks ago, the WSJ ran an article entitled, “On Gauging the Pursuit of Happiness.” It included the most recent edition of the World Happiness Report. The six most important metrics Gallup used to gauge happiness are GDP, life expectancy, generosity, social support, freedom and corruption. In addition, the researchers posed two questions. First, they asked people about their emotional experience the previous day- were they happy, angry, or stressed? Second, they asked respondents to rate their life as a whole on a scale of 0 to 10. How would you have responded?

The U.S., while #1 in overall GDP, is eighth in GDP per capita. Norway, Switzerland, Australia, Sweden, Denmark all are wealthier than us on a per person level. In terms of happiness, however, America ranked 15th, behind Switzerland, Iceland, Denmark, Norway, Canada, Finland, New Zealand and even Mexico. We performed well in GDP but weaker in the other variables.

Countries, including the U.S., are now starting to measure well-being. In 2011, the United Nations adopted a resolution encouraging member states to measure happiness and economic well-being. The U.K. systemically collects data on well-being. Our Labor Department Bureau of Labor Statistics has included well-being questions in its American Time Use Survey. And, lots more is happening at the local level.

Santa Monica, CA, won a $1 million award to develop a well-being project aimed at increasing trust and connectedness among residents. Apparently it is working- Santa Monica residents are even filling potholes these days.

Businesses are joining in as well. Certainly companies have for decades cited lofty mission statements as proof they are interested in more than just net income. And now, workers of all types are demanding more meaning from their careers as work simply takes too much of their time; with longer hours, more competitive pressures and IT “advancements” keeping them tethered to work 24/7. In many cases, employees are not looking for a job but, rather a higher calling. For them, it’s about the purpose, not the task.

For example, KPMG is trying to inspire its accountants with world-changing focus. “We see ourselves as cathedral builders, not bricklayers,” said Global Chairman John Veihmeyer. The company held a contest for its U.S. employees to share stories illustrating the higher impact of their jobs and it received 42,000 submissions. CEO Chris Loughlin of Travelzoo encourages his 400 employees, who help customers book low-cost travel worldwide, to look at their job this way: “if everyone traveled, there would be significantly more peace on earth.” Of course, not every worker believes that their company or their job is changing the world. According to Amy Wrzesniewski from the Yale School of Management, about 1/3 of individuals feel their job is a calling, while 2/3 are happy being a “cog rather than a cathedral builder.”

And, finally, we take a look at the great number of older Americans that are continuing to work. Average retirement ages are climbing and nearly 50% of baby boomers expect to work until 66 or beyond. Certainly, for many, it’s an economic necessity. However, driving the trend of not retiring are highly educated workers in professional-services jobs who are staying there by choice, rather than economic reasons. In some cases, they may continue working (either for pay or as a volunteer) because they believe they are changing the world. However, for most, it is their passion and commitment to stay involved, stay current and make a difference that brings them happiness.

For example, Jan Abushakrah, 69, typically works a 60-hour week as the chairwoman of the gerontology department at Portland Community College with no plans to retire. “I have pretty much purged the word from my vocabulary,” she says. “As long as I am happy and healthy every morning when I wake up and something exciting on my plate to look forward to, it is easy to say I could keep doing this forever.”

As we all start the fall, we hope that you, if asked, would rate your life and well-being (including happiness, health and prosperity) as a 10, or very near a 10. At DWM, our passion isn’t about changing the entire world, but rather helping each of our clients achieve their highest possible state of well-being. It’s our higher calling and passion 365 days a year. Here’s to you and your life and making it a 10.

Ask DWM: I’m Getting a New Vehicle. Should I Buy or Lease?

buy vs leaseThe answer really depends on what the effective rate is (lease vs purchase), how long you typically keep your car, and total miles you drive annually.

  • If you like to get a new car every 3 years or so, you should consider a lease.
  • If you prefer to keep your car a long time, then you probably should buy it.
  • If you put over 15,000 miles per year on your car, avoid a lease as there can be penalties for mileage beyond that. On the flipside if you drive very low miles, e.g. less than 7,500 miles per year, you most likely would be better off buying, as your vehicle would be worth more than the vehicle “residual value” at lease-end.

Beyond the generalities, you should also look at the buying effective interest rate and the leasing effective interest rate as they are not always the same. Many times car companies will offer incentives one way or another.

One of the most important tips is to have a figure in mind of what you want and what you want to pay before you go to the dealership. The automotive industry is so goofy with pricing – MSRP may be 5%+ more than what others are actually paying – so do your homework using Emdunds.com or some other car site where you can actually “build” the car to your liking and get the “true” price of that vehicle. Furthermore, there are still “bad guys” in that industry that cannot be trusted, so paying attention to detail is important or they’ll take more than their fair share from you. Don’t let them pull the “how much can you afford?” trick.

Next big tip is to negotiate your deal to buy the vehicle assuming you will be using cash for the purchase. Hopefully, the negotiated price is close to the “true” price identified in your research. Then, once you have established this number, have the dealer give you pricing if, instead, you lease the car or you finance the purchase. This will give you the information to determine the effective cost of financing or leasing or whether buying for cash may be best. Note: Do your own interest rate calculation or have us do it. Dealer stated rate can be deceptive and incorrect.

Other tips:

  1. It’s no myth that dealerships are pushing to get vehicles off their lot before month-end to make quota. That said, put your purchase or lease off until the end of the month. Furthermore, the winter months can be an excellent time to get into a new vehicle as the lease and purchase incentives on the previous year’s models can be very attractive.
  2. Certified, pre-driven vehicles usually are more bang for the buck. It is true that the minute you drive a NEW car off the lot, it depreciates significantly! With a certified, pre-driven vehicle, you aren’t paying the “new car premium”, but you are still getting a low mileage car which carries a nice warranty.
  3. Is the vehicle for business or personal use? For business use, a lease may be something to consider as the lease payments may be fully deductible. Purchasing the car won’t benefit you as much in this case as income tax rules typically provide only a small amount of annual depreciation for purchased vehicles.
  4. Go online and compare the pending lease or purchase. There are lots of sites out there to compare and analyze. We like Lease Guide.

Cheat sheetGetting a new vehicle is fun, but can also be a challenging process. Deciding whether to lease or purchase is just one of the hurdles. If you need any assistance during your process, please give us a call. We’re happy to help!