Successful Investing Strategies for Millennials

We have all heard how important it is to start saving for retirement at a young age; but what exactly does that mean? A lot of young working people will sock money away in a savings account and think they are doing the right thing. While having cash for a rainy day/unexpected life event is very important, it is not at all how to save for retirement or save for a big purchase (i.e. down payment on a mortgage/new car). The secret behind it all is something called “compounding interest”. Compounding interest is something that happens over the course of many years and is hands down the best strategy to obtaining financial freedom.

For starters, it is important to understand what kind of account you are funding. Ideally, funding both a qualified account and non-qualified account is important. Qualified accounts are tax-advantaged retirement accounts such as Traditional IRAs, Roth IRAs, and 401ks. The beauty about these accounts is that they can grow either tax-deferred (such as a Traditional IRA) or tax-exempt (i.e. Roth IRA), however they cannot be tapped until a later age without penalty. Qualified accounts also come with contribution limits so one cannot put in an indefinite amount. Although you will pay tax on earnings upon sale of investments within non-qualified accounts, the good news is that the funds are available for withdrawal at any time with no age restriction.

We understand young workers may not be able to fund both kinds of accounts early in their careers, therefore, we recommend funding the qualified accounts (retirement) first, followed by the taxable, non-retirement accounts.

Click here to learn a little more about Roth and Traditional IRA’s (qualified/retirement accounts).

The next step is to determine what kind of asset allocation aligns with your ‘Risk Tolerance Level’. We recommend consulting an investment expert, like DWM, to help determine your risk level profile (e.g. defensive, conservative, balanced, moderate, or aggressive) and the funds you should be invested in. Assuming your risk tolerance lands you in a “balanced” portfolio, you should expect a targeted long term rate of return of 6 to 8% per year. This may not sound like an enormous annual rate of return, but after compounding interest over a long investment time horizon, one is capable of achieving impressive portfolio numbers.

Now for the magic of compounding interest, what it can mean for your future, and why it is so important to start early for young workers. The best way to explain this is through an example:

If you contribute $5,500 to a Roth IRA (the max a Roth allows each year) starting at 22 years old and average 7% return per year until retirement at age 65, the $236,500 total contribution will turn into $1,566,121.

Compare that to socking away $5,500 into the same type of account, invested in the same exact funds, starting at age 40: Your account will grow to $372,220. This is still great and much better than not investing at all, but it would be a lot nicer to grow an account to over 1.5 million dollars versus less than 0.4 million dollars going into retirement.

An accepted estimate in the financial planning world is something called “The Rule of 72”. This is a quick and simple math equation that estimates how many years it will take to double an investment, given a certain annual rate of return. If we assume a 7% rate of return, we would divide 72 by 7 to come to a final answer of 10.24. So, with an annual return of 7%, it will take you a little over 10 years to double an investment. Therefore, a 25 year-old has the potential to double his/her invested money every 10 or so years from your early 20’s until retirement (4x over).

This means one would need to more than quintuple your annual income if you wait until age 40 vs. starting at 22 to make up for not putting away the $5,500 the 18 years prior (~$1.25 million) you technically missed out on.

Click here to see what amount you can achieve if you started putting $5,500 away today.

Another big misconception with saving young is “maxing out a 401(k)”. Many young workers will say they are maxing out their 401(k). However, simply putting away the 3-4% a company matches is not at all maxing out a 401(k), in fact, it is barely scratching the surface. As of 2017, the maximum employee contribution, per year to a 401(k), is $18,000- this is maxing out a 401(k). Let’s say a 25 year old makes $50,000 per year and is contributing 4% to his/her 401(k) that the company is matching. This 4% is only $2,000 per year and the match only becomes yours after it vests. It is important to understand your companies vesting schedule because in some cases it can take six years or more for that to actually be considered your money.

Another important step to saving/investing correctly is analyzing the investment menu within your 401(k). This involves studying the funds offered within a 401(k) and identifying an appropriate asset allocation target for yourself in-line with your risk tolerance. It is also important to look at the underlying fees within the funds of the 401(k). If you are in a large cap equity fund charging 70 basis points but there is another large cap fund that charges only 9 basis points, it can make a big difference over 20-30 years. Here at DWM, we do a 401(k) analysis for all clients because we understand the importance a few basis points can have on an individual and their family over the course of a lifetime.

We have all heard our millennial generation and future generations will never be able to retire because of different theories on social security and how rare pensions are today. This could not be further from the truth. We simply need to take our savings just as seriously as our expenses and we may be capable of not only retiring, but comfortably retiring and being able to leave a legacy for future generations. While a lot of millennials believe they are going to invent the next pet rock and become overnight millionaires, it might be a good idea to start saving the correct way because slow and steady does indeed win the race. 

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

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

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

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

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

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

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

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

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

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

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

MS:  Could you give us some examples?

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

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

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

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

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

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

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

MS:  Any final thoughts, Les?

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

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

LD:  Mike, I will look forward to that.

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

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

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

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

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

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

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

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

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

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

President for All Americans

0209-tiled-flag-of-american-diversity-1On the morning after the election, Donald Trump pledged that he “will be President for all Americans.”  That was a great start.  President-elect Trump has now assembled his transition team.  We’re starting to see that some of the campaign rhetoric and issues espoused by candidate Trump were not to be taken literally.  Further, with our government’s checks and balances, there is only so much one man can do by himself.  Being President of the U.S. will be much different than being Chairman and President of the Trump Organization.

First, let’s focus on four key economic initiatives we expect under President Trump: tax reform, infrastructure, trade protectionism and fiscal stimulus.

Tax Reform. House Speaker Ryan and President-elect Trump are not that far apart on tax reform.  The corporate tax (currently 35%) could end up at 20% (Ryan) or 15% (Trump).  The logic here is that lower rates would provide an incentive for American companies to repatriate profits held overseas. And, with that ready cash, they would be in a position to increase capital spending in the U.S.

On the personal side, we’d all get a tax cut.  The current seven tax brackets would be cut to three brackets. The highest bracket, currently 39.6%, would become 33%.  Tax reform could raise the standard deduction, limit exemptions and eliminate the alternative minimum tax.  And, it would eliminate or greatly reduce estate and gift taxes.

Individual tax reform is estimated to cost between $2.2 to $3.5 trillion over the next 10 years.  However, both President-elect Trump and Speaker Ryan believe that tax reform will put more money in people’s pockets and create demand which will grow the economy to offset this cost.

Infrastructure.  Further tax incentives would be given to support private funding for some of the repair and upgrading of roads, bridges and airports.  $140 billion in tax credits could provide funds for $1 trillion in infrastructure investments over the next 10 years.  And, using Standard & Poor’s formula that every dollar spent on infrastructure adds $1.30 to the economy, the plan is again for growth and more jobs.

Trade Protectionism.  Candidate Trump promised to put tariffs on Chinese imports and renegotiate NAFTA with Mexico and Canada.  He opposes the Trans-Pacific Partnership, which would eliminate most tariffs on goods from countries in the alliance.  The net effect is that retail prices may be going up soon (to cover the increased costs of foreign produced merchandise) which may push inflation perhaps to the 3-4% range.

Fiscal Stimulus. Tax reform, along with more public spending on infrastructure, will likely increase the budget deficits and drive up interest rates.  According to Jeffrey Gundlach, CEO of Doubleline Capital, and one who predicted in January that Mr. Trump would be elected President, “Trump’s pro-business agenda is inherently ‘unfriendly’ to bonds.” Mr. Gundlach predicts the 10-year Treasury note, currently at 2.27%, will be 6% in 4-5 years.

Candidate Trump said he can get the economy to grow at 4% a year, twice what it is now.  He also promised add lots of jobs and reduce taxes.  We hope President Trump can make that happen.

Second, we need to recognize that this acrimonious presidential campaign was about more than simply “pocketbook” issues.  It showed very clearly that there are also deep divides in our country over race, ethnicity and culture.  When the votes were counted, millions in the rust belt and rural regions of the country cheered their new champion.  Yet, in the urban areas, thousands of minorities, millennials and millions of women and men fear that our country may be entering a dark and divisive time. We hope that President Trump will continue to change the rhetoric of candidate Trump as he did on 60 minutes Sunday night with Lesley Stahl.  He publicly asked those harassing Latinos and Muslims to “Stop it.”

In conclusion, we hope the economy can grow and help all Americans prosper in the coming four years. We also hope that President Trump will continue throughout his term to denounce the hate in our country and promote the safety and dignity of all of our 320 million diverse people.  If he accomplishes all of this, he certainly will be the “President for all Americans.”

“You’re Hired!”

trump-youre-hired-002“You’re hired!” was something The Apprentice reality show viewers heard at the end of every season as someone emerged from a group of highly different “characters” and was chosen as the winner. In a surreal twist, Donald Trump, the star of that show, has just been hired as our next President after a surprise victory over Hillary Clinton highlighting a populist uprising defeating the status quo.

No, November has not been just a bizarre dream; although on paper, both the Chicago Cubs winning the World Series and Donald Trump winning the US Presidency, seems about as outlandish as a UFO. These events have actually happened! Donald Trump will be our next President for at least the next four years and the Cubs most certainly will become a dynasty during that time. We are in for change. But is change necessarily a bad thing? At this point, the voters have voted and we no longer have a choice. Hence, time to embrace that change. However, what does it mean for you and your money?

First off, this is not Brexit #2. Recall that the markets fell significantly following the surprising June 2016 Brexit “Leave” victory, only for the market to recover fully in several days’ time. Yes, there were times last night when market futures were down big, but it didn’t prevail. Markets opened in steady fashion this morning and are up, not down, close to 1% as of this writing.

That, too, may come as a shocker to many as until now the market had been fluctuating based on Hillary’s success chances. See, the market had been pretty cool with status quo and hesitant of uncertainty, which Trump would undoubtedly bring to the table. But if we look at what Trump will be working on in the early months of his Presidency, we can see that it’s quite possible that it provides positives:

  1. Putting forth a giant infrastructure agenda in the likes of Eisenhower
  2. Working on trade reform which will most likely lead to inflation and thereby helps the banks
  3. Working on healthcare reform – most likely replacing the Affordable Care Act with something that – well, let’s face it – has to be better
  4. Decreasing regulation which will make many corporations and financial markets happy
  5. Working on tax reform – both individual and corporate, including repatriation (bringing back perhaps trillions of dollars of American companies that are currently overseas)

Many of these are pro-growth / pro-economy and the market likes that. Furthermore, for those that feared the Trump bulldog approach, the bark we heard on the campaign trail will be bigger than the bite as there are roadblocks to the rhetoric. The legislative and judicial process tends to mute campaign promises. Trump will not enjoy unlimited power. Smart negotiations will likely be made.

The fact of the matter is that this is a healthy economy in the US right now and poised to get better. GDP is up, unemployment is down. It’s not as “gloomy” as one may feel. This new business-friendly administration coming in will look to keep that going.

In conclusion, polls and markets will remain unpredictable. Don’t let politics overrule how you invest. Here at DWM, we’ve constructed portfolios for our clients to stand the test of time. Sure, we’ll have blips here and there like Brexit and the one we were bracing for this morning that didn’t happen. Volatility will always be a part of investing. The key is to remain invested in a diversified fashion for the long-term and don’t let your emotions turn into knee-jerk reactions you’ll ultimately regret. Last night’s event may have been a bit of a shocker, but the sun did indeed come out this morning and is shining down on America. We are in for a little change. But we should embrace this change and come together as a country to make it stronger than it has been. Hey, if the Cubs can do it, why not the good ole US of A?!? “Holy Cow” as Harry Caray would say!

Happy Halloween!

halloween-moneyHappy Halloween! Halloween can be one of the best times of the year, especially if you’re creating memories with your family and friends. We all love to watch scary movies and get a little spooky on Halloween, but do you know what’s even scarier than a creepy clown on Halloween? Having poor financial habits. My name is Grant Maddox and I am a new Service Associate with DWM.  As a recent College of Charleston Business graduate with a concentration in Finance, I have learned a thing or two about spending while on a “college budget”. I have also learned through my course work how important it is to stay on your budget and not over spend.

Americans love to spend!  The 2015 Bureau of Labor Statistics reported that average spending in the U.S. across all types of expenses increased in 2015. Expenditures for food, housing, apparel and services all rose between 3.4% and 3.9%. We know the Consumer Price Index remained largely unchanged at 0.73% last year. In other words, the increase in spending was principally not the result of inflation. Instead it shows American households simply spent more in 2015.

There are many reasons why Americans may spend more – for one thing, technology has made it so much easier. As accessibility to online retail and credit options increases, so do our spending habits. You can pay with a swipe of a card or by hovering your phone over a machine!  It is eerie how easy you can spend your hard-earned dollars!  In fact, kicking off the end of year spending season is Halloween. Just how much do Americans spend on trick-or-treating and other Halloween festivities? The National Retail Federation (NRF) forecasts total Halloween spending—including candy, costumes, and decorations—to come to $7.4 billion this year. We are inundated with eye-catching campaigns to encourage excessive spending, especially during the holidays.

Establishing a budget that includes life’s essentials such as rent, utilities, food, and transportation is important for setting up yourself or your child for success. It is crucial to encourage saving early and often to gain the benefits of compounding. While many young professionals may see saving for future goals, such as a down payment on a house, as a non-priority, saving, in fact, can certainly make a huge difference. As a parent, you can even encourage your child’s saving by offering to match a percentage of their contributions to a designated savings account. These lessons can be invaluable to them as they grow older. Having direct deposits of paychecks, direct deposits to savings vehicles and automated payment schedules help us manage our bill payments and savings potential more easily.  Technology can be a wonderful attribute to our society and for our spending, when we use it wisely.

At DWM, we encourage you to plan for your major purchases and be sure that your goals are all part of a larger successful financial plan.  Looking for ways to right size your spending isn’t just about planning ahead for luxury items.  Reviewing all household expenditures to determine if they are needs, wants, or wishes is also a great practice. I look forward to learning all I can about total wealth management and helping our clients and others to achieve their financial goals.

aaeaaqaaaaaaaafdaaaajgvhztrjmmuxlwniytatnguwmy1hnjg5lwfjzdq0mjexmji0nqEditor’s Note:  Please join us in welcoming Grant Maddox to our DWM team.  Grant joined our firm in October as a service associate and is training/learning/working toward becoming a junior advisor. Welcome aboard, Grant!

Hurricane Matthew

hurricane-matthew-update-part-2

Hurricane Matthew was a scary time for DWM as it approached the US. For one, we know how devastating natural disasters can be to people’s lives, businesses, homes, and general well-being. Secondly, Matthew could potentially have directly affected our DWM family as it was expected to first touch the US in South Carolina, where half of our team and many DWM clients are located. It was an unsettling experience as our Charleston team/clients, along with much of the southeast coast, were instructed to evacuate to safety.

As Hurricane Matthew first formed as a category 5 hurricane and started its approach toward the US, analysts from JP Morgan projected it to be the second most costly US hurricane on record for insurers, behind Hurricane Katrina in 2005. To earn this devastating title, Matthew would need to reach a total of $25 billion in insured losses. While still devastating, the most recent projections from CoreLogic (a real estate data provider) estimated around $10 billion in total losses, making insured losses between $4-6 billion. If these totals are confirmed, it would make Hurricane Matthew the 22nd most devastating storm since WWII, according to a recent estimate by Goldman Sachs. By the time Matthew made landfall in the US near McClellanville, South Carolina, it was reduced to a category 1 hurricane.

Even with Hurricane Matthew having inflicted significantly less damage than originally projected, Goldman Sachs still estimates it may cost about 5,000 US jobs in October. When storms like Matthew hit, jobs in the restaurant, hotel, and education sectors normally suffer the most. For example, 30,000 jobs were lost in those sectors when Hurricane Sandy struck, however, 40,000 jobs rebounded (mainly in construction) during the rebuild of the 2012 catastrophe.

While businesses almost always suffer and sometimes risk closing their doors when catastrophes like Matthew strike, homeowners can typically expect a higher burden. “These days homeowners who live close to the coast tend to opt for a 5% deductible on the hurricane wind damage portion of their policy,” said Bob Hunter, Director of Insurance for the Consumer Federation of America. Meaning: a homeowner, whose $500,000 house was fully destroyed, would have the obligation to pay $25,000 of repair costs before the insurance company covers the remaining $475,000.

While it is good news Matthew did not strike the East Coast with the force we originally expected, that reinsurers will likely be able to cover all insured losses, and that only .003% of all jobs in the US will be affected; it all pales in comparison to the 34 lives that were lost in the US and over 1,000 lost in Haiti. DWM’s thoughts and prayers go out to all families affected during this awful natural disaster.

P.S. Our new Charleston office at Church and Broad streets came through unscathed with no damage.  And, Les, Ginny Wilson, and our newest team member, Grant Maddox, and their families evacuated and all were safe and dry.  Grant, by the way, is a recent College of Charleston graduate in finance who has had some very interesting internships.  These included a stint as deputy finance chairman for the successful campaign of Charleston’s current mayor, John Tecklenberg.  Please join us in welcoming Grant to the DWM team.

DWM 3Q16 Market Commentary

wall-street-vs-main-streetWith all the uncertainty in the news today, a human being might emotionally feel quite anxious. If you hadn’t looked at your portfolio in a while, you may assume it’s not doing so great. But your portfolio does not have emotions and, if properly constructed, is capable of producing in all environments. In fact, if your portfolio did have emotions, it would probably be feeling quite happy as 2016 has so far been a pretty good year performance-wise, at least the portfolios we supervise. The thing is that Wall Street and Main Street don’t operate on the same level. Main Street may be feeling a little down, but Wall Street on the other hand may shrug off those fears and look at the opportunities. Or vice-versa. Case in point: The recent negative feelings of Main Street don’t resonate with the recent positive results stemming from Wall Street.

After a wild finish for stocks in 2q16 thanks to the surprising June 23rd Brexit vote, the US stock market calmed down and continued upward as represented by the S&P500 gaining 3.9% for the third quarter. Other equity markets did even better like small caps* and emerging markets**, both up 9.0%. Outside of equities, both fixed income and alternative markets generally charged ahead, adding to this upbeat 3q16 report.

Let’s start with the results of the major asset classes:

Equities: The MSCI AC World Equity Index registered +5.3% for the quarter and is now up 6.6% on the year. International small cap value***, up 10.5%, was one of the best places to be in the second quarter. That said, the stars of the year remain the mid cap space****, +12.1%, and emerging markets**, +16.0%. The S&P500 underperformance trend continues.

Fixed Income: The Barclays US Aggregate Bond Index, the most recognized bond benchmark, was up 0.5% in 3q16 and now up 5.8% for 2016. Unfortunately, that benchmark doesn’t allocate to the two hot spots in bond land this year: high yield bonds, +5.6% and 15.1%, quarter-to-date and YTD, respectively, and emerging markets debt, +4.8% and 16.6%. Hence, it is prudent to construct fixed income portfolios that contain more than treasury, investment-grade corporate, and agency exposure like the “Agg” and invest into other areas that can provide diversification and potentially better returns.

Alternatives: The Credit Suisse Liquid Alternative Beta Index was up 2.1% for the quarter and 3.2% YTD. Of course, one of the key benefits of alts is that they generally don’t trade in symphony with the rest of the market. But that doesn’t mean they necessarily will go down when equities and fixed income are up, like they were in this quarter. Alts beat to their own drum. What we think is important for our clients is designing an alternatives model with multiple non-correlated alternative assets and/or strategies that collectively produce consistent positive returns.

By looking at the above results and doing some simple math, we can theoretically see that an investor; with a balanced portfolio of, say 50% in equities, 25% fixed income, and 25% alternatives; could have overall net results of 6-8% YTD. And there’s still a quarter to go in 2016! Of course, nothing is guaranteed and there is certainly “uncertainty”. Whereas Wall Street may shrug off lots of things Main Street would not, here is the short list on what is keeping those traders up at night:

  1. The Election – this really is something that is causing more anxiety for Main Street than it is Wall Street. As crazy as it may seem, the market can actually see “good” in either of the major candidates. What the market doesn’t like is a surprise. If results came out opposite of the polls ala Brexit, it could get ugly, i.e. markets would trade lower. We don’t see that happening though.
  2. The European banking sector – Is Deutsche Bank with its thin capital issues the next Lehman Brothers? We don’t think so, but those banks all trade with one another and if one major bank fails, there can be a contagion effect that could even affect us on the other side of the globe.
  3. The economy – If you looked at the companies within the S&P500 and used that as a yardstick for the US economy, you might get a little alarmed to know that 3q16 will almost certainly be the sixth consecutive quarter of falling earnings. That hurts valuations now but we’re cautiously optimistic that that trend will end soon. When actual earnings (and estimates) start to rise, the market could continue to climb (even) higher.
  4. The Fed – What’s next for the Fed? There are two more meetings this year. We think one 25 basis points rate hike is already “baked” into the market. In other words, traders are expecting it. As long as the Fed keeps communicating clearly, they and their actions shouldn’t cause that much disruption.

In conclusion, Main Street is not Wall Street. For many, this Presidential Election is bringing a lot of unnecessary anxiety and we can certainly understand why. Of course, the market is generally efficient by constantly looking ahead at expectations and adjusts accordingly. Unless there are major surprises, it tends to shrug off news that can make Main Street nauseous. So if it’s getting to be too much for you, feel free to turn off the media noise and keep it off until November 9th, the day after the Election. Wall Street will keep doing its thing. More importantly, DWM will be doing its thing, keeping our clients’ portfolios prepared for what’s next.

Brett M. Detterbeck, CFA, CFP®

DETTERBECK WEALTH MANAGEMENT

 

*represented by the Russell 2000 Index
**represented by the MSCI Emerging Markets Index
***represented by the DFA Intl Small Cap Value Fund
****represented by the Dreyfus Mid Cap Index Fund
† represented by the Barclays Capital US Corporate High Yield Bond Index
‡ represented by the PowerShares Global Emerging Markets Sovereign Debt ETF

Diabolical Financial Products

financial-diabolicalMerriam Webster’s Dictionary defines diabolical as “of, relating to, or characteristic of the devil.” Unfortunately, there are a quite a few investment products that meet that definition.  They are often overpriced, extremely conflicted, non-transparent and are sold regularly as “suitable” retirement options to gullible investors.

Here are some to avoid:

  • Front-Loaded Mutual Funds. These are usually the “A” shares of a mutual fund. An upfront fee, as much as 5.75%, goes to the brokers, so a $100,000 investment may start with a net value of $94,250.  Generally, these “actively managed” mutual funds will then charge 1%-2% in annual fees on top of this, so long-term underperformance is virtually guaranteed.
  • Proprietary Mutual Funds. These are mutual funds created by the broker.  This is cross selling at its best (or rather its worst).  Brokers extract both selling fees and much of the operating fees.  Furthermore, many of these mutual funds are not publicly listed and therefore tracking performance is almost impossible.  (Yes, non-transparency is wrapped into these mutual funds.)
  • Equity-Indexed Annuities. This is a tax-deferred investment whose credited interest (growth) is tied to an equity index, such as the S&P 500.  However, the upside is typically capped and there is usually a large potential for a substantial loss.  Add in an upfront sales charge of up to 10% and this investment becomes indeed diabolical.
  • Variable Annuities. The average contract cost is 1.5% per year.  And, because it uses actively managed funds, one needs to add another 1% or so to annual expenses.  As a result, there is a 2.5% drag on performance each and every year, at a time when equity returns are expected to be in single digits.  A losing proposition.
  • Non-Traded REITs.   Last week, our blog discussed publicly traded Real Estate Investment Trusts (“REITs”).  http://www.dwmgmt.com/real-estate-investment-trusts-reits/  Non-public REITs, on the other hand, have significantly underperformed their publicly traded cousins.  Four reasons:  Huge (up to 10%) upfront commissions, lack of transparency, higher annual fees, and illiquidity (cannot be turned into cash readily).  Run from these.
  • Hedge Funds. Due diligence is prudent before any investment in hedge funds, given hurdles such as a possible 2% annual fee plus a possible 20% charge on annual profit, along with high minimums and illiquidity.

These diabolical products cost investors trillions of dollars over time in unnecessary fees, which directly reduce performance.  They have been described as “created by foxes, sold by wolves, and bought by sheep.”

Moral:  Avoid diabolical investment products.  Choose low fees, transparency, liquidity and a wealth manager who will act as your fiduciary, always putting your interests first.  And, have fun with the little devils at Halloween.

Real Estate Investment Trusts (“REITs”)

reit-promo-type-1What do soaring rental markets, high yields and diversity have in common?  Answer: they are all part of the reason that Real Estate Investment Trusts (“REITs”) are booming.  In fact, they just became a new sector in the S&P 500 index.

For the first time since 1999, the S&P 500 index is being reconfigured; breaking out REITs from the financial sector. It makes sense, due to the unique characteristics of REITs. They own or finance property and pay no taxes, but have to distribute 90% of earnings to shareholders.  Their current yield is 3.6% more than double the 1.7% yield offered by a ten-year Treasury bond.

The growth of REITs have been accelerated by increases in renting as more people have decided to rent, not own, their houses.  Rents have increased 3%-6% per year in cities such as New York and San Francisco.  REITs have become very involved with residential real estate.  Some REITs, for example, own and rent groups of suburban single-family houses with gardens and make a substantial return doing it.

REITs have become more and more diverse. The early RE ITs of the 1960s were primarily used to own office buildings and produce a steady stream of rental income.  They were viewed similarly to bonds; drawing little interest in the 80s and 90s when stocks were providing double-digit annual returns.  Today REITs own cell towers and data centers.  Casinos and hotels have sold their properties to REITs and lease them back for their operating business.  Macy’s and McDonald’s have been receiving pressure from activist groups to do the same.

REITs have been one of the hottest investments of the last decade.  They’ve attracted $68 billion in Exchange Traded Funds (“ETFs”) since 2010; the most by any major industry classification, outpacing energy, technology and all the others. They are trading at 23 times earnings, compared with 17 for the S&P5 500 index on average.  With the influx of new cash, they have reduced their debt-to-asset ratio from 70% in 2008 to 31% today.

At DWM, we consider REITs as an alternative; neither a stock nor a bond. REITs have been part of our Liquid Alternatives model for many years.  As such, they currently represent about 7% of our clients’ alternative asset class. There is a small overlap due to the fact that REITs represent about 3% of the S&P 500 Index which clients gain exposure to via our DWM Core Equity model.  Overall, a typical DWM investor would have a roughly 1.5-3% overall allocation to REITs in their diversified portfolio.

With REITs being hot, it comes as no surprise that we’ve received questions recently wondering if now is the time to increase our overall REIT allocation.  We think not.

It’s curious.  Seventeen years ago, the S&P 500 Index added a new sector, technology, by splitting it from industrials.   This was right before the dot.com bust in March of 2000.  It took 13 years for the tech sector to return to its 1999 levels.  Similar results occurred with the Dow Jones industrial Average added Microsoft, Intel and Apple.  At the time of admission, all companies were at all-time highs, but once admitted, their values fell and it took considerable time for them to recover to those levels.

No one knows if the REIT breakout will help or hurt this sector. We do know REITs have performed well for our clients, for us and for others. We also know they have relatively high current valuations.  This is a good reason to keep the allocation where it is now and keep monitoring the situation.