DWM 4Q14 & 2014 Market Commentary

brett-blogDiversification. We talk a lot about it. It’s basically our religion when applying reasoning to investing. Diversification is a technique that reduces risk by allocating investments among various financial asset classes, investment styles, industries, and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-term financial goals while minimizing risk. As great as “diversification” is to CFA Institute practitioners, it might be just a long winded word to someone that doesn’t enjoy the occasional financial periodical. In fact, to that someone, diversification may seem pretty silly in a year like 2014 where really only a couple areas of the market stood out and made everything else seem trivial.

What am I talking about? Well, if you haven’t heard by now, the S&P500 just racked up another double-digit year, gaining 13.7% in 2014. However, the rest of the equity markets, weren’t close to this. In fact, the average US stock fund was only up 7.6% and the average international stock fund was down 5.0% for 2014. In other words, besides a few dozen mega-cap stocks that powered the market-cap-weighted S&P500, most stocks were up for the year, but only modestly.

Frankly, like I’ve said before, the S&P500 is not the best benchmark for a diversified investor. A better barometer or benchmark may be the MSCI ACWI Investable Market Index which captures large, mid and small cap representation across 23 developed markets and 23 emerging markets countries. With 8603 constituents, the index is comprehensive, covering ~99% of the global equity investment opportunity set. For 2014, this index was up 4.16%.

Changing gears, let’s talk about bonds. Like equities, developed international exposure didn’t help much shown by the Barclays Global Agg Bond Index only posting a 0.59% return on the year. Here in the US, it unexpectedly turned out to be a decent year for bonds with the average taxable bond fund notching a 2.8% return. Long-term US Treasuries, which everyone was afraid of going into this year, did really well (+5.1% for the Barclays US Total Treasury Index) because interest rates went down instead of up as almost everyone was predicting. In fact, the yield on the 10-year Treasury Note started 2014 right at 3.0% and just dipped under 2.0% at the time of this writing! One should not expect a marked rise in US rates any time soon and the basic reason is a lack of inflation. Remember the days when we fought inflation?! Well, now it’s looking like central banks around the world need to worry about deflation. Case in point: the US has not been able to get to its 2% CPI inflation target, the biggest culprit being oil down over 50% from its June 2014 peak. New Fed Head Janet Yellen has laid the groundwork for the central bank to raise interest rates around midyear 2015, but she’ll need the economy to keep cooperating to do so.

Liquid Alternatives were a mixed bag this year. Real estate securities had a great year as most real estate related funds were up well over 10%. Managed Futures also were a bright spot with our fund of choice AQR Managed Futures, up over 9% for the year. If you were long-only commodities, it was a terrible year with energy down big with the oil drop. And some hedge fund type strategies that employ a very active approach had difficult times. For example, a manager betting on rising rates and increased inflation going into 2014, most definitely was a loser. Like any other actively managed investment, the liquid alternative managers need to be monitored closely. Again, alternatives are a prudent part of someone’s overall portfolio because of the extra diversification it brings to the table. For the record, the Credit Suisse Liquid Alts Beta Index was up 3.6%.

Turning the page to 2015, we can only truly count on one thing: increased volatility. Volatility has been very low the last few years and that most likely will change as this bull market which started in 2009 has created equity prices in the US that are above historical fundamental standards. And whereas the US economy is now on a roll – evidenced by the best hiring stretch since the 1990s boom, record auto sales, unemployment falling to 5.8%, job openings near a 13 year high, and the number of Americans working surpassing its prerecession high – there are also significant headlines our global economy still faces. Some of these concerns include China’s slowing growth, Europe’s flirtation with recession, Russian instability, a US labor force participation rate that is near the lowest since the 1970s, US wage growth which remains weak, and US part-time workers that want, but can’t find, full-time work.

We would also like to point out how there is a relation to inflation and returns. When inflation is higher, expected returns are higher and vice versa. Inflation has averaged over 4% per annum over the last 40 years, e.g. a “balanced” portfolio with a historical nominal return may be around 7.3%, but adjusted for inflation, the real return is actually 3.1%. We are in a hugely different inflation environment now where inflation is much lower, hence expected returns will also be lower. Our clients know first-hand that it is the real return that is they key and what it used for their planning scenarios.

In conclusion, now perhaps more than ever is a good time to be working with a wealth manager to keep you on track to reach your long-range goals and to prevent you from taking on unnecessary risk, like loading up in any one stock or investment style. Investing is like a marathon. You want to be well prepared, resilient, disciplined and focused in order to complete the long race. Sprinting, like short-term investing or investing in the latest fad, is really a different sport entirely, and for a lot of people, a way to quickly hurt themselves. Just as a marathoner in training benefits from a good running partner or coach, your long term results can be enhanced with the right financial advisor.

Here’s to an excellent 2015.

Turning Uncle Sam into Santa Claus

uncle sam santa clausWe hope everyone had a great Thanksgiving holiday. We certainly did. Now starts the final countdown for 2014. Only twenty-some days to Christmas, and less than 30 days left before 2015 arrives. Hard to believe. Certainly, most everyone’s calendar is packed full for the next four weeks. We just wanted to make sure that tax planning is on your list of “must do” items before year-end. Of course, tax planning doesn’t rank in the same category as giving my mother a Christmas kiss, being with my family or watching Dickens’ “A Christmas Carol” for the fiftieth time, but it is important.

Two good reasons: none of us likes surprises and most everyone wants to take advantage of every legal way to reduce taxes. By reviewing your taxes before year-end (hopefully with your CPA), you not only see roughly where you are for the year, but also learn what you might be able to do before year-end to reduce Uncle Sam’s share of your income.

Congress is making it tough on all of us this year. They have delayed action on more than 50 business and individual tax breaks that expired on December 31, 2013. These so-called “tax extenders” include provisions that allow businesses to write off the cost of substantial equipment at a faster rate, tax credits to weatherize homes and some higher education expenses to be deducted.

The tax extenders have commonly been renewed each year, often right after elections or even retroactively at the beginning of the next year. As we go to press, the jury is still out on renewal. Even so, there are some tax breaks you should consider for 2014:

  • Consider upping your charitable contributions. This could be writing a few more or larger checks and/or giving non-cash items, like clothing, furniture and even an old car.
  • Consider giving appreciated stock to charity this year. You get a deduction for the value of the stock given, not the cost. And, you don’t pay capital gain taxes on the money if you have held the security for 12 months. If you aren’t sure of the charity you want to give the funds, you can make the gift to a donor-advised fund, such as Schwab’s, which allows you to get a deduction this year and then advise on the recipient next year.
  • Consider gifts to your family. No, there is no tax deduction for gifts. But, you can give up to $14,000 ($28,000 if you are married) to as many individuals as you like before December 31 without anyone incurring any tax. And, if you would like to, you can do it all over again on January 1, 2015.
  • Consider harvesting tax losses within your portfolio. DWM clients know that we already did this for our clients last month. It was tough again this year, as most positions for our clients are showing unrealized gains. Furthermore, remember that you can’t sell a loss position and buy it back within 30 days. That’s a “wash sale” and the IRS bars you from claiming this loss.
  • Consider paying certain items before year-end. These could include items such as real estate taxes, state income taxes, college costs, and mortgage payments.
  • Consider funding your IRA or Roth early. Yes, you have until April 15th to make the contribution for 2014, but why not get it working for you as early as possible. And, consider making 2015 contributions in early 2015.
  • Consider a Roth conversion for part of your IRA funds. Pay the tax once and allow the funds to grow tax-free forever; for your lifetime and that of your descendants. Furthermore, there are no required minimum distributions from Roth accounts starting at age 70 ½. You and your tax adviser will need to look at current and expected future tax rates to determine if this makes sense for you.
  • Check your withholding. Compare your estimated taxes to how much you have withheld. If you are way under, consider taking extra withholding in your final paychecks. And, if you are way under or way over, consider revising your withholding allowances for 2015.

So, between all the holiday festivities in December, you’ve got some homework to do. Get with your CPA and review your 2014 taxes and see if you can lower them. Let’s try to make Uncle Sam start to look like Santa Claus. Cheers!

New Year’s Financial Resolutions

new years resolutions list

It’s still early in 2014- time to make financial resolutions for the New Year. Here are 11 you can make and keep:

  1. Establish/update your goal-based plan. It starts with goals- financial independence, college education, travel, etc. You add in resources, liabilities and expected time lines. You need a plan that has an excellent chance of success and that has been stress tested for potential “surprises” in the future. Our clients know that we accomplish this with our MoneyGuidePro software, which uses Monte Carlo simulations to calculate expected success and use the “play zone” and the “what am I afraid of?” screens to stress test.
  2. Review your Risk Profile. Your risk profile includes your risk capacity, your risk tolerance and your risk perception. The world and the investment landscape changes regularly. In addition, personal circumstances change over time. Hence, it is important to review your risk profile and make sure that your asset allocation conforms to it.
  3. Invest in a diversified asset allocation portfolio. Consider all three major asset classes; stocks, bond and alternatives. Within each asset class there should be sufficient diversification including, for example, small, mid and large cap U.S. stocks, international and emerging stocks, corporate bonds, international bonds, floating-rate bonds, high yield bonds, and various complementary alternatives. With the end of the 30 yr. bond bull market, allocations should be reviewed. Historical rules of thumb, such as “the percentage of bonds in your portfolio should equal your age,” very likely are not appropriate in today’s investment environment.
  4. Use a robust investment management platform. The old “set it and forget it” doesn’t work. You need regular rebalancing. Furthermore, research has shown that for equities and fixed holdings, passive management outperforms active management by roughly 1% a year, just about equal to the higher operating expenses for actively managed funds. Alternative investments, on the other hand, often are actively managed and can still provide an excellent net benefit to your portfolio.
  5. Max out your deferred accounts. Income you invest before taxes starts out with about a 40% advantage. And, often you receive employer contributions. You should max out your IRA-$5,500 for those under 50 and $6,500 for those over 50-even if the amount is not deductible. If not deductible, you might consider a “backdoor Roth.”
  6. Review your insurance. You need to review your coverages and what you are paying for them. Do you have too much life insurance or not enough? How about long-term disability, long-term care, home, auto, umbrella Have you “shopped” the policies recently to compare prices? We don’t sell insurance, but we know insurance. We regularly help our clients with this review.
  7. Review/refinance your debt. Interest rates have gone up significantly in the last year and will likely climb more in the next few years. It’s a good time to review your home mortgage and other debt.
  8. Save for college. Set up or add to a 529 plan or college account. College isn’t cheap. Also, you may want to review the investment allocation within your college funds. Typically, they should be less aggressive as the student nears college age.
  9. Plan your estate. At a minimum you need a will, health care power of attorney and property power of attorney. You may need trusts and you may need planning to minimize federal and/or state estate and inheritance taxes. A visit to an estate attorney may be a good suggestion for 2014.
  10. Simplify, organize and store records electronically. Move your banking online. Consolidate various investment accounts. Check with your CPA and shred as many tax returns and supporting documents as you can. Make PDF copies of important documents, including estate planning, business papers, tax records, real estate records, titles, personal papers (such as birth certificates) and list of key advisors and important contacts. Then, save these electronic records in at least two safe places.
  11. Get help (if you need it), to accomplish these resolutions. We’re all busy and we all have different talents and priorities. Sometimes we need an expert and/or coach. In financial matters, DWM is both. We help our clients with all of these items and more as part of our Total Wealth Management Program. If you need help, give us a call.