SC Business Review Interviews Les Detterbeck: “Consider Alternatives!”

Press Release:  Tomorrow morning, May 23, at 7:50 a.m. ET on NPR/WSCI Radio (89.3) Mike Switzer will conduct his SC Business Review.  I will be his guest. The 6 minute segment was taped three weeks ago. The topic is “Liquid Alternatives.”  Please tune-in if you can.

Mike Switzer:  Hello and welcome to SC Business Review.  This is Mike Switzer.  As stocks continue their long-term upward trend, many are concerned about what will happen to their portfolios when the bull market ends.  Today, we are talking with Les Detterbeck, a wealth manager with Detterbeck Wealth Management.  Les is one of the few professionals in the country who has attained a CPA certificate, is a CFA charter holder and a Certified Financial Planner professional.  Welcome, Les.

Les Detterbeck:  Good morning, Mike.  It’s a pleasure to be with you this morning.

MS:  Les, the markets keep going up.  What happens when the bull market ends?

LD:  Mike, of course, no one can predict the future.  We will have a pullback, correction or crash sometime in the future. We just don’t when and how much.  Right now, we’re in the midst of the second longest bull market in history- 8 yrs and counting.  There is still optimism about tax reform, deregulation and infrastructure additions boosting the economy and the markets.

MS:  Yes, Les, but what are some of the concerns?

LD:  Mike, there’s been a recent ramping up of potential global conflicts, there is significant political risk both here and abroad, and stock valuations are at an elevated level, just to name some of the major ones.

Let’s remember what happened in 2008 when the financial crisis turned a bull market to a bear.  Equities were down 40-50%.  Most investors lost a major part of their portfolio.  However, prepared investors stayed invested and only lost 5-8%.  And, they didn’t have to climb out of a big hole when markets reversed in March 2009.  Many of these investors who did well owe their results to alternative investments, designed to participate in up markets and protect in down markets.

MS:  Les, what do you mean by an alternative?

LD:  Basically, these are not traditional equity or fixed income investments.  Alternatives provide diversification and therefore reduce risk and volatility.  They are not correlated to the equity market and therefore can provide a return even when stocks are not doing well.  For those investors whose primary focus is protection and secondary is growth, alternatives are a great addition to a portfolio.

MS:  Could you give us some examples?

LD:  Certainly.  Gold and real estate are alternatives.  They are not part of the traditional asset class of equities or fixed income.  Other examples are non-traditional strategies, such as market-neutral funds, arbitrage funds, and managed futures funds.  All designed to perform in both up and down markets.  New alternatives come to the marketplace regularly.  Recently we have reviewed and added to our client portfolios alternative assets investing in the global reinsurance industry and online consumer lending.

MS:  Les, tell us why and how alternatives work?

LD:  First, they provide increased diversification.  We all have heard “don’t put all your eggs in one basket.”  Second, lower correlation.  They don’t perform in lock step with stocks.  Harry Markowitz won a Nobel Prize by showing that combining assets which do not exhibit a high correlation with one another gives investors an opportunity to reduce risk without sacrificing return.  Studies, including those by the CFA, show that inclusion of at least 15% of alternatives can reduce the volatility and increase the returns of portfolios.  As a result, clients can get comfortable with their allocation and stay fully invested.  No need to try to time the markets-which is a loser’s game.

MS:  How did you get into alternatives and how are they used?

LD:  My son Brett and I started our business in 2000, the year of the dot.com bubble burst.  Stocks lost 15% and our clients did slightly better than that.  We didn’t take any solace in beating the S&P 500- our clients had lost money.  In 2001, the stock markets were again down and again, our clients lost money.  We realized we needed to find an answer- how do we protect our clients’ money and grow it as well?

We researched, reviewed and investigated everything we could find on alternatives. And, bought them ourselves so we could “test drive” them.  In early 2008, at a time somewhat like now, when valuations were high and there were concerns that the bull market might be ending, we knew it was time to prepare our clients for the end of the bull market.

We compiled and issued a report to them in January 2008 entitled “The Bubble Bust” which outlined our concerns about the coming end of the bull market and how alternatives could protect their portfolio.  We met with our clients and, in general, reduced equity allocations and substituted alternatives.  When the crisis came that fall, our clients were prepared.  Their overall portfolio losses were minimized.   Today, virtually all of our clients use three assets classes; equities, fixed income and alternatives.  Asset allocations vary by client and alternatives compose 15%-40% of a typical client portfolio.

MS:  Any final thoughts, Les?

LD:  If your focus is on protecting and growing your portfolio, consider adding liquid alternatives; designed to participate in up markets and protect in down markets.  In times like this, they can really reduce risk, increase returns and provide great peace of mind.

MS:  Les, thank you so much for visiting us today.  We hope you will join us again.

LD:  Mike, I will look forward to that.

Ask DWM: “Please Explain how Investment Returns are Calculated”

Excellent question from a valued client and an extremely important one.  You need to know how your investments are performing.  Are you on track to meet your goals?  Are any changes needed?

To start, focus on your “total return.” In simplest terms, this is the total increase in your portfolio for the period. Let’s say you had $100,000 in one account at the beginning of the year and you didn’t add money or subtract any money during the year. At the end of the year, this account has grown to $111,820.  Your total return is $11,820 ($111,820 ending value minus $100,000 beginning value).  This is an 11.82% total return ($11,820 divided by $100,000).

Next, let’s drill down a little further.   The total return is composed primarily of two parts; the change in market value during the period plus dividends and/or interest earned.  Let’s assume, for simplicity sake, that this $100,000 portfolio only had one investment on January 1, 2016 and it was invested entirely in the Schwab S&P 500 Index Fund (SWPPX).  Those shares were valued at $31.56 per share at the beginning of that year- 3,168 shares with a total value of $100,000 (3,168 times $31.56).   Here is what actually happened with those shares in 2016:  Their value went up to $34.42. The $2.86 per share increase ($34.42-$31.56) amounted to a $9,062 increase in value.  And, in December, dividends were paid totaling 87 cents per share, a total of $2,758.  So, the account increased by a total of $11,820, of which there was a $9,062 price increase (9.1%) and a $2,758 (2.7%) dividend return.  Overall, an 11.82% total return for 2016.

Dividends and interest are the income received for holding the security and are called the “yield.”   Some investors focus on a high yield and ignore the potential impact of market increases or decreases.  We believe that is a mistake.  Historically, there are times, such as periods of low inflation, when dividend-paying stocks have outperformed.   And, there are times, such as the 1990s, when tech stocks with limited earnings and no dividends outpaced dividend payers by nearly 5% per annum.  Focus on total return (and, of course, diversification).

Now, let’s look at the situation where money is added or subtracted from the investment portfolio during the year.  When this happens, the performance results are generally calculated and shown as “time-weighted returns” which eliminates the impact of money coming in or going out and focuses on daily returns. Our DWM/Orion reporting system calculates the daily return for each holding and multiplies the daily returns geometrically to determine the time-weighted return.

The DWM/Orion reports show gross total returns for all holdings and asset classes and deduct management fees in calculating the time-weighted return.  Furthermore, reports covering a period of less than a year are not annualized.  For example, if the time-weighted return for the first three months is 2%, the report shows 2% and does not annualize that number (assuming the next three quarters will be similar results) and show an 8% annualized return.  However, on reports covering a period of more than one year, the overall results are reduced to annual amounts.  For example, if a performance report covering a three-year period shows a time-weighted return of 6%, then the overall return for that total period is approximately 18%.

The CFA Institute, the global association of vetted investment professionals, including Brett and me, which sets the standard for professional excellence and integrity identifies clear, trustworthy investment reporting as the most valuable tool for communicating investment information.  Early on, we at DWM determined that we and our clients needed a robust reporting system to calculate, help monitor and report on your investments.  Schwab as custodian provides regular statements for each account showing balances and activity during a given period. However, the statements don’t show performance vs. benchmarks on a percentage basis.  It also only shows one account at a time. Our DWM/Orion reporting system can show you performance at various levels: asset, asset class, account and household for a more complete, holistic review.

In today’s world, when there is so much data and so much news and much is either fake or biased, it’s important to know that your investment returns with DWM are calculated in an objective basis and compared to benchmarks for any time period.  This allows proper monitoring and facilitates modifications, when needed.

Thanks again for the question and let us know if there are any follow-up questions.

Let’s Make Taxes Simpler and Fairer!

Last Wednesday, President Trump’s one-page Tax Reform Proposal was released.  We expect the Administration will soon discover that Tax Reform is similar to Health Care Reform.  President Trump’s February 27th “epiphany” concerning Obamacare was expressed this way:  “Nobody knew that healthcare could be so complicated.”

Tax Reform isn’t simple either.  The last major Tax Reform was in 1986 and it took years of bipartisan effort to get it done.  In 1983, Richard Gephardt of Missouri and Bill Bradley of NJ introduced a tax reform bill to cut rates and close loopholes.  The proposal was predictably attacked by special interest groups and didn’t gain much traction.

In 1985, President Reagan met with a bipartisan group of senators to push forward revenue-neutral tax reform. Four key principles were established:

  • Equity, so that equal incomes paid equal taxes
  • Efficiency, to let the market allocate resources more freely
  • Simplicity, to reduce loopholes, and
  • Fairness, to ensure those who have more income pay more tax

Dan Rostenkowski, Democratic chairman of the House Ways and Means committee and Bob Packwood, Republican chairman of the Senate Finance Committee were tasked with getting the bill passed.  It wasn’t easy.  Ultimately, many loopholes and “tax shelters” were eliminated, labor and capital were taxed at the same rate, low-income Americans got a big tax cut, corporations were treated more equally, and the wealthy ended up paying a higher share of the total income tax revenue.  In the end, the bipartisan 1986 Tax Reform Act, according to Bill Bradley, “upheld the general interest over the special interests, showing that clear principles, legislative skill and persistence could change a fundamentally unfair system.”

The current Tax Reform proposal is, of course, only an opening wish list, but it has a long way to go.  The current proposal would basically give the richest Americans a huge tax break and increase the federal debt by an estimated $3 trillion to $7 trillion over the next decade.  As an example, it would eliminate the Alternative Minimum Tax, which would have saved Donald Trump $31 million in tax on his 2005 income tax return (the only one Americans have seen). Furthermore, there’s lots of work to be done on corporate/business rates, currently proposed to be revised to 15% (from a current top rate of 40%).  Workers of all kinds would want to become LLCs and pay 15%.

U.S. Treasury Secretary Steven Mnuchin at the time of presenting the proposal last week stated that the Administration believes the proposal is “revenue-neutral.”  The idea is that tax cuts will produce more jobs and economic growth and therefore produce more tax revenue.  We’d heard estimates that real GDP, which was .7% on an annual basis in 1Q17 and 2% for the last number of years, would grow to 3-5% under the current tax proposal.  However, there is no empirical evidence to show that tax cuts cause growth and, in fact, can result in severe economic problems.  The latest disastrous example was the state of Kansas.  The huge tax cuts championed by Governor Sam Brownback in 2012 haven’t worked.  Kansas has been mired in a perpetual budget crisis since the package was passed, forcing reduced spending in areas such as education and resulting in the downgrading of Kansas’ credit rating.

Furthermore, we’ve got some additional issues that weren’t there for President Reagan and the others in 1986.  First, our current federal debt level is 80% of GDP.  It was only 25% in 1986.  Adding another 25% or 30% of debt, to what we have now, could be a real tipping point for American economic stability going forward. Second, the demographics are so much different.  Thirty years ago, the baby boomers were in their 30s and entering their peak consuming and earning years.

Tax Reform is needed and can be done.  It’s going to take a lot of work and bipartisan support.  It was great to see Congressional leaders reach a bipartisan agreement on Sunday to fund the government through September, without sharp cuts to domestic programs, an increase in funding for medical research, and not a penny for Trump’s border wall.  On Monday, Republican Charlie Dent (PA) and Democrat Jim Hines (CT) put together a great op-ed in the Washington Post calling for compromise and cooperation.  It concluded:  “Ideological purity is a recipe for continued bitterness. …Failure to seek commonality or accept incremental progress will threaten more than our congressional seats and reputations.  It puts our systems of government at risk.  We owe it to our country to do better.”

Hear! Hear!  Yes, let’s make the tax system fairer.  Let’s do tax reform correctly- the way they did it in 1986- putting our country’s interests ahead of personal or special interests.