“American Spirit and Values”

David McCullough, Pulitzer Prize winning historian has a new book.  “The American Spirit,” is a compilation of speeches Mr. McCullough has made over the last 25 years.  His hope is to “remind us, in this time of uncertainty and contention, of just who we are and what we stand for, of the high aspirations of our founders and of our enduring values.”   Our country has always stood for opportunity, vitality and creative energy, fundamental decency, insistence on truth, and good-heartedness to one another.

However, much of what we read in the papers these days belies our American values.  Today, let’s look at two key areas- corporate America and Washington- that require substantial improvement.

First, let’s talk about today’s problem of big business focusing solely on “maximizing shareholder value.”  The result has been an almost Dickens-like atmosphere for consumers and employees. Turning airplanes into cattle cars is a good example.  We all saw the United passenger dragged off the flight in April.  United used to have a bonus program for executives based on on-time arrivals, consumer satisfaction and profit.  It doesn’t now- it’s only based on pretax income and cost savings.  Same thing for American Airlines.  After years in Chapter 11, AAL came out of bankruptcy by merging with US Airways in 2013.  Earlier this year, after finally making a profit, management awarded its long underpaid flight attendants and pilots with a raise to bring them to industry levels of compensation. Wall Street “freaked out” that some potential shareholders earnings were being diverted and AAL’s stock price tanked.

Wal-Mart doesn’t want that to happen to them. Seven Walton family members (with a net worth of $130 billion) own ½ of WMT.  In 2015, WMT made $14.7 billion and shareholders got $10.4 billion in dividends and stock repurchases. WMT’s “low, low prices” are in part made possible by low, low wages for its 1.5 million employees. Many full-time WMT employees live in poverty, without enough money to pay for an apartment, buy food, or get basic health care. And, each year, we taxpayers pay $153 billion to pay for food stamps and other welfare programs for low paid employees, with WMT employees receiving about $7 billion of it.  WMT’s CEO made $21.8 million last year. The median annual pay for CEOs of the S&P 500 companies is now $11.7 million.

The real issue with low wages is the impact on the overall economy.  One company’s workers are another company’s customers.  Profitable companies could pay workers more and shareholders less, leading to more spending on products and services from other companies. This is turn could increase the revenue and profits of the overall economy.  Treating employees more fairly, giving them more opportunity and training is good for America and the economic growth and happiness of our country.  Focusing on making super products and providing excellent customer service are great.   Those aspects of capitalism are good for American.  The greed and selfishness parts are not.

Which brings us to Washington.  In less than five months, President Trump has transformed us from leaders of the free world to whiny bullies.  He pulled us out of the Trans-Pacific Partnership, refused to reaffirm the mutual defense commitment to NATO and abandoned the voluntary Paris climate accord.  Here’s how Mr. Trump’s national security adviser, Lt. Gen. H.R. McMaster described the President’s world view:  “The world is not a ‘global community’ but an arena where nations, nongovernmental actors and businesses engage and compete for advantage.”

Really?  Is it all about self-interest? What happened to the more cooperative, rules-based vision that motivated America and its allies since WWII?  Our leadership was good for the world and has been good for our country.  A world of cutthroat competition and zero-sum outcomes is not.

On the domestic side, the House passed the Financial Choice Act (FCA) last week.  Very disappointing.   This legislation would replace the post 2008 financial crisis Dodd-Frank regulations, designed to protect Americans.   FCA would repeal the “Volker Rule,” which restricts banks from certain types of trading, and would strip the Consumer Financial Protection Bureau of its power to write rules and supervise investment firms (particularly regarding deceptive practices and consumer complaints.)  This, like the Health Care Choice Act and proposed tax reform, is just another Congressional attempt to give Wall Street and the top 1% unfair advantages so they can keep making more money at the expense of most Americans.

History can be a strength and an inspiration- it reminds us who we are and what we stand for.  Certainly, let’s make America Great, but let’s do it the right way- working together and providing opportunities for all 321 million Americans to reach their full potential. Let’s move away from the toxic polarization, greed and selfishness we see every day and get back to the high aspirations of our founders; cooperation, vitality, energy, basic truth and decency.  And, yes, let’s “Make Our Planet Great Again” and work with almost 200 countries worldwide to mitigate global warming.  We 7.5 billion citizens of the world are all in this together, hopefully for centuries and centuries to come.  Finally, let’s remember and promote our American Spirit and Values.

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.

Computers and Technology- A Current Potpourri

Gary Kasparov

Gary Kasparov has always interested me.  Born in the Soviet Union, he was a world champion chess player from 1985-2005.  He has long been a vocal activist opposing Putin’s policies. Today Mr. Kasparov is the chairman of the Human Rights Foundation in NY.  But perhaps he is best remembered for what happened on May 11, 1997.  That day he “resigned” and became the first world chess champion to be beaten by a machine-IBM’s Deep Blue.

Newsweek’s cover article the next week called the match “The Brain’s Last Stand.”  As no surprise, Mr. Kasparov hated losing, but over the last twenty years, after learning more, he became convinced that we need to stop “seeing intelligent machines as our rivals.”  They are not a threat, but help provide great opportunities to extend our capabilities and improve our lives.

While most of us won’t face head-to-head competition with a computer the way Mr. Kasparov did, many Americans will be challenged, surpassed and replaced by automation.  Every profession will eventually feel the pressure and that’s what we should expect as humanity makes progress.  We shouldn’t fight it.  Here’s Mr. Kasparov’s analogy: “Waxing nostalgic about jobs lost to technology is little better than complaining that antibiotics put too many gravediggers out of work.”

The human vs. machine narrative was a major topic during the Industrial Revolution.  In the 60s and 70s, robots starting replacing union workers and then in the 80s and 90s the information revolution eliminated millions of jobs in the service and support industries.  There is no going back.

Learning to Think Like a Computer

President Obama’s “Computer Science for All” initiative was launched in 2016 and focuses on expanding computer science knowledge by learning how to code.  Kindergarten students are now learning using wooden blocks.  The blocks have bar codes with the instructions such as “forward,” “spin” and “shake” that are used to program robots.  By sequencing the blocks and having the robot scan in information, the children are directing the actions of the robot.  Studies show that after the kids have learned to program the robots, they become better at sequencing picture stories, or even listing the steps required to brush their teeth.

The job market is hungry for coders.  Since 2011, computer science majors have doubled. At Stanford, Tufts and Princeton, it’s the most popular major.  And, even non-majors are cramming into computer science classes.  Learning to think like a computer can help all of us in our daily lives. In addition, the digital age has brought us great access to information.

Steve Ballmer’s Treasure Chest of Real Data

You may remember Steve Ballmer as Bill Gates’s right hand man and CEO at Microsoft from 2000-2014. Or as the high bidder ($2 billion) of the LA Clippers basketball team in 2014.   A few years ago, he started a website, USAFacts.org designed to answer in detail the question:  “What does government do with all the money we taxpayers send it?”  He wanted to create a fully integrated look at revenue and spending across federal, state and local governments.  The site, USAFacts.org, went live yesterday.

In an age of fake news and accusations about manipulating data to fit biases, Mr. Ballmer’s website is a welcome resource. Certainly, people can come to different opinions on the same subject, but shouldn’t they at least start with the same believable common data?  USAFacts.org was designed to do that.

There is lots of interesting data from 70 government sources.  Want to know how much revenue is brought in from parking tickets?  And what percentage of Americans suffer from depression? It’s there. Here’s a good one: how many people do you think work for government in the U.S.?  Remember, this includes those in education, the military, law enforcement, government hospitals, etc.  Answer: 24 million.  Take a look.  You’ll like it.

Think Like a 94-year Old

Lastly, many over the age of 70 think that they were born too late to be part of the computer/tech revolution.  Someone forgot to tell that to 94-year-old John Goodenough.  Mr. Goodenough’s team at the University of Texas has just filed a patent application for a new battery that would be so cheap, lightweight, and safe it would revolutionize electric cars and put an end to petroleum-fueled vehicles.  This is not Mr. Goodenough’s first major patent. In 1980, at age 57, he co-invented the tiny lithium-ion battery.

As a society, we often tend to assume creativity declines with age.  Yet, some people actually become more creative as they grow older.  In the U.S., the highest-value patents often come from inventors over the age of 55.  Mr. Goodenough figures it this way: “You have to draw on a fair amount of experience in order to put ideas together.”  He also said that his old age gave him intellectual freedom.  At 94, he said, “You no longer worry about keeping your job.”

Conclusion

For those of us of all ages, computers and technology should be our friends, not our enemies.  With the information it provides and our continued learning and lifetime experiences, hopefully we will all benefit from the great digital age in which we live.  Here at DWM, we embrace technology and strive to make our processes as automated, robust and efficient as possible.  However, we recognize that some of the most important aspects of our work are accomplished through personal interactions with our clients and friends.  Don’t worry-we have no plans to have one of Deep Blue’s cousins doing that favorite part of our job for us.

Your Choice- $1 Million or $5,000 per Month for Life?

Most of our readers will likely have to make that type of decision someday.  From our perspective, it’s a pretty easy answer.  As Cuba Gooding, Jr. famously told Tom Cruise in “Jerry Maguire”:  “Show me the money!!”

Yet, an article in the WSJ on Monday tried to make the decision sound really tough, with losers on both sides.  It would have you believe that many will suffer from either an “illusion of poverty” or an “illusion of wealth” and are likely going to experience a disappointing retirement.  Really?

Researcher Daniel Goodwin at Microsoft Research asked people how adequate they would feel if they have $1 million at the time they retired.  He used a seven-point system with one being “totally inadequate” and seven being “totally adequate.”  Then, he asked them to rate instead an income each month in retirement of $5,000.

In theory, the choices are similar based on pricing of annuities. If a 65 year old paid $1 million for a “single premium immediate annuity” they could receive payments of $5,000 each month for their life.  Actuarially, a 65 year-old is expected to live 18-20 years.  So, 19 years of monthly payments of $5,000 would be $1,140,000 and represent a 1.4% annual return on the investment.

Yet, believe it or not, many people, feel that $5,000 per month is more adequate than the $1 million lump sum.  Mr. Goldstein says that this group suffers from the “illusion of poverty.”  Apparently, these folks are “inclined to think about wealth in terms of monthly income” and don’t want the “burden” of a lump sum which could run out someday.  Hence, they dial down their expenses, eliminate any wants or wishes and make do on their $5,000 per month.

Mr. Goldstein then suggests that I and most people may suffer from the “illusion of wealth.”  He thinks that those selecting the lump sum, through a false sense of security, may spend too much and run out of money. In fact, the larger the lump sum, the more likely the “extra millions will lose their meaning.”  Really?  Do we all suffer from illusions, as Mr. Goldstein suggests?  Are we all on the road to an unsuccessful retirement regardless of our choices?  It certainly doesn’t have to be that way.

Perhaps I should contact Mr. Goldstein and invite him (and his wife) to go through the DWM Boot Camp.  First, we’d sit down and help them with their goal setting. We’d help them identify their needs, wants and wishes.  We’d look at their assets, health care costs, income taxes, expected inflation and investment returns, and insurance and estate matters.  Ultimately, we’d help them design a financial plan.

If Mr. Goldstein was under an “illusion of poverty,” we’d show him that his $5,000 per month program is a poor choice.  To begin with, his $5,000 per month would lose its purchasing power each month due to inflation.  With 3% inflation, after 15 years of retirement, his $5,000 would only buy $3,200 worth of goods in today’s dollars.  Second, if he did a “personal annuity” by simply taking the lump sum, investing it, earning 6%, e.g., and withdrawing the $5,000 per month, his family would still have the $1 million in principal when he passed away.  No need for an illusion of poverty here.

On the other hand, if Mr. Goldstein was under an “illusion of wealth”, the plan would help him identify his needs, wants and wishes and would have helped evaluate whether those potential expenses were affordable based upon his assets, expected investment returns and the other metrics.  We would have created numerous scenarios to ultimately result in a plan that was successful.  The plan would be stress tested for items that could negatively impact that plan and monitored and modified over time.  In short, the plan would not suffer from an illusion of poverty nor of wealth.

We’re glad contributors Shlomo Benartzi and Hal Hershfield ran the article Monday focusing on Mr. Goldstein’s findings. Retirement/financial independence planning is extremely important.   However, we don’t agree that it has to be a dire situation with poor choices, lots of suffering and disappointments.   It’s simple: take the lump sum and put together your realistic plan with a fee-only adviser like DWM and then have us help you monitor it for the changes that will undoubtedly occur in the future. You’ve worked hard for your money, the time will come to enjoy it. As Ginny’s blog http://www.dwmgmt.com/blogs/82-2017-02-07-23-30-00.html pointed out a few weeks ago, retirement/financial independence should be a time for “jubilation” not illusions or disappointments.  Proper planning with the right team can make that happen.

What’s Ahead for the Global Economy and Financial Markets?

Last week, the Federal Reserve raised rates- the third increase since the financial crisis.  Yet, despite world economic growth and the stock markets surging since President Trump’s election (until yesterday), the Fed is still cautious about the future.

The world economy has been picking up.  The Economist reported last week that “today, almost ten years after the most severe financial crisis since the Depression, a broad-based economic upswing is at last underway.”  This is a big change from the early months of 2016 when stocks were down 10% or more due in part to anxiety about China’s economy and related plunging raw material prices.  Fortunately, China, through controls and stimuli, turned things around and by the end of 2016, China’s nominal GDP was growing again.

At the same time, global manufacturing has gotten stronger.  Factories are much busier in the U.S., Europe and Asia.  Taiwan and South Korea are rocking.  Worldwide equipment spending is up; growing at an estimated annualized rate of 5.5% in 4Q16.  American companies, excluding farms, added 235,000 workers in February.  The European Commission’s economic-sentiment index is at its highest since 2011.  Japan, whose growth has been anemic, has revised their 2017 forecast from 1% to 1.4%.

The stock markets have, until yesterday, risen dramatically based on both current economic growth stats and expectations about the future.  With Mr. Trump’s election, there has been hope that taxes and regulations will be reduced which would help businesses and increase corporate profits.  Further, the expected return of $1 trillion of untaxed cash held overseas by American companies could be coming back (repatriated) at new low tax rates.  These funds could produce a big boom in business investment.  And, then add to this the possibility of a $1 trillion private-public infrastructure push for America. Mr. Trump has been talking about growth of 3.5-4%.  There’s been lots of optimism.

Yet, Fed officials forecast growth of only 2.1% this year; about where it has been for 8 years.  So, what’s their cause for relative skepticism?

The list of concerns includes fears about protectionism stifling trade, political disruption in Europe, China’s ability to sustain strong growth, and closer to home, whether or not the White House and Congress can work together to get legislation passed.  If the repeal of Obamacare gets sidetracked, there is concern that tax reform and infrastructure will endure the same fate.  And, of course, we haven’t even talked about a black swan- an unexpected event of large magnitude and consequence.  All bets are off in the case of major problems such as war, terrorism or some other major catastrophe.

We could be on the precipice of a new era with the cutting of taxes and regulations and a huge infrastructure boom creating a turbocharged economy.   Or, we could have a repeat of the many times in the past decade when optimism at the start of the year faded as the year progressed.  No one knows what the future holds.

Yesterday’s stock market declines of roughly 1% were, in large part, a concern about the ability of the White House and Congress to enact their legislative agenda, starting with the repeal of Obamacare.  People are nervous that if the health-care bill doesn’t pass or gets delayed, what will that mean for other policies.    Tax cuts could be delayed and even face a tougher fight in Congress.  Treasury Secretary Steven Mnuchin had earlier thought that tax reform would pass Congress by August and now he is hoping for early next year.  And, infrastructure would come after that.

With all of that in mind, the Fed understandably is cautious and we at DWM are as well.

The F-Word (Fiduciary) is Becoming the Antidote

Fiduciary: n. from the Latin fiducia, meaning “trust.”  For Registered Investment Advisers, the legal obligation to always put their clients’ interest first and be proactive in disclosure of any potential conflicts of interest.

Contrast that with a commissioned salesperson.

When you buy a car you know that the salesperson is going to earn a commission.  You know the salesman is there to sell you a car at the highest price you’ll accept and then try to get you to sign up for extras.  It’s your job to do your homework beforehand; know what you need and can afford, and then fight for the best deal you can.  Caveat emptor– buyer beware.

Unfortunately, in the arena of financial services it’s also caveat emptor.  You may think that the commissioned salesperson is there to help you.    They may call themselves “financial consultant,” financial advisor,” or “financial planner,” and may have a business card with some interesting initials or designation as a V.P.  Regardless, if they are paid commission, they are generally focused on selling you products that are best for them and their employer, not you.  There is a fundamental conflict of interest that works against you.  Often the highest commissioned products include large upfront and/or ongoing fees to recoup the big commissions.  The future performance of your investments is diminished dollar for dollar for these excessive fees.

In the 1980s and 1990s, when economic growth and higher inflation pushed equity returns into annual double digit returns, high fees might have been overlooked.  But, when today’s lower growth and inflation produce lower returns, a 1% annual difference in fees, for example, makes a huge difference. Fortunately, astute investors have been moving away from high-cost, conflicted advice and toward low-cost investment advice and total wealth management where the adviser acts in their best interests.  Members of National Association of Personal Financial Advisors (NAPFA), such as DWM, have seen major upticks in business and are helping more and more families reach their financial goals.  NAPFA is the country’s leading professional organization of Fee-Only financial advisors.  Its members sign the NAPFA Fiduciary Oath legally requiring all of us to always put your interests first and disclose any potential conflicts of interest.  See the oath: http://www.napfa.org/consumer/NAPFAFiduciaryOath.asp

Not surprisingly, the big banks and brokerages have tried to limit their continuing losses of business by trying to confuse the issue.   Most have set up a part of their business as “fee-only” and describe their total offering as “fee-based.”  Caveat emptor– “fee based” means the big banks and brokers charge you a fee to begin with and then get commissions on top of that for products they can sell you.

Last summer, the Department of Labor (“DOL”), which is responsible for safeguarding employees, issued a ruling that as of April 1, 2017 all investment professionals who work with retirement plans or provide retirement planning advice would be legally bound to act as fiduciaries, putting the clients’ interests first. This rule would impact trillions of employee retirement dollars and likely save participants billions annually in fees. As expected, Wall Street and the related lobbyists have attacked the ruling.  Their complaint is threefold: 1) it would limit choices to participants (yes, it would reduce many of the toxic overpriced funds currently used), 2) trigger dislocations in the retirement services industry (yes, like modifying the behavior of the bad guys or eliminating them), and 3) causing increased costs for consumers (no, it wouldn’t- this is simply an “alternative fact.”).  Last week, as expected, President Trump issued a presidential memorandum to direct the Labor secretary to begin a new rulemaking process to modify the DOL rule.  Of course, NAPFA, the Financial Planning Association (FPA) and the CFP Board all applaud the new rule and are working diligently to put it in place, keep it there and expand it.  We do too.

We support sensible regulation to protect consumers in the area of financial advice and the requirement of fiduciary responsibility to be in place for all investments.  It is estimated that the shifting of $5 trillion of investments from high-cost, ineffective products to low-cost products could save consumers $50 billion per year, transferring those excess commissions and fees from Wall Street, big banks and brokers to your pocket.

Here’s the best part:  Neither Washington nor Wall Street can stop the movement. The DOL fiduciary rule is not shaping investor behavior, it is simply catching up with it.  Vanguard, the industry leader in low-cost indexing, had $1 trillion in assets before the financial crisis, now it has $4 trillion.  Total Wealth Management firms like DWM, which provide both independent investment advisory services and value-added financial services on a fee-only, fiduciary basis, are working with more and more families.

Consumers know what’s best for them- fee-only fiduciaries who put their interests first. They are voting with their feet and their money away from the old toxic models of the big banks and brokers.  The F-Word (Fiduciary) is becoming the antidote to the sale of commissioned financial products.

Warning: Alternative Facts May be Hazardous to your Portfolio Returns

Alternative facts may work sometimes in business and politics, but they don’t work with investments.  Returns are based on reality, which can be complicated, random and uncertain.

30 years ago, in his book, “The Art of the Deal,” Mr. Trump extolled the virtues of “truthful hyperbole” which he described as “an innocent form of hyperbole-and a very effective form of promotion.”  In interviews over the years, Mr. Trump has inflated everything from the size of his speaking fees to the cost of his golf club memberships to the number of units he had sold in his new Trump buildings.   His decades of habitually inflating claims about his business acumen and his wealth have helped produce lucrative licensing deals for the Trump brand around the world.

It is no surprise that President Trump has continued his pattern in his first days in office.  He has made inflated claims about how many people attended his inauguration, his insistence (contradicted by his own Twitter posts) that he had not feuded with the intelligence community, or his claim that Hillary Clinton won the popular vote only because millions of people voted for her illegally.  No worries. Trump adviser Kellyanne Conway simply refers to these as “alternative facts.”  Others might call these falsehoods, some would call them lies.  Regardless, they are part of the “post-truth” era in politics.  Very disturbing but apparently part of the current political landscape. Overall, it reminds some people of George Orwell’s “1984” in which the Ministry of Truth had three slogans:  “War is peace.  Freedom is slavery.  Ignorance is strength.” Yes, very scary.

Even so, in business and politics, alternative facts may be effective.  Voters live in their own bubbles of perception and confirmation bias.  Once they lock in on a candidate, it’s tough to change their minds regardless of subsequent facts.  It’s true- all of us have patterns of irrationality.   We all get lead astray.  This is described brilliantly in Michael Lewis’s new bestseller, “The Undoing Project.”  We can become victimized by the “halo effect” in which our thinking about one positive attribute causes us to perceive other strengths that aren’t really there.  Another is “representativeness” which leads us to see cause and effect when we should accept uncertainty or randomness.  Mr. Lewis showed how pioneer behavioral economists Daniel Kahneman and Amos Tversky demonstrated that all of us misanalyse all sorts of situations, in business, politics, and everyday life.  We accept alternative facts rather than true reality.

Investors can lose lots of money when their beliefs diverge from the reality and they are led by alternative facts and subjective reality.  They believe they understand major issues; such as how tax reform might impact corporate earnings, the odds for a recession, and repatriation of overseas capital.  The real problem is their absolute certainty in areas which are, in reality, uncertain or random.  (The U.S. election results and the markets’ behavior thereafter is a great example).

The subjective reality investor imagines they can understand complex issues and predict what the marketplace will do and even how specific sectors and individual securities will perform.  They exhibit “representativeness,” believing they understand the cause and effect, when it fact they should accept uncertainty or randomness.  Subjective reality investors often believe they know how to “time the market” which has been shown to be a losing strategy over and over again.  Even full-time mutual fund “active” managers consistently underperform benchmarks over time.  Using alternative facts and subjective reality, these subjective reality investors put their (and others) capital at far more risk than they should.  Sometimes they get lucky, most often they don’t.

What really gets these subjective reality investors in trouble is the difference between fact and opinion and falling prey to overconfidence.  No one knows the future.  None of us can possibly comprehend all the forces at work every day and how these continually change.  Each of us has our own baggage we bring to our decision-making every day that turns facts into opinions and often truth into alternative facts.

At DWM, we always say, focus on what you can control and respect what you can’t.  Establish a diversified portfolio with an asset allocation commensurate with your risk profile.  Keep costs low.  Stay tax efficient.  Stay invested.  Stay disciplined.  Monitor results and rebalance as necessary.  Don’t try to time the market.  Don’t think you’ve found the “silver bullet.”  Don’t kid yourself-your subjective beliefs and alternative facts can be hazardous to your portfolio returns.

Winning the Super Bowl and Achieving Long-Term Financial Success

Clemson and Alabama know it.  The Super Bowl contenders-Patriots, Steelers, Falcons and Packers- know it.  There are many factors and lots of hard work that contribute to success.  You need consistent, effective blocking and tackling.  You need excellent offense, defense and special teams.  You need a super game plan.  And, you need to be able to make modifications as conditions change.  It’s the same thing with achieving your long-term financial goals. This “elephant” needs to be eaten in “smaller bites.”  Wealth management requires attention to the key building blocks, a disciplined process and likely an accountability buddy and coach to be successful.

Here are the main building blocks to achieving your long-term financial goals:

  • Goals– establishing the financial and personal goals for your lifetime and your legacy; separate them into needs, wants and wishes.
  • Financial Plan– developing the road map for your future; showing how you get from point A to point B and accomplish all of your goals.
  • Investments– identifying your investment objectives, constraints, risk tolerance, asset allocation, and rebalancing and other procedures to protect and grow your assets.
  • Income Taxes– determining strategies to minimize your income taxes and make sure your investments and financial planning strategies are tax efficient.
  • Insurance/Risk Management- making sure your coverage is appropriate (like Goldilocks, “not too much and not too little”) and the premiums are as low as possible.
  • Estate Planning- ensuring that your estate will be distributed in the manner you wish, that you pay the least amount of estate tax and that estate administration is inexpensive and hassle-free.

At DWM, we review these key areas with new clients using our DWM “Boot Camp” process.  This is a series of four to six meetings, typically over a 4-12 week period.  For you ex-athletes, our clients tell us these meetings are like “two a day” practices:  “It feels great when they are over.”

Next is monitoring.  Again, you need a process.  In today’s world, “set it and forget it” just doesn’t work.

On a daily basis, you need to track activity in your investment accounts.  You need to keep up to date with the news, the investment environment and the financial information that could be impacting you and your goals.  At least monthly, you need to review investment performance by asset class and compare to benchmarks.  On a quarterly basis, you need to review your investment portfolio for performance and asset allocation.

You should review your financial and personal goals at least a couple of times per year and update your financial plan.  You should review your prior year income tax returns in May, determine what new strategies might apply for the current year and obtain a current year projection.  You should review and update this tax projection in the fall.  You should carefully examine your insurance premium statements when received and, at least every couple of years, go out for quote again.  You should review the key points of your estate plan every year, including executors, trustees and agents and their successors. Based on updated current assets, you need to review if your estate is taxable and the distributions and their timing based on your current plan.

Monitoring is a big job. And, then add to that some of the key life events for you and your family (that may also require changes to your game plan) including:

  • Birth of a child or grandchild
  • Educational matters
  • Child/grandchild reaches majority
  • Weddings
  • Job and career changes
  • Moving
  • Major illnesses
  • Inheritance
  • Divorce
  • Onset of physical incapacity in old age
  • Death of a spouse, parent, sibling or other significant person

Is it any surprise that with all you need to do to achieve financial success and manage your wealth that you might consider an accountability buddy and coach, perhaps someone like DWM?

At DWM, we use a proprietary process to help you develop, monitor and modify your financial plan and manage your wealth over time.  Our Boot Camp is a great way to develop your plan.  Our daily, weekly, bi-monthly, and monthly processes which we refer to as “Increasing Wealth by Adding Value” are designed to monitor your plan and provide suggestions to improve your plan.  Personal meetings with you are times to review both progress and status of your building blocks and changes (including key life events) so we can help you keep your plan current.  And, most importantly, as your independent friend and coach, we are accountable to you and help you be accountable to yourself and your family in achieving your long-term goals.  When you accomplish all of that, it’s like you (and we) have won the Super Bowl.