DWM 3Q17 Market Commentary

“Train Kept A Rollin’ All Night Long…” The US economic expansion continued on during the third quarter of 2017. It is the third longest expansion since World War II and is now closing in on 100 months.  There were plenty of negatives that tried to slow it down. Politically, we had the debt ceiling deadline, a failed attempt to repeal Obamacare, and a war of words with North Korea. Even the lives and economic losses from the likes of Hurricane Harvey, Irma, Maria, western wildfires and two Mexican earthquakes – amounting to what could be the most expensive year for natural disasters ever – couldn’t slow this train down.

Thing is: the positives outweigh those negatives. At the end of the day, the market is powered by companies’ earnings. And those earnings have been robust and are expected to continue to be! And it’s not just domestically; growth is accelerating at a global level with Eurozone businesses and households more confident about their prospects than at any time in more than a decade. Japan has shown decent growth and inflation this year. And emerging markets are enjoying better fundamentals with more credible politics. Choo! Choo!

We are big believers in asset allocation which is why we showcase the major asset classes each quarter. Here’s how each fared:

Equities: The S&P500 rose 4.5% on the quarter and is now up 14.2% year-to-date (“YTD”). Sounds excellent, but actually a more diversified benchmark, the MSCI All Countries World Index, which includes US large cap stocks, US smaller cap stocks AND international stocks, did much better, up 5.3% quarter-to-date (“QTD”) and now up 17.3% YTD. We’ve been saying for some time that domestic large cap stocks in general look pretty “frothy” and hence it’s not surprising to see this rotation out of domestic large cap stocks into other cheaper equities. The other thing at play is the renewed interest in the so-called “Trump trade”. The areas that moved post-Trump Presidential Election, like small cap and value, have ‘steamed ahead’ in the last few weeks from the renewed hope of possible tax cuts. In just September, the Russell 2000 outperformed the S&P 500 by 4.2% and the Russell 3000 Value outperformed the Russel 3000 Growth by 1.6%.

Fixed Income:  During the quarter, the Fed announced that they are pushing ahead with an aggressive schedule for rate increases. We are happy to see the Fed take this path toward “normalization” while the economy is strong. The US needs to get back to higher rates so that the Fed has “some coal for their engines” if things go bad. That said, this announced path has succeeded in boosting inflation expectations, which has pushed up yields in both the 2-year and 10-year US Treasury notes, with the latter closing the quarter at 2.3%, its first quarterly gain of 2017. For the record, the Barclays US Aggregate Bond Index gained 0.9% in the third quarter and is now up 3.1% for the year. The inclusion of global fixed income assets led to better results with the Barclays Global Aggregate Bond Indexregistering +1.8% for 3Q17 and +6.3% YTD.

Alternatives:  Let’s take a look at a few ‘alts’ we follow. Gold gave back a little in September, but registered a +3.1% 3Q17 return represented by the iShares Gold Trust. With 2017 going down as one of the worst natural disasters year on record, the alternative exposure to reinsurance-linked securities (sometimes referred to as ‘catastrophe’ securities) took a hit. One would have thought oil would have suffered from the hurricanes as well, but demand was strong and with slowing US production, oil prices (WTI) ended the quarter up 12.2%. For the record, the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, was up 1.6% for the third quarter and 2.8% YTD.

For balanced investors, It’s been a pretty nice three quarters to start 2017. Looking forward, this bull market train can continue to roll, and a case can be made that returns can even get stronger given the great economic fundamentals around the globe. If Washington can get something done relative to a tax cut, look for stocks to accelerate into year-end.

Of course, there will always be (rail) road blocks. We are thrilled to see inflation measures move toward the Fed target range around 2%, but there are many out there concerned that inflation might ‘chug’ right through those target levels and create havoc on the back-end. Furthermore, the announced and about-to-start-very-soon Federal balance sheet reduction is an unprecedented experiment. And it’s not just the US attempting this.  Global central banks at some point need to do some house-cleaning and will be reducing their balance sheets as well. There is a huge risk something can go wrong and send this train off track. Lastly, we don’t think the markets are adequately pricing in the geopolitical risk out there, which some would say is approaching multi-decades high. Frankly, when a small probability risk is hard to price in, the market usually just shrugs it off. With trading activity so light recently and little risk currently priced into the market, things could get ugly very quickly if anything goes wrong.

In conclusion, these are challenging times. It’s not easy to navigate the terrain out there. So make sure you have good direction and management. Don’t fall victim to a bad conductor and wind up like Ozzy Osbourne “going off the rails of a crazy train!” Make sure that your engineer is keeping you on track. At DWM, we engineer our clients’ portfolios to ride safely through the peaks and valleys that this train has and will travel through. With the right team at the controls, you can make your journey a pleasant one.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

DWM SAYS THANKS – LAST WEEKEND AT ARLINGTON PARK!

This past Saturday, many clients/family/friends attended our annual Chicagoland Friends of DWM Appreciation Event at Arlington Park Race Track in Arlington Heights, IL. We were blessed with a warm, sunny day under the shade of one of Arlington Park Race Track’s marquee tents!

A great time was had by all!

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Don the Handicapper educated us aka “Arlington Park Betting 101”.

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And we had some lucky winners!

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Then again not all of us were old enough to bet, but still had fun!

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Some just wanted to chill…in a tree!

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Some of us – both young and old – even had a roll down the hill match! (Thanks for organizing, L.M.)

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For those that attended, thank you very much for coming and partaking in what was a truly special day for our Detterbeck Wealth Management team. And to both those that did attend and to those that couldn’t make it, let us reiterate that we are honored to have you all as our friends and look forward to a continued great relationship! Thank you!!!

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Lastly, for those in Charleston area, we look forward to hopefully seeing you at our October appreciation event!

“An Ounce of Prevention is Worth a Pound of Cure”- B. Franklin

Millions of Americans are being impacted by two Category 5 disasters- Hurricane Irma and the Equifax data breach!!  Certainly, we’re all watching Irma spread through FL and our hearts and prayers are with all those in Irma’s path.  But don’t discount the Equifax high-tech heist as something small.  Last Thursday, Equifax announced that personal and confidential information for 143 million Americans.  This included names, social security numbers, birth dates, addresses and, in some instances, driver’s license numbers and other information.

This epic breach is a really big deal and a great concern.  Equifax, Experian and Transunion warehouse the most intimate details of Americans’ financial lives, from credit cards to medical bills.  Once security is breached, the hackers typically sell the stolen information to sophisticated identity thieves.  Last year, 15.4 million Americans were victims of identity theft, which totaled $16 billion.  In most cases, the money was recovered, but only after a tremendous amount of time, money and stress.  One man said the thieves so ruined his credit that he was unable to secure a needed mortgage refinance.  One lady’s social security number was used by others to file her income taxes and get a refund before she even filed her own return.  It took her over a year to get it straight with the IRS.  In the first half of 2017, there were a record 791 data breaches in the U.S., up 29% from last year.  Victims have recounted what a terrifying experience it is to have your identity stolen.  “You’re worried about the tremendous implications this could have and the possibility of it going on for years.”

Here’s the really bad part of the Equifax breach. We now know that the breach occurred six weeks ago, July 29th.  The hackers probably sold the information shortly thereafter.  We’ve likely all been compromised for six weeks and we didn’t know it.  Equifax is now under investigation for the breach and their lack of transparency by Congress, New York’s attorney general and the Consumer Financial Protection Bureau. If you call Equifax, it’s another frustration.  Their “hot line” is staffed with people who really can’t tell you if your information was taken or not.  You should assume that it was.  Ouch!!

It’s time for us to play defense.  Step one- put a credit freeze on all three reporting services immediately.  It’s your only hope.  A credit freeze prevents existing creditors and new creditors from using your information.  It prevents new accounts being opened in your name.  When you contact the sites listed below you will receive a PIN that allows you to temporarily lift or “thaw” your freeze.  Put that number in a very safe place (see below).  Yes, you may be delayed a day or two to get your information released when you need to apply for new credit, but that’s a small problem compared to potential identity theft.

Here are the sites:

Equifax – https://www.freeze.equifax.com/Freeze/jsp/SFF_PersonalIDInfo.jsp

Experian – https://www.experian.com/freeze/center.html

TransUnion – https://freeze.transunion.com/sf/securityFreeze/landingPage.jsp

I froze Elise and my accounts yesterday in about 20 minutes.

 

Step two-you need to create strong passwords and store them in a secure spot. The bad guys have two pieces of information, your social security number (which you don’t want to change) and your address.  Don’t help them with the next step by having weak passwords.

Updating your passwords will take some time.  Focus first on the key ones; your credit cards, financial institutions, and key retailers like Amazon and Apple; anywhere there is money or where thieves could get merchandise or services.  If a site offers additional security with a two-factor authentication, enable it.   Once you’ve got the key sites, start knocking out the others.

You should use a password manager like 1Password or LastPass.  It’s always important to update your password every so often. These sites create a unique random number password for every website you visit and stores them in a database that you create.  This makes it much more difficult for the thieves to decode your password. Further, these are great places for all of your passwords and your PINs.  Of course, you need to keep your master password in a special spot and share that with your spouse and/or another trusted person.

No question, this is a real pain!!  But, the alternative is possible identity theft which could be a 100 times worse.  We live in an age of Big Data.  We have all allowed the emergence of huge detailed databases full of information about us.  Thanks to technology, financial companies, tech companies, medical organizations, advertisers, insurers, retailers and the government can maintain and access this information.  Unfortunately, companies like Equifax are only lightly regulated and there’s not much punishment for breaches.  Hence, breaches will keep happening.  Even with new technology, like Apple’s new iPhone8 which includes face recognition to unlock it, the consumer credit bureaus are not going away anytime soon.

Please do yourself a favor and freeze your credit, change your passwords and store everything securely this week.  The process will certainly feel like more than an “ounce” of prevention, but if it saves you from identity theft, it will be far more than a “pound” of cure.

My, How Jobs Have Changed

Hope you had a super Labor Day weekend!  Wonderful to be with family and friends.  It’s amazing how jobs have changed over the years.  The NYT over the weekend illustrated how life is so much different for workers by comparing two janitors working for two top companies then and now.

Gail Evans was a janitor for Eastman Kodak in Rochester, NY almost forty years ago.  She was a full-time employee, received 4 weeks paid vacation, reimbursement for some tuition costs to go to college and bonuses. And, when the Kodak facility was temporarily closed, the company kept paying her and had her perform other work.  Ms. Evans took computer classes at night, got her college degree in 1987 and ultimately became chief technology officer for Kodak.

Marta Ramos cleans floors for Apple in Cupertino, CA.  She isn’t on Apple’s payroll. She works for one of Apple’s contractors.  Ms. Ramos hasn’t had a vacation in years-she can’t afford the lost wages.  Going back to school is out of the question. There are no bonuses and no opportunities for some other role at Apple.  Ms. Ramos earns $16.60 per hour, about the same as Ms. Evans did in inflation-adjusted terms.  But her only hope for advancement is to become a “team leader”, which pays an extra $.50 per hour.

Over the last 35 years, American corporations have increasingly focused on improving their bottom line by focusing on their core competency and outsourcing the rest. Part of the success of the Silicon Valley giants of today has come from their ability to attain huge revenues and profits with relatively few workers.  It’s led to huge profits for shareholders, helped grow the U.S. economy, but also has fueled inequality.

In 1993, three of the then tech giants – Kodak, IBM and AT&T – employed 675,000 employees to produce $243 billion of revenue in inflation-adjusted dollars.  Today, Apple, Alphabet and Google produce $333 billion in annual revenue with less than 1/3 of that number, employing only 205,000 employees.

Apple is quick to point out that its products generate many jobs beyond those who receive an Apple paycheck.  It estimates that 1.5 million people work in the “app economy.” However, research shows that the shift to a contracting economy has put downward pressure on compensation.  Many corporations hire full-time employees only for the most important jobs and outsource the rest; obtaining contractors at the time and place needed for the lowest price possible. It’s not just janitors and security guards that are outsourced.  There are also people who test operating systems, review social media posts and screen job applicants, for example.  It’s understandable: companies face really tough competition and if they don’t keep their work force lean, they risk losing out to a competitor that does.

In addition, outsourcing often results in a culture of transience.  Contracted workers are often changing jobs every 12 to 18 months, which obviously can be stressful to them and their family.  Contractors generally don’t receive stock options nor robust health insurance.  Also, retirement plans, even for full-time employees, have changed considerably in the last 35 years. In 1979, 28% of workers were covered by a company paid pension program and 7% had a 401(k). In 2014, only 2% of workers were covered by a pension plan and 34% had a 401(k) plan, which of course, means that most of the funding now is coming from the worker.

Here’s what’s really amazing.  With all these changes, job satisfaction has gone up.  For the first time since 2005, more than half of U.S. workers say they’re satisfied with their jobs.  This optimism has led to consumer spending increasing every month this year and a strong economy.  Apparently, after a decade of job cuts, minimal raises and reduced benefits, workers have lowered their expectations.  Rick Wartzman, author of “The End of Loyalty: The Rise and Fall of Good Jobs in America,” feels that young workers today “don’t even know what they are missing.”

On Monday, we celebrated Labor Day, honoring working people.  That’s particularly important these days as many workers don’t have it nearly good as it was 30-40 years ago.  Even so, American values, spirit and resiliency continue to be very evident in these ever-changing times. Perhaps we need another holiday, “Resilience Day.”  Time to get the grill heated up again!

How Much do You Know About Labor Day?

We are all aware that Labor Day signifies the end of a summer filled with backyard BBQs, family and sunshine. It is the one long weekend of the year when families come together to say goodbye to summer, unwind and prepare for the changing seasons ahead. However, many of us don’t take the time to consider the true origin of Labor Day.

The concept of Labor Day dates back all the way to the Industrial Revolution in the U.S. during the late 1800s. The typical work day was 12 hours long, and the typical work week was seven days. Working conditions were far from ideal, and even children as young as four or five years old were commonly seen working in mills and factories to help their struggling families scrape by.

Many workers began organizing protests and strikes across the U.S. Unfortunately, many of these demonstrations turned violent and, in some cases, deadly. In 1894, Eugene V. Debs, with the support of the American Railroad Union, organized a strike and boycott of the Pullman Palace Car Company in Chicago. This strike effectively crippled all railroad traffic in the U.S., leading then President Grover Cleveland to deploy 12,000 troops to the area to dissolve the strike.

The use of military force on behalf of the U.S. government essentially poured gasoline on the already burning fire of discontent with current labor wages and conditions. Several people were killed during the Pullman strike altercation, and although the strike did come to an end, American workers were still unhappy and began to condemn President Cleveland’s aggressive response.

Meanwhile, union workers in New York City had been organizing and going on strike one day of the year in support of the idea of a national Labor Day that had been circulating around the U.S.

Later in 1894, which happened to be an important election year, President Cleveland decided to implement a nationally recognized annual celebration of American workers to appease his critics – and thus Labor Day as we know it was born.

Fast forward to 2017, where we at Detterbeck Wealth Management are fortunate enough to do what we are passionate about everday in a constructive and collaborative environment. We choose to use this year’s Labor Day as an opportunity to reflect on and appreciate how far the U.S. economy and workforce has come since those historic strikes in 1892.

From everyone here at DWM, have a great Labor Day Weekend and enjoy some time with the family!

“The Markets are going to Fluctuate”

Last Thursday, August 17, the equity markets took a hit of 1-1.5%.  In overall terms, it wasn’t a pullback (5% drop) or a correction (10%) yet some were concerned this might be the “start of the end” of the long-term bull market.  Yes, stock valuations have been high for some time, but many people wondered “Why now?” Various reasons were given to “explain” the causes of Thursday’s decline.  Let’s take a look at some of these:

“Terrorism.”  The first reports of the attack in Barcelona were posted in New York around noon last Thursday.  The markets were already in a decline and gold and bonds were moving higher.  Though the attack was dreadful and disgusting, it likely didn’t move the markets.

“Corporate America abandons the White House.”  Kenneth Frazier, CEO of Merck, resigned Monday, August 14.  Others followed and the major business councils disbanded on Wednesday, August 16.  However, participation on President Trump’s councils is voluntary and the first priority of each of the CEOs is their “day job,” which involves working with their customers, employees, suppliers and investors.  Their departure shouldn’t have been a surprise.

“All Donald Trump all the time has worn out people’s patience.”   Certainly, many may be exhausted by the almost singular focus of the news being the White House for the last seven months.  However, impatience is unlikely to cause the markets to move lower.  It was only two weeks ago that we all were worried about the possibility of a nuclear war starting in the Korean peninsula. And, that scare didn’t move the markets.  Therefore, it’s hard to believe the daily White House news would be a source of concern for the markets.

“The White House Economic Team is Leaving.”  Early last Thursday, a rumor floated through Wall Street that Gary Cohn, the Director of the National Economic Council, was resigning.  Mr. Cohn, along with Treasury Secretary Steven Mnuchin are leading the all-important tax reform and infrastructure initiatives.  The S&P 500 began a sharp move down around 10 am last Thursday exactly the time the false tweet came out.  Fortunately, the rumor was squelched almost immediately but the markets, nevertheless, continued to fall.   Hence, the rumor seems not to have been the catalyst for the sale, though the loss of either Mr. Cohn or Mr. Mnuchin would, in fact, be a major concern.

In short, these “explanations” given after last Thursday’s market drop really don’t identify why it happened.  Even so, story lines will continue.  We humans want them.  We are wired to try to understand why and how things happen and use that information to guide our future.

Legend has it that about a century ago, an alert young man found himself in the presence of John Pierpont Morgan, one of the most successful investors of all time.  Hoping to improve his fortune, the young man asked Mr. Morgan’s opinion as to the future course of the stock market.  The alleged reply has become a classic:  “Young man, I believe the market is going to fluctuate.”

Yes, there are many things we cannot control and, fortunately, some we can.  At DWM, we focus on helping you to create and maintain an investment portfolio that is designed to participate in good times and protect in bad times by:

  • Identifying and implementing a customized asset allocation based on your goals and risk tolerance
  • Diversifying the holdings by asset class and asset style
  • Using the lowest cost investments wherever possible
  • Striving to make the portfolio tax efficient
  • Rebalancing regularly
  • Staying fully invested
  • Providing discipline to keep you on track and, for example, making sure you are not trying to time the markets or chase performance

Yes, the markets are going to fluctuate.  We can’t control that.  But, at DWM we can help you control those key metrics that, over the long run, can produce higher expected returns with lower risk.

Let’s All Work to Grow Human Capital!

Your biggest financial asset may be your human capital.  Yes, perhaps even more important than your investment portfolio, house, real estate and other assets.  Simply put, human capital refers to the abilities and qualities of people that make them productive.  There are many factors that contribute to human capital.  Knowledge is the most important, but discipline, punctuality, willingness to work hard, personal values and the state of one’s health are among the other factors.

Generally, younger people will have more human capital than financial capital.  In an economic sense, their human capital is the net present value of their lifetime earnings.  In a larger sense, human capital is our ability to add value to others and improve their lives and, by doing so, improve our own.  Decisions young people make early on regarding their education, their careers, their job choices, life partner choice, etc. will all have huge impacts on their eventual financial capital and human capital. Key questions they should answer include “What is your passion?” “When are you at your best?” and “What allows you to engage your human capital at the highest level?”

Historically, the cross-over point where financial capital starts to exceed human capital occurs when one is in their 50s.  However, with people living longer or pursuing “encore” careers, human capital may remain a significant personal asset for octogenarians and beyond.  A perfect example is 86 year old Warren Buffet who is committed to growing human capital:  “Investing in yourself is the best thing you can do.  Anything that improves your own talents cannot be taxed or taken away from you.”  Regardless of your age, human capital is like a garden, you need to continually give it your time and effort in order for it to grow.

For decades after WWII, the G.I. bill and the American economy pushed workers to build skills and maximize their economic potential.  This was arguably the greatest period of shared prosperity in the history of capitalism.  Last week’s Economist featured an article about University of Chicago Nobel Prize winner Gary Becker’s concept of human capital. Dr. Becker found that 25% of the rise in per-person incomes from 1929 to 1982 in the U.S. was because of increases in schooling.  Other components included on-the-job training and better health.  Dr. Becker was fond of pointing to Asian economics, such as South Korea and Taiwan, with few natural resources, who have invested in human capital by building up their education systems.  There is no debate that well-educated populations have greater incomes and broader social gains. There is a debate over whether the government should supply the education or students should bear the cost; yet both will receive the rewards.

Dr. Becker also wrote about “good inequality” and “bad inequality.”  Higher earnings for doctors, scientists and computer programmers, for example, help motivate students to push harder and achieve top paying jobs.  On the other hand, Dr. Becker wrote, when inequality becomes too extreme, the schooling and even the health of children from poor families suffers, with parents unable to adequately provide for them.  Inequality of this sort “depresses human capital, leaving society worse off.”

Certainly, many, if not most, of our DWM blog readers are committed to increasing and using their human capital to benefit themselves and others.  But, there are many Americans who do not or cannot.  Some are in occupations that have been hit hard by technological changes, others are in declining industries, others have limited education, and others have little opportunity.  As a result, there are lots of unhappy people due to this huge current gap between full human capital and employed human capital.  Can you imagine our country where the vast majority of our 323 million people were increasing their human capital and using it to benefit themselves and society?  Can you imagine an annual economic growth rate of GDP of 5-10%, like it was in the 60s and 70s, compared to the 2% it is currently?  Can you imagine hundreds of millions of Americans happy with their shared prosperity and with optimism for the future?

Let’s make growing human capital a lifetime commitment. And, let’s also commit to using our human capital to help others grow theirs.  It’s up to each of us. Mahatma Gandhi put it so well: “You must be the change you wish to see in the world.”

Some Cures for Procrastination

While most of us are having a super summer, maybe traveling a little bit, maybe kicking back a little, 60 psychologists were in Chicago last week attending the 10th Procrastination Conference. Their goal:  to better understand who procrastinates and discuss how the dreaded loop of perpetual delay can be altered.

Amazing.  20% of people are true procrastinators.  It seems of all countries surveyed, including the U.S., to Poland, Britain, Germany, Japan, Saudi Arabia, Turkey, and Peru, all have about 1 in 5 residents who are chronic procrastinators, or “procs.”  They delay in completing a task to the point of experiencing subjective discomfort, such as anxiety or discomfort.  A proc is usually consistent; procrastinating in multiple areas of her or his life- work, personal, financial and social.  Procs often lose jobs, have broken marriages, suffer deflated dreams, have self-esteem issues and are in financial disarray. Procrastination can be a real problem.

Hopefully, though, we have none or only few chronic procs in our readership.  However, for those who are in the other 80% who “on occasion” delay making decisions until it is too late, find themselves saying “I’ll do it tomorrow,” putting things off until the last minute or simply neglecting important items, here are some ideas on ways to get more things done.

  • Begin by forgiving yourself for being a part-time procrastinator.
  • Break down tasks into smaller pieces. For example, “select your blog topic,” as opposed to “write the blog.”
  • Consider using the Pomodoro technique. Plan your day in 25 minute intervals with a 5 minute break after each.  Complete small tasks throughout the day which will produce a huge cumulative effect and a wonderful feeling of accomplishment.
  • Adopt the “Seven Minute Rule.” If you have a task that requires seven minutes or less, just get it done now.  No need to put it on a to-do list or waste energy thinking about it over and over again, just knock it out.
  • Minimize distractions. One key area is emails.  Consider being email free for 15-25 minutes at a stretch to be able to concentrate and complete a project rather than getting sidetracked every other minute.
  • Deal with problems now. Remember the following saying:  “If you have to swallow a toad, it’s best not to look at it too long.”
  • Seek external help for your goals.

It’s no surprise that many people procrastinate on getting their financial matters in order.  Making decisions for what happens to your estate when you die isn’t all that much fun.  Reviewing insurance coverage for when your house is destroyed or your dog bites your neighbor isn’t extremely enjoyable.  Income tax planning isn’t a bowl of cherries.  Planning for retirement and making choices about needs, wants and wishes is not like having a birthday party.  Trying to make investment decisions by yourself with so much information available and so many  conflicting, self-proclaimed “experts” is difficult and frustrating.

However, all of these items are very important and do need to be put in order. Wealth management is one of those key areas where seeking external help can break your procrastination and help you reach your goals.  Consider working with a full-service fee-only fiduciary like DWM.  Not only will you get an experienced, competent team to guide you and provide information and choices so you can make decisions on all aspects of your finances.  In addition, with firms like DWM, who have a proprietary and prudent process in place, you receive regular, consistent follow-up on all investment, financial planning, insurance, income taxes and estate planning matters for years to come.

So, don’t procrastinate.  Consider some of these ideas for getting more things done. And, if you need external help on your finances in order, please give us a call.

Tick, Tock… Is it Time for your Required Minimum Distribution (RMD)?

“Time flies” was a recent quote that I heard from a client.  Remember a long time ago…putting money aside in your retirement accounts, perhaps at work in a qualified traditional 401(k) or to an individual retirement account (IRA)?  It’s easy to ‘forget’ about it because, it was after all, meant to be used many years down the road.  It would be nice to keep your retirement funds indefinitely; unfortunately, that can’t happen, as the government wants to eventually collect the tax revenue from years of tax deferred contributions and growth.

In general, once you reach the age of 70 ½, per the IRS, many of those qualified accounts are subject to a minimum required distribution (RMD) and you must begin withdrawing that minimum amount of money by April 1 of the year following the year that you turn 70 1/2.  Of course, there are a few exceptions with regards to qualified accounts, but as a rule, when you reach 70 ½, you must begin taking money from those accounts per IRS guidelines if you own a traditional 401(k), profit sharing, 403(b) or other defined contribution plan, traditional IRA, Simple IRA, SEP IRA or Inherited IRA.  (Roth IRAs are not required to take withdrawals until the death of the owner and his or her wife.)  Inherited IRAs are more complicated and handled with a few options available to the beneficiary, either by taking lifetime distributions or over a 5 year period.  The importance here, is to be aware that a distribution is needed.  Another word of caution…In some cases, your defined contribution plan may or may not allow you to wait until the year you retire before taking the first distribution, so review of the terms of the plan is necessary.  In contrary, if you are more than a 5% owner of the business sponsoring the plan, you are not exempt from delaying the first distribution; you must take the withdrawal beginning at age 70 1/2, regardless if you are still working.

The formula for determining the amount that must be taken is calculated using several factors.  Basically, your age and account value determine the amount you must withdraw.  As such, the December 31 prior year value of the account must be known and, second, the IRS Tables in Publication 590-B, which provides a life expectancy factor for either single life expectancy or joint life and last survivor expectancy, needs to be referenced.  The Uniform Lifetime expectancy table would be referenced for unmarried owners and the Joint Life and Last Survivor expectancy table would be used for owners who have spouses that are more than 10 years younger and are sole beneficiaries.  It comes down to a simple equation: The account value as of December 31 of the prior year is divided by your life expectancy.  For most of us, your first RMD amount will be roughly 4% of the account value and will increase in % terms as you get older.

It all begins with the first distribution, which will be triggered in the year in which an individual owning a qualified account turns 70 ½.  For example, John Doe, who has an IRA, and has a birthdate of May 1, 1947, will turn 70 ½ this year in 2017 on November 1.  A distribution will need to be made then after November 1, because he will have needed to attain the age of 70 ½ first.  Therefore, the distribution can be taken after November 1 (for 2017), and up until April 1 of the following year in 2018.

Once the first distribution is withdrawn, subsequent annual RMDs need to be taken for life, and are due by December 31.  In this case, John Doe will need to next take his 2018 distribution, using the same formula that determined his first distribution.  This will become a regular obligation of John’s each year.

So, we’ve talked about who, what, why and when, now let’s talk about the where.  Once the distribution amount is calculated, an individual can then choose where he or she would like that money to go.  Depending on circumstances, if the money is not needed for living expenses, it is advised to keep the money invested within one of your other non-qualified accounts such as a Trust or Individual account, i.e. you can elect to make an internal journal to one of your other brokerage accounts.  Alternatively, if you have another thought for the money, you can have it moved to a personal bank account or mailed to your home.  Keep in mind that these distributions, like any distribution from a traditional IRA, are taxed as ordinary income, thus, depending on your income situation, you may wish to have federal or state taxes withheld from the distribution.  At DWM, we can help our clients determine if, and what amount, to be withheld.

Another idea for the money could be a qualified charitable distribution (QCD).  Instead of the money going into one of your accounts, a direct transfer of funds would be payable to a qualified charity.  There are certain requirements to determine whether you can make a QCD.  For starters, the charity must be a 501 (c)(3) and eligible to receive tax-deductible contributions, and, in order for a QCD to count towards your current year’s RMD, the funds must come out of your IRA by the December 31 deadline.  The real beauty about this strategy is that the QCD amount is not taxed as ordinary income.

It may be pretty scary to know how quickly time flies, but with DWM by your side, we can take the scare out of the situation!

DWM 2Q17 Market Commentary

“Let the Good Times Roll!” Yes, the 1979 song by Ric Ocasek and the Cars may describe the market’s attitude in the first half of 2017. “You Might Think” the markets are “Magic” or “All Mixed Up” – other classic Cars songs – but, nonetheless, investors should be pleased to see their mid-term results.

With the trading year half-way complete now, “It’s All I Can Do” to give you the major market stories in 2017:

  1. 1.All three major non-cash asset classes (equities, fixed income, and alternatives) are positive to start the year.
  2. 2.Large-cap equities have significantly outperformed small-cap equities, the largest outperformance to start the year in almost 20 years. Large caps, as represented by the S&P500, were up 3.1% for 2Q17 and up 9.3% Year-to-date (“YTD”) through June 30th. Small caps, as represented by the Russell 2000, were up 2.5% and 5.0%,
  3. 3.Growth is significantly outperforming value. In fact, it’s the biggest outperformance to start a year ever besides 2009. The S&P500 Growth Index was up 4.4% 2Q17 & 13.3% 1H17 vs the S&P500 Value Index, up 1.5% and 4.9%, respectively!
  4. 4.International stocks are outperforming domestic stocks. The last several years have seen the opposite, but now international is outperforming domestic in what may be a tidal change. The MSCI EAFE Index was up 6.4% for the second quarter and now 13.8% YTD!
  5. 5.Minimal volatility – Despite political noise and other headlines around the world, the equity market continues to move forward with little whipsaw. The CBOE Volatility Index, Wall Street’s so-called “fear gauge”, saw its lowest level in over two decades!

Let’s drill down into the various asset classes.

Equities: Obviously, we can see from above that returns in ‘equity land’ were quite decent. In general, stocks rallied on strengthening corporate earnings, improving economies both here and abroad, and continued support from central banks. Earnings from S&P500 companies increased 14%, the best growth since 2011.

Fixed Income: The Barclays US Aggregate Bond Index gained 1.5% in the second quarter and is now up 2.3% for the year. The Barclays Global Aggregate Bond Index produced even better returns, +2.6% 2Q17 and +4.4% YTD, thanks to stronger results overseas. Many bond investors, including DWM, have been surprised at the falling US government bond yields. The 10-year Treasury Note started the year at 2.45, peaked in March at 2.61, only to close the quarter at 2.30. Why aren’t rates going up? Much of it has to do with skepticism about the passage of Trump’s fiscal agenda. Amongst other things, there has not been the promised major tax reduction nor a flood of fiscal spending yet. As such, inflation expectations weakened in June. However, hawkish comments in the last several days from major central banks, including our US Fed indicating a strong chance that they will announce in September a decision to start shrinking its balance sheet, has caused a reversal in bond yields to start the third quarter. We see the Fed continuing to unwind the past years of stimulus via rate hikes or balance sheet reductions in a well-announced, controlled fashion.

Alternatives:  The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, was up 0.4% for the second quarter and 1.1% YTD. This benchmark gives one a good feel for what alternatives did in general. Of course, there are many flavors of alternatives so drilling down into the category can reveal very different results. Furthermore, alternatives can take the form of either alternative assets and/or alternative strategies. “Traditional” alternative assets like gold* and real estate** fared well through the first half, up 7.8% and 3.2%, respectively. However, another “traditional” alternative in oil (a commodity) suffered, falling back into bear territory. US fracking companies continue to pump at lower prices frustrating OPEC’s goal of price stability via OPEC member supply cuts. A couple of alternative strategies fared differently: managed futures*** have shown losses in the first half, down -5.6%; whereas merger arbitrage**** has had a decent gain of 2.2%. These examples show how alternatives behave independently, thereby providing the ability to reduce the volatility of one’s overall portfolio.

It has been a solid first half for most balanced investors. Looking forward, it’s hard to say what path the markets will take. They could continue this nice trajectory upward – did you know that US stocks were up in January, February, March, April, and May? This is significant because, historically, when US stocks are up in the first 5 months of the calendar year, the average return for US stocks for the full calendar year was +28.8%! This first-five-months-up event has only happened 12 times and in all 12 times, the year ended up in double digits!

However, domestic stocks are getting expensive. The S&P500 now trades at 18x projected earnings over the next 12 months, its highest level in 13 years. Overseas stocks are still a relative bargain compared to the US and one of the reasons for their recent and expected-to-continue outperformance. Furthermore, where the US has raised short-term interest rates four times since the end of 2015, international central banks have been and will remain relatively more accommodative for the near future.

The other scary thing is that the equity and bond markets are sending mixed signals. If bond yields stay down, that would tell us that the bond market sees tepid economic growth, which could be true if all of the pro-growth Trump agenda plans do not come to fruition. For now, the equity markets are signaling otherwise – that this bull market has legs based upon strong corporate results and improving fundamentals. No, Mr. Ocasek, the signals from the bond market and equity market are not “Moving In Stereo.” Only time will tell to see what market is signaling correctly. In the meantime, the goal is to have a portfolio in place that can weather any storm. At DWM, we think our clients’ portfolios are well-positioned for what the markets will throw at us. We look forward to the journey. In fact, and finishing with one last Cars’ classic, “Let’s Go!”

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

*represented by the iShares Gold Trust

**represented by the SPDR Dow Jones Global Real Estate ETF

***represented by the AQR Managed Futures Strategy Fund

****represented by the Vivaldi Merger Arbitrage Fund