Tick, Tock…is it Time for Your Required Minimum Distribution (RMD)?

“Time flies” was a recent quote that I had 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 Required Minimum 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 hold a traditional 401(k), profit sharing, 403(b) or other defined contribution plan, traditional IRA, Simple IRA, SEP IRA or Inherited IRA.  (Roth IRA withdrawals are deferred until the death of the owner and his or her spouse).   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 a review of the terms of the plan is necessary.  In contrast, 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 individuals, the first RMD amount will be roughly 4% of the account value and will increase in percentage each year.

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, 1949, will turn 70 ½ this year in 2019 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 2019), and up until April 1 of the following year in 2020.

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 2020 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, individual or joint account, i.e. you can elect to make an internal journal to one of your other investment 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 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.  One exception is the qualified charitable distribution or QCD, which is briefly discussed next.

Another idea that may be a possibility for some individuals is for the distribution amount to be considered 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.  You would simplyprovide the QCD acknowledgement receipt(s) along with your 1099R(s) to your accountant for the correct reporting on your tax return.

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!

Ask DWM: Should I Consider Investing in Marijuana?

In 1996, California became the first state to legalize the use of medical marijuana. This began, for many, the first opportunity to legally invest in this industry. In 2012, both Colorado and Washington State legalized the use of recreational marijuana. Both events were monumental for the development of marijuana investments but, arguably, the most momentous day in marijuana investments occurred on October 17th, 2018 with the legalization of recreational marijuana in Canada. In June of 2018, Canada voted “yes” to legalization and became the first major country to do so. Interest in these investments have soared ever since.

Cannabidiol (“CBD”) is one of the major attractions in this story. CBD is a cannabis compound used primarily for medical purposes. CBD has been proven to provide benefits for pain management, sleep aid, and stress. The primary difference between marijuana and CBD is its lack of hallucinogenic properties. CBD does not contain tetrahydrocannabinol (“THC”), the main hallucinogenic property found in marijuana. CBD is currently legal in all 50 states. As of February 2019, marijuana has been legalized in over 30 US states for medical purposes and ten, including Washington D.C., have approved it for recreational use.

Spending in the legal marijuana industry is expected to surge from $8.5 billion in 2017 to over $23 billion in 2022. As a side note and for comparison purposes, illegal sales of pot represented 87% of all North American sales and over $46 billion in 2016 according to Arcview Market Research. Hard to not get excited about those growth figures! Further, in a sign of credibility to the industry, major investments from some of the world’s largest beverage makers including Coca-Cola and Corona brewer Constellation Brands have created even more hype and have sent some pot stocks soaring. It’s not just Wall Street taking notice, but ordinary people are wondering if they should get in on the craze.

But just like Bitcoin & other cryptocurrencies, this upstart legal cannabis industry has many red flags and may lead to some scary results.

First off, “FOMO” or the Fear Of Missing Out is no reason to plow good money into a speculative area. It is prudent to do some serious research before dipping into the waters of an industry that faces many legal, regulatory and other hurdles. Further, beware of fraudsters on the internet claiming “this pot stock is the next big thing!” Investing in cannabis is like the wild, wild west and similar to the dot.com mania of the 90s with tons of extreme volatility and broken promises.

More specifically, there are a variety of risks associated with investing in this area. Marijuana is still not legal at the Federal level, which makes banking for marijuana companies within the US difficult and future issues uncertain. Second, most marijuana companies are considered “start-ups” where company revenues are low or nil, and they may be running at a loss. In addition to this, overall investments in marijuana continue to remain small, albeit growing, in comparison to developed industries. For example, the ETFMG Alternative Harvest ETF (symbol: MJ), one of the largest marijuana funds available, holds just $1 billion in capital. Lastly, with only a handful of well-known “reputable” companies in this area, don’t get burned by loading up in just one or two names and thus becoming subjected to company-specific risk.

If you are still interested in investing in marijuana, there are a few considerations to keep in mind. As a general rule, you should not allocate more than a couple percent of your total investment portfolio to one company name. Further, prudent portfolio management suggests to limit your overall exposure to a speculative area like this to no more than 5% of your total investable assets. Avoid concentrated company-specific risk and diversify. A diversified mutual fund or ETF like the ETFMG Alternative Harvest ETF (symbol: MJ) mentioned above is a great choice for those that aren’t good at research but “have to get in”…

At the end of the day, investments in marijuana should be considered widely speculative and highly susceptible to losses. Volatility in both specific companies and funds have been extremely high since their inception. Investments in these areas should be considered more like taking your money to Las Vegas. It’s a gamble and you could potentially lose your entire investment.

At DWM we consider ourselves to be financial advocates for our clients and we love being a part of all of our client’s financial decisions. Questions such as investments in marijuana have been a reoccurring theme as of late, eerily similar to those in 2017 about Bitcoin and we know what happened there….In other words, if you are still interested in this area, PROCEED WITH CAUTION!!!

At this time, DWM is not investing in marijuana for managed accounts due to the many issues mentioned above. For clients still interested in reviewing marijuana investments via a self-directed/unmanaged account, we welcome your calls.

DWM 4Q18 & YEAR-END MARKET COMMENTARY

Fantasy Football and portfolio management may be more similar than one would think. Over the past weekend, I drafted a playoff fantasy football team which I’m hoping will amass more points than the other five “owners” in my league. Fantasy football drafting for both the regular season and playoffs is similar in that you want to take the NFL players that get the most touchdowns and the best stats in turn for rewarding you with higher points. The team with the most collective points wins! However, playoff fantasy drafting is much different than a regular season fantasy draft, with the key difference being one doesn’t know how many games that a player will actually play! Patrick Mahommes may be the best player available per game on paper; but if his KC Chiefs lose in their first game, a middle-of-the-road player like Julian Edelman from the Patriots who is expected to play multiple games, can be superior. Thus, the key is trying to pick not only the best available player, but also the one who will play the most games.

It’s sort of like investing, where picking NFL players and their teams become synonymous with picking companies. You want a collective bunch of players/securities that outperform others which ultimately leads to higher values. I looked at this draft pool of players like I would constructing a portfolio: diversifying my picks by player positions and teams.

Some of the other owners didn’t follow this disciplined approach, instead opting at throwing all of their marbles into the fate of one team and hoping it would lead them to the Fantasy Football Holy Land. And just like investing all or the majority of your dollars into one stock, this type of “coaching” can lead to utmost failure. Case in point: one owner loaded up on one team, taking several players on the Houston Texans. Ouch. (If you’re an NFL fan, you know that the Texans were squashed by the Colts and are out of the playoffs, just like this “owner” is now out of contention in our Fantasy League!) The morale of this story is: there is no silver bullet in football or investing; stay disciplined and diversified and reap the rewards over the long term.

And now onto the year-end market commentary…

Unfortunately, there were not many good draft picks this year. In fact, as stated in one of our previous blogs, around 90% of asset styles were in the red this year. And I don’t mean the Red Zone! Let’s see how the major asset classes fared in 4q18 and calendar year 2018:

Equities: Stocks were driving down the field, reaching record highs right before the 4th quarter began and then…well, let’s just say: “FUMBLE!” with the MSCI AC World Index & the S&P500 both dropping over 13%! This was the steepest annual decline for stocks since the financial crisis. Yes, investors were heavily penalized in 4Q18 for several infractions, the biggest being:

  • The slowing of economic growth
  • The ongoing withdrawal of monetary policy accommodation, i.e. the Fed raising rates and until recently, signaling more raises to come
  • Trade tensions continuing to escalate
  • The uncertainty of a prolonged US Government shut-down
  • Geopolitical risk

None of these risks above justify the severe market sell-off, which brought the MSCI AC World Index to a -10.2% return for 2018. This is in stark contrast to 2017, when it was up 24.0%! “Turnover!” Frankly, the stock market probably overdid it on the upside then and now has overdone it to the downside.

Fixed Income: The Barclays US Aggregate Bond Index & the Barclays Global Aggregate Bond Index “advanced the ball” in the fourth quarter, up 1.6% and 1.2%, respectively. Still, it wasn’t enough to produce any “first downs” with the US Agg essentially flat and the Barclays Global down 1.2% on the year. Bad play: In December, the Fed raised rates another quarter-point and indicated they may do more. Good play: within the last week, they may have completed the equivalent of a “Hail Mary” by signaling a much more dovish stance – it certainly made the stock market happy, now up 7 out of the last 9 days at the time of this writing.

Alternatives:  Like an ordinary offense playing against the mighty Chicago Bears D, alts were “sacked” in the fourth quarter as evidenced by the Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, falling 4.0% for the quarter and finishing the year down 5.1%. This is the worst showing ever for this alternative benchmark. Frankly, we are shocked with this draw-down, chalking it up to 2018 going down as the year where there was no place to hide. Gold*, Managed Futures**, and Merger Arbitrage*** proved to be good diversifiers in 4q18, up 7.5%, 3.6%, 2.4%, respectively; but not many “W’s” (aka “wins”) for the year in alts or any asset class for that matter.

Put it all together and a balanced investor is looking at negative single-digit percentage losses on the year. Yes, 2018, in particular the fourth quarter, was a brutal one for investors. It was like we were in the Red Zone about to score an exhilarating touchdown, only for a “Pick 6” to happen. (Pick 6 is when the football is intercepted and returned into the opposing end zone.) What we learned is that “L’s” (aka “losses”) or corrections can still happen. Going into this year, many had forgotten that markets actually can and do go down. Further, markets can be volatile, down big one day, and up big the next. So what is one to do now, besides putting the rally caps on?

The answer is: essentially nothing. Be disciplined and stay the course. Or, if your asset allocation mix has fallen far out-of-line of your long-term asset allocation target mix, you should rebalance back to target buying in relatively cheap areas and selling in relatively expensive areas. Or, if you happen to have come into cash recently, by all means put it to work into the stock market. This may not be the absolute bottom, but it sure appears to be a nice entry point after an almost 20% decline from top to bottom for most stock indices. From a valuation standpoint, equities haven’t looked this attractive in years, with valuations both here in the US and around the globe below the 25-year average.

And speaking of football, it’s easy to be a back-seat quarterback and say, “maybe we should’ve done something differently” before this latest correction. But we need to remember that empirical studies show that trying to time the market does NOT work. You have to make not just one good decision, but two: when to get out and when to get back in. By pulling an audible and being out of the market for just a few days, one can miss the best of all days as evidenced by the day after Christmas when the Dow Jones went up over 1000 points. In conclusion, if you can take the emotion out of it and stay fully invested through the ups and downs; at the end of your football career, you give yourself the best chance to make it to the Super Bowl.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the iShares Gold Trust

**represented by the Credit Suisse Managed Futures Strategy Fund

***represented by the Vivaldi Merger Arbitrage Fund

Understanding Benchmarks: Why is my Portfolio Trailing the S&P 500 so far in 2018?

Many investors with well-balanced, diversified portfolios might be asking this exact question when they compare their year-to-date (“YTD”) return with that of the S&P 500. To understand the answer to this question is to understand your portfolio composition and your relative performance to a benchmark which may or may not include the S&P 500.

Per Investopedia, “a benchmark is a standard against which the performance of a security or investment manager can be measured. Benchmarks are indexes created to include multiple securities representing some aspect of the total market.” Within each asset class – equities, fixed income, alternatives, cash – you’ll find lots of benchmarks. In fact, the total number of indexes is somewhere in the thousands! That said, “when evaluating the performance of any investment, it’s important to compare it against an appropriate benchmark.” So let’s start by getting familiar with the most popular as well as the most applicable benchmarks out there.

  • Dow Jones Industrial Average: Arguably the most well-known index for domestic stocks, the Dow is composed of 30 of the largest “blue chip” stocks chosen by the editors of the Wall Street Journal. The Dow is not a good benchmark to compare your diversified equity portfolio because 1) 30 companies is a small sample given there are over 3000 publicly listed stocks traded in the US alone. 2) The Dow isn’t well diversified with a heavy influence to industrials and excludes big names like Apple, Amazon, & Berkshire Hathaway. 3) It is price-weighted, meaning a stock with a higher price will have a higher weighting in the index than a stock with a lower price. Change in share price is one thing, but absolute share price shouldn’t dictate measurement. Thus, this index is severely flawed.
  • The S&P 500: Another index for domestic stocks, composed of 500 large-cap companies representing the leading US industries chosen by the S&P Index Committee. It’s certainly not as flawed as the Dow, but it too has its own problems: the biggest being that it is market-cap weighted, meaning that a stock’s weighting in the index is based on its price and its number of shares outstanding. So as a company’s stock price rises and its market-cap grows, this index will buy more of that stock and vice-versa. Thus, the index is essentially forced to buy larger, more expensive companies and sell companies as they get cheaper. This “flaw” is great in times when large cap growth companies are hot: think about FAANG – Facebook, Amazon, Apple, Netflix, Google – these are all stocks that up until recently have soared and essentially the reason why the S&P500 heading into this month was one of the only 10% of 2018 positive areas amongst all of the asset categories Deutsche Bank tracks. (See graph below.) However, the S&P500 won’t show too well when growth is out of favor and investors emphasize value and fundamentals like they did in the 2000s, a decade when the S&P500 had basically zero return.
  • There are many other popular equity benchmarks such as the Russell 2000 (representing small cap stocks), MSCI EAFE (representing international stocks – in particular ones from developed regions of Europe, Australiasia, and the Far East), MSCI EEM (representing stocks of emerging regions), and lots more.
  • All of these above focus on a particular niche within the equity market. Therefore, none of them really make a good benchmark for comparison to your well-balanced, diversified portfolio. It’s like comparing apples to oranges! Which is why we favor the following benchmark for equity comparison purposes: MSCI ACWI (All Country World Index): This index is the one-stop shop for equity benchmarks consisting of around 2500 stocks from 47 countries, a true global proxy. It’s not a perfect benchmark, but it does get you closer to comparing apples to apples.

Next, we look at popular benchmarks within Fixed Income:

  • Barclays Capital US Aggregate Bond Index:  Basically the “S&P500 of bond land” and sometimes referred to as “the Agg”, this bond index represents government, corporate, agency, and mortgage-backed securities. Domestic only. Flaws include being market-cap weighted and that it doesn’t include some extracurricular fixed income categories like floating rate notes or junk bonds.
  • There are others, like the Barclays Capital US Treasury Bond Index & the Barclays Capital US Corporate High Yield Bond Index, that focus on their respective niche, but probably the best bet comparison for most diversified fixed income investors would be the Barclays Capital Global Aggregate Bond Index. This proxy is similar to the “Agg”, but we believe superior given about 60% of its exposure is beyond US borders. Not exactly apples to apples, but it can work.

Lastly, Alternatives:

  • For Alternatives, benchmarks are somewhat of a challenge as there aren’t as many relative to the more traditional asset classes of stocks & bonds because there are so many different flavors and varieties of alternatives. We think one of the most appropriate comparison proxies in alternative land is the Credit Suisse Liquid Alternative Beta Index. It reflects the combined returns of several alternative strategies such as long/short, event driven, global strategies, merger arbitrage, & managed futures. As such, it can be considered as an appropriate comparison tool when comparing your liquid alternative portion of your portfolio.

Now that you’re more familiar with some of the more popular and applicable benchmarks of each asset class category, you may be asking the question: which one of the above is the best for comparison to my portfolio? The answer is: none of them alone, but rather a few of them combined. In other words, you would want to build a blended proxy consistent with the asset allocation mix of your portfolio. For example, if your portfolio is 50% equities / 30% fixed income / 20% alternatives, then an appropriate blended benchmark might be 50% MSCI AWCI Index / 30% Barclays Capital Global Aggregate Bond Index / 20% Credit Suisse Liquide Alternative Beta index. Now you’re really talking an apples-to-apples comparison!

You now should be equipped on how to measure your portfolio versus an appropriate benchmark. With 90% of assets categories being down for 2018 according to data tracked by Deutsche Bank through mid-November (see graph below), most likely you are sitting at a loss for 2018. 2018 has been a challenging year for all investors. Besides a select group of large cap domestic names (that are big constituents of the S&P500), most investment areas are down. That 90% losing figure is the highest percentage for any calendar year since 1920! Yikes! This also could be the first year in over 25 that both global stocks and bonds finish in negative territory. Wow! It’s a tough year. Not every year is going to be a positive one, but history shows that there are more positive years than negative ones. Stay the course.

Our investment management team here at DWM is made up of CFA charterholders. As such, we believe in prudent portfolio management which adheres to a diversified approach and not one that takes big bets on a few select areas. We know that with this diversified approach, it’s inevitable that we won’t beat each and every benchmark year-in and year-out, but we can be capable of producing more stable and better risk-adjusted returns over a full market cycle. Further, we are confident that our disciplined approach puts the client in a better position to achieve the assumed returns of their financial plans over the long run, thereby putting them in a position to achieve much sought long-term financial success.

Have fun with those comparisons and don’t forget to lose the oranges and double up on the apples!

A True Halloween Scare: Volatility Returns to the Marketplace

Recently, we here at DWM posted a blog discussing the phenomenon that “Bull Market Runs Come in All Lengths”. Within this article, we mentioned the idea that before our current bull run ends, we may see many more pullbacks and/or corrections.

Within the current month, we have seen these types of market downturns as investor fears of upcoming mid-term elections, tariffs, rising rates,  and international economic slow-down issues have spiked levels of consumer fear (measured by the volatility index, VIX), by nearly 50% .

While this data can’t tell us whether the current bull market run is coming to an end, it opens up the opportunity to better understand just what is happening in the economy, and how we should handle times like these.

To understand the severity of market moves, there are three unique distinctions: a pullback, a correction, and a bear market, which signify downward market moves of 5%, 10%, and 20% respectively.

Over the past month, securities within all asset classes – equities, fixed income, and alternatives – have experienced one of these. On October 23rd, in fact, over 40% of the stocks in the S&P 500 were considered to be in bear market territory. Since then, markets have continued their run of ups and downs.

What can this market data tell us about the future? Unfortunately, not much. While markets tend to be cyclical in nature over the long-term, the short-term is usually marred by emotions (herd mentality, greed, and fear) rather than by solid fundamental and economic modeling. Furthermore, the risk of attempting to predict these short-term outcomes can have a serious long-term effect on the performance of an investor. Studies have shown that by missing out on only a few days strong returns in a market cycle can drastically impact the portfolio’s overall return.

Thus, in order to stay on track with long-term financial goals, one of the most successful and least anxiety-inducing ways to manage investments is to generate a financial plan, assess and re-assess risk tolerance regularly, and continually stay disciplined to these values in order to avoid making emotional and poor decisions. In conjunction with these actions, an investment portfolio needs both an appropriate asset allocation based on a client’s financial plan and has to be made up of a well-diversified portfolio that can help provide exposure to market areas, such as fixed income and alternatives, that are arenas that may still produce returns even with stocks stuck in a slowdown. The combination of these strategies can work as shields to protect both an investor’s assets, and his/her mental health during times of volatility such as today’s challenging marketplace.

At times, corrections, pullbacks, and even bear markets can actually be good things! If certain areas of the market are being overvalued, or company valuations are getting ahead of their fundamentals, pullbacks and corrections can serve as a check and balance system, to get these more in line. This makes companies, sectors, and markets more stable as they can refresh a bull market that is verging on inflating itself beyond its means.

Furthermore, a pullback, correction, or bear market move down for a certain security can provide other opportunities. For example, this month, DWM will be creating value for clients by taking advantage of tax-loss harvesting options. Tax-loss harvesting is the process of selling out of a security that has lost value since an investor first bought it, and using that loss to offset any gains that an investor realized during a tax year. This upside can serve as a nice treat to offset the “trick”-y investment arena of October.

One other somewhat notable factoid is that in the mid-term election year of October 2014, the stock market took a noticeably similar look. That of the Dow Jones down nearly 3%, rebounding, and selling off throughout, ultimately dropping into correction territory. This was quickly followed by a November post-election market boom hitting record highs for the Dow and S&P 500. Once again, while interesting to see, take these numbers with a grain of salt moving forward and looking at future returns.

All in all, keeping in mind that while volatility and uncertainty in the marketplace can be scary, maintaining a balanced, disciplined portfolio and financial plan, and staying dedicated to that plan throughout all market cycles is the key to being financially sound and minimizing the number of sleepless nights. At DWM, we proactively discuss these matters with clients, and strive to keep our clients informed, motivated, and on-target to their financial plans to help them reach their long-term financial goals. Happy Halloween!

Your “Hidden Brain” Impacts Your Politics

Hopefully, all of us will vote in the midterms on 11/6 or before. Roughly half the country will vote for Republicans (conservatives) and half will vote for Democrats (liberals.). Did you know that your choices are not only impacted by your upbringing and experiences, but also very specifically by your genes? We’re hard-wired from birth for much of our political views.

Shankar Vedantam is one of my favorite authors and commentators. He is NPR’s social science correspondent and before that a journalist at The Washington Post. His 2010 book “The Hidden Brain: How our Unconscious Minds Elect Presidents, Control Markets, Wage Wars and Save our Lives” describes how our unconscious biases influence us. I highly recommend it.

Mr. Vedantam relates the story that on a regular basis, right before an election, someone will share an article with him about how science proves that the brains of a liberal are stunted or that Republicans are less intelligent than Democrats. While those claims likely have no merit, Mr. Vedantam contends that there are “genuine psychological differences between liberals and conservatives.”

On a recent Hidden Brain telecast, Mr. Vedantam hosted political scientist Dr. John Hibbing to the show. Dr. Hibbing is co-author of “Predisposed: Liberals, Conservatives and The Biology of Political Differences.” Dr. Hibbing pointed out that differences between partisans are not limited to politics. There are generally differences in food choices, living spaces, and temperaments. Conservatives generally like meat and potatoes; liberals are more likely to prefer ethnic food. Conservatives tend to have organized rooms with things like sports memorabilia, while liberals tend to have lots more books and may not be as tidy. As far as temperament, conservatives tend to favor order and tradition and liberals tend to be more comfortable with ambiguity and change.

Then, there’s a huge difference between conservatives and liberals when it comes to threats and danger. According to Dr. Hibbing, conservatives tend to see the world with its terrorists, home invaders, drug cartels, and immigrants as a very dangerous and threatening place.   Liberals tend to believe they live in a relatively safe society.   Conservatives therefore want and need the government to help them “protect themselves and their family, limit immigration, and put lots of money into defense and law and order.” Liberals, on the other hand, are reinvigorated by immigrants coming to our country, don’t see the need to spend so much money on defense and support gun control. Conservatives and liberals read about events of the world and they simply don’t respond to them in the same way.

Mr. Vedantam chimed in: “There is a very powerful illusion that we have that the rest of the world sees the world the way we see the world. And, if they come to a different conclusion, it must be because they’re being deliberately obtuse or somehow deliberately biased, as opposed to the idea that people are actually seeing the world the same way, but reacting to it differently.” Psychologists call it a case of “false consensus” that we assume others will see the world the way we do.

People are wired differently. Roughly 30-40% of our political views come from genetics based on research by Dr. Hibbing. 60-70% comes from our environment. Mr. Vedantam has described how researchers separate the effects of biology from those of the environment. They look at fraternal and identical twins. Both sets of twins have identical initial environments, but the fraternal twins have similar but not identical genes. Data from thousands and thousands of twin pairs supports the conclusion that political views are quite “inheritable.”

Finally, brain activation patterns of liberals and conservatives are different. Dr. Hibbing has conducted tens of thousands of experiments in which he showed various pictures to individuals whose brain was being scanned. Liberals’ brains would highly activate at times much differently than when conservatives’ brains were highly active. The brain scan results alone proved “incredibly accurate in determining whether an individual was a conservative or liberal.”

Frankly, I find it very helpful to learn that political views are at least, in part, biological. Years ago, left-handers (like both my mother and father) were thought to be lazy and had their hands hit with a wooden ruler to make them write “correctly,” using their right hand. People saw left-handers as a flaw, something that needed to be driven out. Now, of course, we understand that being left-handed is very biological. Similarly with politics. Dr. Hibbing concludes: “If we recognize that others, virtually half the country, are oriented to the world in a different fashion, maybe we would be a bit more tolerant to them. This is the only way we’re going to get anywhere if we at least understand where they are coming from even if we might deeply disagree with their conclusions.”

As we approach the midterms with the vitriol rising, let’s all remember our hidden brains and those of others, particularly family and friends and show tolerance and respect to all. We may see the same world differently: our unique genes, unconscious biases and life experiences may produce different conclusions and different political preferences. Yet, we’re all Americans and we and our country will all do better if we work together.

DWM 3Q18 MARKET COMMENTARY

Get yourself fit! A diversified portfolio is like a well-balanced diet. You need all major asset classes/food groups for proper nutrition. Think of the major asset classes (equities, fixed income, alts) as your protein, carbs, and fats. If you were to load up in one particular area (e.g. carb loading), you might feel better in the short-term, but it could seriously affect your health in the long-term. And it’s the same way with investing: if you “overindulged” in any one particular area for too long; you are bound to get ill at some point. Which is a good segway for this quarter’s market commentary. Yes, US stocks – those in the large cap growth area in particular – ended the third quarter near records, but now is not the time to be one-dimensional.

But, before we dive into a proper nutritional program, let’s see how the major asset classes fared in 3q18:

Equities: Let’s start with the spicy lasagna…the S&P500, the hot index right now, which climbed 7.7% in the quarter and up 10.6% for the calendar year. However, most don’t realize that just three companies (Apple, Amazon, & Microsoft) make up one-quarter of those year-to-date (“YTD”) gains. Besides these outliers, returns in general for equities are more muted as represented by the MSCI AC World Index registering a 3.9% 3q18 & 3.65% YTD return. Emerging Markets* continue to be the cold broccoli, down 1.1% for the quarter and now -7.7% for the year. In other words, even though the headlines – which like to focus on domestic big-cap stocks, like the ones in the S&P500 and Dow – are flashing big numbers; in reality, the disparity amongst equity benchmark returns is huge this year with some areas up sizably and some areas down sizably.

Fixed Income: The Barclays US Aggregate Bond Index, was basically unchanged for the quarter and down 1.6% YTD. The Barclays Global Aggregate Bond Index fell 0.9% and now down 2.4% YTD. Pretty unappetizing. The shorter duration, i.e. the weighted average of the times until the fixed cash flows within your bond portfolio are received, the better your return. It’s a challenging environment when interest rates go up, but the Fed continues to do so in a gradual and transparent manner. Last week, the Fed raised its benchmark federal-funds rate to a range between 2% and 2.25%. We could see another four rate hikes, one for each Fed quarterly meeting, before they stop/pause for a while.

Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, increased +0.7% for the quarter and now off only 1.2% for the year. Alts come in many different shapes and forms so we’ll highlight just a few here. Gold** continued to drop, down 4.9% for qtr and now off 8.6% for year. Oil*** continues to rise, up 4.7% 3q18 & 27.5% YTD. MLPs**** jumped 6.4% on the quarter and now +5.0% for 2018. Whereas alts have not been “zesty” as of late, think of them like your morning yogurt: a great source of probiotics, a friendly bacteria that can improve your health when other harmful bacteria emerge.

So after a decent 3q18 for most investors, where do we go from here and what should be part of one’s nutritional program?

Let’s first talk about the economy. It’s been on a buttery roll as of late. The Tax Cut & Jobs Act of 2017 has created a current environment for US companies that has rarely been more scrumptious, as evidenced by earnings per share growth of 27% year-over-year (“YOY”). Unemployment clicked in at last measure at 3.9% and most likely will continue to drop in the near future. With the economy this strong, many may find it surprising to see the lack in wage growth and inflation. Wages are only up 2.8% and core inflation is up only up 2.0% YOY. Wages are staying under control as the Baby Boomers and their higher salaries exit the work field, replaced by lower-salaried Millennials and Gen Z. Part of the lack of inflation growth is because of the internet/technology that gives so much information to the Buyer at the tip of their fingers, keeping a lid on prices. Trade talk/tariffs, have been a big headliner as of late creating a lot of volatility; but that story only seems to be improving with the revised NAFTA taking shape with Mexico and Canada. Some type of agreement with China could be on the near horizon too.

This is all delectable news, but the tax stimulus effect will peak in mid-2019 and companies will have to perform almost perfectly to remain at their current record profit margin levels. With earnings a major component of valuation, any knock to them could affect stock prices. Further, the S&P500 is now trading at a forward PE ratio of 16.8x, which is north of its 16.1x 25-year average. This is not the case in other areas of the world – Europe, Japan, Emerging Markets – where valuations are actually lower than averages. If you haven’t done so already, time to put those on your menu.

It’s not only a good diet you want for your portfolio; you also want to make sure of proper fitness/maintenance, i.e. rebalancing back to established long-term asset allocation mix targets. Time to bank some of those equity gains and reinvest those into the undervalued areas if you haven’t already done so recently. Regular portfolio rebalancing helps reduce downside investment risk and instills discipline so that investors avoid “buying high” and “selling low”, a savory way to keeping you and your portfolio healthy.

In conclusion, we are in interesting times. The economy is peppery-hot, but incapable of keeping this pace. A slowdown is inevitable. The question is two-fold: how big will that slow-down be, and are you prepared for it? Now is the time to revisit your risk tolerance and compare that to how much risk is in your current portfolio. That spicy lasagna, aka the S&P500, has been a delicious meal as of late, but don’t let too much of it ruin your diet. Make sure your portfolio is diversified in a well-balanced manner. Stay healthy and in good shape by working with a wealth manager like DWM who can keep your portfolio as fit as a triathlete.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the MSCI Emerging Markets Index

**represented by the iShares Gold Trust

***represented by the Morningstar Brent Crude Commodity ER USD

****represented by the UBS AG London BRH ETracs Alerian MLP ETF

THE FINANCIAL CRISIS: 10 YEARS LATER

On September 15, 2008, Lehman Brothers imploded; filing a $691 billion bankruptcy that sent stock markets into a deep dive of 40% or more. The global financial crisis ultimately would destroy trillions of dollars in wealth- $70,000 for every single American. The deep financial trough produced the Great Recession.

Now, 10 years later, how are we doing and what lessons have we learned?

How are we doing?

Official economic statistics would say that the American economy is fully recovered. We are in a 9+ year bull market with a cumulative total return of 350%. The total combined output of the American economy, known as our gross domestic product (“G.D.P.”) has risen 20% since the Lehman crisis. The unemployment rate is lower than it was before the financial crisis. These key measurements, now a century old tradition, however, don’t tell the whole story. The official numbers are accurate, but not that meaningful.

For many Americans, the financial crisis of 2008-2009 isn’t over. It left millions of people-who were already just “getting by”- even more anxious and angry about their future. The issue is inequality. A small, affluent segment of the population receives the bulk of the economy’s harvest. It was true 10 years ago and is even more so today. So, while major statistics look good, they really don’t measure our country’s “human well-being.”

The stock market is now 60% higher than when the crisis began in 2007. While the top 10% of Americans own 84% of the stocks, the other 90% are much more dependent on their homes for their overall net worth. The net worth of the median (not the “average”) household is still 20% lower than it was in 2007, despite the record highs for the stock markets.

The unemployment rate, currently at 3.9%, does not take into account two major items. First, the number of idle working-age adults has swelled. Many of them would like to work, but they can’t find a decent job and have given up looking. Currently, 15% of men aged 25-54 are not working and not even looking; therefore, they are not considered “unemployed.” Second, many Americans are working at or near the federal minimum hourly wage- which has been $7.25 per hour since July 2009. Neither group is benefitting from low, low unemployment rates.

There is a movement to change these metrics to something more meaningful.   A team of economists, Messrs. Zucman, Saez and Piketty, have begun publishing a version of G.D.P. that separates out the share of national income flowing to rich, middle class and poor. At the same time, the Labor Department could modify the monthly jobs report to give more attention to other unemployment numbers. The Federal Reserve could publish quarterly estimates of household wealth by economic class. Such reports could change the way the country communicates about the economy. Economist and Nobel Laureate Simon Kuznets, who oversaw the first G.D.P. calculation in 1873, cautioned people not to confuse G.D.P. with “economic welfare.”

What lessons have we learned?

Mohammed A. El-Erian, the chief economic adviser at Allianz, the corporate parent of PIMCO, recently summarized, in the “Investment News,” some key lessons learned from the crisis.

Accomplishments:

  • A safer banking system due to strengthened capital buffers, more responsible approaches to balance sheets and better liquidity management
  • A more robust payment and settlement system to minimize the risk of “sudden stops” in counterpart payments
  • Smarter international cooperation including improved harmonization, stronger regulation and supervision and better monitoring

Still outstanding issues:

  • Long-term growth still relying on quick fixes rather than structural and secular components
  • Misaligned internal incentives encouraging some institutions who are still taking pockets of improper risk-taking
  • The big banks got bigger and the small got more complex through the gradual hollowing out of the medium-sized financial firms
  • Reduced policy flexibility in the event of a crisis because interest rates in most of the advanced world, outside of the U.S., are still near zero and world-wide debt is significantly higher than 10 years ago.

Yes, we’ve made some good progress in the last 10 years since the financial crisis. But, there’s still plenty of room for improvement.

Financial Literacy: Money Matters!

As you all know, we provide proactive financial advice on matters such as investment management and value-added services such as tax planning, risk management and estate planning to name a few.  Something you probably didn’t know is that earlier this year, we launched a campaign to promote financial literacy for children and young adults!  It is called the Young Investors program.  Some of our clients have recently become the first recipients of this new program!

Financial literacy is a person’s ability to recognize and use the money and other resources he or she has to get what is needed and wanted.  Another way of saying this is that financial literacy is being able to set goals for using financial resources, make plans, and use the plans to meet financial demands and achieve goals.  To achieve financial literacy, a person needs to have experiences with money.  That is why it is important that children begin to learn about money and its use when they are young.

You might not know this, but financial literacy availability for young children is scarce, primarily because the school systems lack time and budget resources to incorporate financial education into the curriculums.  In fact, only 16 states require any instruction in economics between Kindergarten and 12th grade.  Even worse, only 7 states require students to take courses in personal finance.

There’s been a greater awareness of this educational need in the past 10 years and some financial-literacy advocacy groups have begun to take some steps to fill this educational void.  Some have responded by offering summer camps to young children whose parents want to teach their children the basics of money management.  Feedback from many of the attendees is that, believe it or not, they had fun!  Of course, we want to join in on the fun, and we are also excited to be a part of the solution.

We know that a financial foundation is best achieved when started early, reviewed, as well as reinforced often.  It’s important to teach young children even before they are in school about the concept of money, and that it’s not all about spending!  For example, something simple that a parent can start as early as age 3 can have lasting effects for the future.  Consider this:

Activity: Tell your toddler that you’ll give him a cookie now if he wants it, but you’ll give him two cookies if he waits an extra ten minutes. See what he chooses and try to encourage him to wait for the extra cookie.

Lesson Learned: Be patient and wait for a bigger payoff, rather than always going for instant gratification.

Although it might not look like much, it sets the stage for a less impulsive, more thoughtful response, and hopefully not just one involving money in the future!

Thinking about the scenario above, in an article I read the other day from the Wall Street Journal on personal finance summer camps, a 12 year old boy cited some camp attendance takeaways such as stopping and pausing before making purchases and long term planning!  I suppose it’s true that small things do matter!  And more interesting feedback from the camp directors is that many children ages 10-14 didn’t know what stock and bonds were.  Some thought the investments were a form of real estate.  Clearly, more attention needs to be given to this area.

We love the opportunities these summer camps offer and hope to provide some of our own financial education to our client families year round.  With our financial literacy agenda, our Young Investor program is structured with several tiers of age appropriate interactions and dialogue starters on financial matters for our clients to have with their children or grandchildren.  Age appropriate financial suggestions, tools, links to pertinent financial articles and fun activities to engage their minds are some of the content we will be sharing.  With the importance of starting as early as possible, we literally start at the very beginning, with newly born children/grandchildren, and capture all ages through the early 20s.  Specifically, we break out the tiers in roughly 5 year intervals, so age 0-5 years is the first group, 5-10 years is next, then 10-15 years, with 15-20ish years being the last group.  Our goal is that by age 25, the child or grandchild will be more than ready to begin a lifetime of investing!

Even after your children and grandchildren start their careers, it is our hope that they will join our Emerging Investor program, where they can establish their own brokerage accounts with Charles Schwab and have some of the same great DWM advantages and services as their parents and grandparents.  We are happy to help them by protecting and growing a diversified portfolio to preserve assets and provide moderate growth with minimal risk.

With our help, the young children of today will come to ask for financial assistance and have some of the best mentors in their lives, YOU!  And we all know that money is not an elective in life, so let’s keep the dialogue going with our young generation and keep providing them with good ‘sense’!  We hope you find this program to be a valuable experience.  As always, please let us know your thoughts or if you need financial assistance with a young investor in your life.

Tax Efficient Investing

Think of these opposites:  Good/Bad.  Rich/Poor.  Gain/Loss. Joy/Sadness.  Investment Returns/Income Taxes.  Yes, Uncle Sam is happy to take all the joy out of your investment returns and tax them.  That’s why tax efficient investing is so important.

You have three types of investment accounts: taxable, tax deferred or tax exempt.  For taxable accounts, you must pay taxes in the year income is received.  Retirement accounts, IRAs and annuities are examples of tax deferred accounts, in which you pay tax on the income when you take it out. Tax-exempt accounts, like Roth IRAs and Roth 401ks, are not taxed even at withdrawal.

Strategy #1:  Know Your Bracket.  The tax brackets have changed for 2018.  The top federal marginal rate of 37% will hit taxpayers of $500,000 and higher for single filers and $600,000 for married couples filing jointly.  There can be a huge difference between taxes on current ordinary income and taxes on long-term capital gains. Capital gains are the appreciation on your holdings over time and often represent a very significant portion of your total investment return.  Securities held for over a year generally qualify for long-term capital gain taxes, which are taxed at 0% to 20%, with most investors paying 15%. The difference between ordinary and capital gains taxes on your investment income can be substantial.

Strategy #2:  Asset Allocation includes Asset “Location.”  Tax efficient investments should be in taxable accounts, tax inefficient investments should be in tax deferred or tax-exempt accounts.  For example, bonds are tax inefficient.  Interest earned on bonds in taxable accounts is income in the year received and is taxed at ordinary income tax rates.  However, bond interest earned in a tax deferred account is also taxed as ordinary income, but only at withdrawal, when presumably you might be at lower income and tax levels.  Hence, bonds should generally be located in tax deferred accounts, such as IRAs and 401ks.

Stocks are more tax efficient. First, the qualified dividends received on stocks are taxed at the capital gains tax rate, which is likely less than your ordinary income tax rate. And, second, the largest part of your investment return on equities is often your capital gain, which is also generally at 15% tax and is only paid when you sell a security.  Hence, stocks and equity funds are tax efficient and generally should be located in taxable accounts.  Conversely, holding equities in retirement accounts is not generally a good idea because even though the tax is deferred, the ultimate withdrawals will be taxed at ordinary rates, not capital gains.

Alternative investments, which are designed to be non-correlated with bonds and stocks, may generate more ordinary income than tax-efficient income.  Hence, they should generally be located in tax deferred accounts.  Tax-exempt accounts, such as Roth accounts, can hold tax efficient and tax inefficient holdings. Hence, tax-exempt accounts are already tax efficient and can hold all three asset classes; equity, fixed income and alternatives, in appropriate asset allocations without any income tax cost.

Strategy #3:  Grow your Roth Assets.  Because Roth assets are tax-exempt and, therefore, 100% tax efficient, they are the most valuable investment asset you can own; both in your lifetime and your heirs.  Roths only have investment returns, no taxes.  Furthermore, Roth accounts, unlike traditional IRA accounts, do not require minimum distributions when you and/or your spouse reach 70 ½.  Upon your passing, the beneficiaries of your Roth assets can “stretch them” by allowing them to continue to grow them tax-free. However, the heirs will be required to take minimum distributions.

Roths can be funded in a number of ways.  If you have earnings, you can make Roth contributions of $5,500 per year ($6,500 if you are 50 or over) if your income is below a certain threshold.  In addition, if you are working for a company with a 401k plan, that plan may allow Roth 401k contributions. In this case, there are no earnings limitations and you can contribute $18,500 ($24,500 if you are 50 or over.)  You can also convert IRAs to Roths.  This is done by paying income tax on the difference between the amount converted and the cost basis of the IRA. There is no limit of the amount you can convert.  The concept is “pay tax once, have the Roth grow tax-free forever.” Oftentimes this conversion takes place after retirement but before age 70 ½ and is done in an annual installment amount to keep the tax implications within a given tax bracket.   We encourage you and/or your CPA to look at this possibility.

Strategy #4:  Do an Income Tax Projection.  Tax projections are really important, particularly in 2018, with all the new changes brought on by tax reform.  The projection provides information as to your income, deductions, tax bracket, estimated taxes (to minimize surprises and penalties) and, hopefully, also possibilities for tax savings.  We prepare “unofficial” tax projections for our clients for these very reasons.  Investment management must consider income taxes.

Ultimately, your return on investments is your gross return less the income taxes.  Therefore, we encourage you to make your investment portfolio operate as tax efficiently as possible and accentuate the positive; good, rich, gain, joy and investment returns.  Rather than the negative; bad, poor, loss, sad and income taxes.  You should make yourself happy, not Uncle Sam.