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Why Do-It-Yourself Investors Underperform

The results of research performed by Dalbar Inc., a company which studies investor behavior and analyzes investor market returns, show that the average investor consistently earns below-average long-term investment returns.  This is amazingly consistent no matter what time period is measured.

Their 2016 study looked at the twenty-year period ended December 31, 2015.  During this period, the S&P 500 Index averaged 8.19% a year – a pretty attractive historical return.  The average multi-asset individual investor earned a market return of only 2.11%.

 

Admittedly, this data is outdated, spanning the 20-year period from 1996 to 2015.  However, 20 years is long enough to identify a strong trend.  The data is also consistent with earlier Dalbar studies.  While asset class returns may have modestly changed during the past five years, I highly doubt that the average individual investor has evolved to the point that his or her returns wouldn’t still be sitting somewhere towards the bottom end of this chart.

I saw similar charts early on in my own investing career and instead of getting discouraged, I decided to investigate why the average retail investor performs so poorly.  It didn’t take long to realize that there are two primary issues that we all have to overcome – fear and greed.                                 

Fear and Greed

Humans are a flawed species. We’re emotional creatures.  Often, in real life, that’s a good thing.  Joy and love, heartbreak and loss, hope and longing — these are all sensations that make life worth living.  However, when it comes the stock market, emotion is best left at the door.  It leads to undisciplined, irrational decisions, and often these emotions lead to losses.

Everyone knows it’s best to buy low and sell high.  This is an easy enough principle to understand.  However, it’s not easy to enact.

Most people love price reductions when they’re available at the grocery store, in the shopping mall, or on an e-commerce site.  However, people tend to be afraid of discounts in the stock market. 

On the contrary, many retail investors are prone to the herd mentality, where there is perceived safety.  They’re willing to chase momentum, allowing the fear of missing out to overwhelm their good sense.  Far too often, the average investor has shown a willingness to sell at bottoms and buy at tops, which is why their performance is so low relative to the performance of individual asset classes.

 

Why the Underperformance?  Emotions! 

We humans are emotional creatures.  Research shows that the main reasons for the dismal performance are related to emotional and behavioral factors. Turns out, the majority of us are terrible investors when investing our own money due to the way our brain is wired.  We just simply aren’t programmed to be rational, disciplined investors.  It’s not our fault.  It’s baked into our DNA!  Humans suffer from a myriad of behavioral biases which stem from emotions that impair our decision-making processes.  As a result, we tend to make irrational decisions at the worst possible times, which in turn lead to lackluster long-term investor performance.  This flaw in our make-up impacts us continuously.  Although its less obvious during roaring bull markets, it punishes us mercilessly during bear market downturns when the ramifications of our failure to adhere to a sound plan become clearer and painfully acute.   

 

Emotional Biases 

If you are going to manage your own investments, you will need to master your emotions and behavior.  This is not easy.  It is extremely difficult to emotionally detach ourselves from our money.  Investors need to recognize the biases they are most prone to.  Below is an overview of a few of the most powerful “money-losing” biases that control our behavior, even in those circumstances when we are fully aware: 

 

Buying High

Study after study shows that when the stock market goes up, investors put more money in it.  And when it goes down, they pull money out.  This is akin to running to the mall every time the price of something goes up and then returning the merchandise when it is on sale – but you are returning it to a store that will only give you the sale price back.  This irrational behavior causes investor market returns to be substantially less than historical stock market returns. 

What would cause investors to exhibit such poor judgment?  After all, at a 7% return, your money will double every ten years (see"Rule of 72").Rather than chasing performance, you could simply have bought a single index fund, and earned significantly higher returns. 

 

Overreacting

The problem is that the human reaction to both good news or bad news is almost always to overreact.  These emotional triggers cause illogical investment decisions.  The tendency to overreact can become even greater during times of personal uncertainty; near retirement, for example, or when the economy is bad.  There is an entire field of study which researches this tendency to make illogical financial decisions.  It is called behavioral finance.  The study of behavioral finance documents and labels our money-losing mind tricks with terms like "recency bias", “availability bias” and “herd mentality”.  Human beings tend to…   

·       Exhibit a recency bias, where we overweight what happened recently and extrapolate it into the future. 

·       Show an availability bias, making us more willing to invest into stocks we can readily recall. 

·       Perceive less risk in something we have familiarity with, thus helping to explain why so many are so comfortable keeping concentrated positions in their employer. 

·       Pursue gambles that have significant upside potential, despite their improbable outcome — explaining why we continue to buy lottery tickets with a highly negative expected value. 

·       Exhibit a significant aversion to losses.  Loss aversion refers to people's tendency to prefer avoiding losses to acquiring equivalent gains: it is better to not lose $5 than to find $5.  The utility of a monetary payoff depends on what was previously experienced or was expected to happen.  Some studies have suggested that losses are twice as powerful, psychologically, as gains. 

·       Move with the herd, showing a strong bias to do what everyone else is doing, and avoid the risk that comes with being singled out — especially if there’s a bad outcome and someone needs to be blamed. 

·       Overconfidence.  Investors repeatedly overestimate their ability to predict market events.  This leads to higher frequency of trading, which typically results in lower returns. 

·       Chasing Performance.  The average investor repeatedly performs the cardinal sin of investing, which is “buying high and selling low”.  Studies show that individual investors tend to wait to invest until they see strong market returns.  By the time their money is invested, they may have missed the majority of the market increase.  On the other hand, investors tend to panic after a significant decline and usually sell out near the bottom.  Waiting too long to invest and selling on fear will inevitably hurt a portfolio’s return.   

These are but a very few of our biases that negatively impact our decision-making.  If you want to blow your mind, take a look here at the many others that make up the full and depressing list:  https://en.wikipedia.org/wiki/List_of_cognitive_biases  (P.S.  Is it any surprise that our politics are so broken when you see the complete list of cognitive biases that drive our thinking?) 

A picture (or bar chart) that’s worth a thousand words

What is a wise investor to do? 

As the research shows, most individual investors have a difficult time ignoring their emotions when making investment decisions over their own money. But if you’re one of the rare individuals that can consistently do all of the following things, you may not need professional help.  Ask yourself if you can… 

·       invest the time and energy to create, implement and stick with a thoughtfully designed asset allocation plan (known as “investment policy” in industry jargon).   

·       design your investment policy to produce an “expected return” that is consistent with your long-term goals and ability to accept risk.  Risk and volatility are inherent in investing.  There is no “free lunch”.  Risk and return are always inversely related.  Risk doesn’t always manifest itself immediately, but tends to overwhelm after long periods of complacency. 

·       select low-cost, tax-efficient index funds or ETFs to build your portfolio consistent with the asset allocation plan defined in your investment policy. 

·       rebalance your investment portfolio periodically to maintain the desired allocation, all the while being aware of the tax consequences of your actions. 

·       harvest losses periodically to build a war chest of tax loss carryforwards that can be used to mitigate the inevitable tax consequences that will result if you’re successful. 

·       ensure that each of your investment assets is located in the ideal type of account to minimize future taxes.  This is known as “asset location” (as opposed to “asset allocation”).  For example:  

o   Real estate investment trusts or REITs should always be held in tax-deferred retirement accounts since they pay high “unqualified” dividends that are subject to high ordinary income tax rates.  

o   Precious metals should ideally be located in tax-deferred retirement accounts since their long-terms gains are taxed as “collectibles” at a 28% rate rather than the regular 15% capital gains tax rate. 

o   High dividend paying value stocks and funds should be held in taxable investment accounts to take maximum advantage of the qualified dividend tax rate of 0%, 15% or 20% depending on your taxable income. 

o   Assets with high long-term growth expectations should be located in Roth IRAs or Roth 401(k)s where their long-term growth will occur completely tax free.  

·       sit tight and do nothing in periods of extreme market turmoil or other times of great personal stress.  This is when otherwise disciplined investors make their greatest mistakes that destroy their long-term average returns. 

Don’t overestimate your ability to keep fear and greed in check when managing your own money.  Even highly-skilled professional investment managers who do this for a living tend to outsource the management of their own portfolio to another investment manager.  All humans make emotional mistakes when it comes to their own money.   

Unless you have the logic and emotion-devoid disposition of Leonard Nimoy’s “Spock”, greed will slowly and deliberately cause you to deviate from your well-designed plan.  Likewise, fear will cause you to panic during periods of stress.  This is why the average investor in America fail to produce investment returns much better than the rate of inflation over long periods of time.  The past twenty years included two market crashes and several other periods of extreme volatility.  It took many investors 15 years to recover from the tech collapse of 2000 when the NASDAQ lost 78% of its value and broad US stocks fell by more than 50%.  A similar fate befell many less disciplined investors in 2008 when financial institutions collapsed, decimating investment portfolios and causing the Great Recession of 2008.  Those were the two biggest drops since 1987 and 1929.   

Significant market corrections tend to occur every 8 to 12 years.  None of us know when the next one will come, how severe it will be, or how long it will take to recover.  We can’t control returns, but we can control the risk we take to achieve them.  Absent an infallible crystal ball, asset allocation (spreading your eggs across different baskets) is a basic strategy in any well-designed investment plan.  Notice in the chart below the unpredictability of returns for each asset class from year to year.  Last year’s winner may be next year’s dog.  Or repeat for another winning year.  Putting too many eggs in one basket almost always results in broken eggs.  

Individual asset class returns in any given year are random and unpredictable.

Owning roughly equal weights of most asset classes (periodically rebalanced) produces a higher likelihood of solid and consistent returns.  I follow a discipline of investing across 7 asset classes, which I further divided into 20 sub-asset classes.  Each asset class and sub-asset class has been carefully selected based on their previous return history and their lack of correlation to each other.  Some can be expected to zig when others happen to zag.  After all, if the asset classes all performed equally, there would be no point in diversifying.  Historically this level of extreme diversification has produced returns similar to the best performing single asset class, but with much less risk and less volatility.   

In the following chart, notice that an equally weighted 7-Asset Class Portfolio produced an average annual return that was almost as high as the best performing asset class, but with (a) much less volatility (i.e. a lower-standard deviation from the mean), (b) more shallow periodic losses and (c) fewer negative years.  Although this data covers a full 46-year period, the same pattern repeats itself over any ten-year rolling period that one might choose to analyze. 

This data provides solid evidence for a well understood phenomena:  Following a disciplined investment strategy that equally weights multiple asset classes is likely to produce consistently higher returns with less stomach-churning volatility than owning any single asset class alone.   

This demonstrates a counter-intuitive but mathematically sound anomaly.  It consistently works because returns experienced by each individual asset classes tend to be non-correlated or even negatively correlated to each of the other asset classes.  Each responds differently to uncontrollable factors such as inflation, interest rates, government policy, and the ebbs and flows of dozens of other factors including human behavior.  Including them all in the mix smooths out the returns for the portfolio as a whole as those factors unexpectedly take center stage from time to time.     

Loss avoidance is the key to making this work.  Full recovery from a market loss requires a gain equal to roughly twice the magnitude of the original loss.  For example, after a 20% loss, it takes a 40% gain to return from the new lower base to get back to the original starting point.  Minimizing the size of periodic losses through effective asset allocation and routine rebalancing minimizes the size of the subsequent gain that is needed to fully recover.  One of the many pearls of wisdom dispensed by Warren Buffett is “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1”.  In reality occasional losses are inevitable, but keeping those losses shallow is the key to long-term success. 

Investing during bull markets always seems easy.   

Just ask your next-door neighbors, friends and co-workers who may not know much about behavioral science, portfolio design, market discipline, rebalancing, tax loss harvesting, the math behind Buffett’s Rule #1, and who may have forgotten the stomach-churning lessons of 2000 and 2008!  However, they marvel at their own bull market investing prowess and wonder why you would pay someone to do what they do so easily.  That is the fallacy of focusing entirely on return, without understanding the risks one took to achieve that return.  Like a bad houseguest, those risks have a way of showing up unexpectedly and with great fanfare at very inconvenient times.     

 

Yes, investing always seem easy when everything you buy keeps going up.  Flaws in portfolio design, tax efficiencies, high fund expenses, and the failures to rebalance and harvest losses are easily ignored when the markets are rising.  Rising markets hide these sins.  But even in these good years, an undisciplined investor may be leaving money on the table.  The inherent costs mount through good times and bad, but are often unrecognized until the portfolio heads south.  Only then does the importance of asset allocation, rebalancing and tax loss harvesting tend to come into sharper focus.  Lack of attention to these disciplines tends to quietly punish investors even in good markets, but can be quite painful when markets turn negative as they inevitably do from time to time.   

For those Spock-like individuals who have the skills to build and consistently maintain a well-designed asset allocation plans – and who have superhuman abilities to detach oneself emotionally from their money during periods of great stress – going it alone may be for you.  But for the other 99% of the population, including many investment professionals, their challenge is to find competent and trustworthy professional help that will put their client’s interests ahead of their own. 

It’s an industry that is known for “smoke and mirrors” sales tactics and high fees charged by commissioned brokers and insurance agents, where does one find a true professional who will put your interest first?  Here’s a foolproof formula: 

·       Competence:  Make sure that your advisor is a CERTIFIED FINANCIAL PLANNERTM.  Good investment management begins with a well-designed and comprehensive financial plan.  Only CFPs have the skillset and industry-leading resources to build such a plan.  Most others offer “financial plans” that are little more than sales tools in disguise. 

·       Integrity:  Only work with someone who is a FIDUCIARY.  Stockbrokers and insurance agents are not fiduciaries.  They may call themselves “financial advisors”, “financial consultants” or “financial solutions advisors” (nobody like the titles “salesman” or “asset gatherer”).  But make no mistake, most of the people hiding behind these titles are commissioned stockbrokers and insurance agents in disguise.  The job is to keep as much of your money as they can get away with.  Their only obligation is to recommend “suitable products” – a very low bar.  You should only do business with “Registered Investment Advisors”.  Only registered investment advisors are fiduciaries.  Fiduciaries have a legal obligation to put your interests ahead of their own.  These others do not.  Ask for their Form ADV-Part 2 (their regulatory “firm brochure”) which all Registered Investment Advisors must provide. 

·       Fee-Only:  Know how your advisor is compensated.  “Fee-only” advisors reduce conflicts of interest by fully disclosing their fees and refusing to accept product sales commissions, mutual fund trails and any other forms of third-party compensation.  Fee-only advisors are more likely to recommend products like index funds and ETFs that are much less expensive since they don’t provide kickbacks to the advisor.  Be careful of the deceptive words “Fee-Based”.  That’s a clever way of saying that they take commissions, trails and other product sales compensation in addition to the fees that you pay to them directly.  Sadly, how much they’re paid and who pays them is not required to be disclosed. 

·       Track Record:  Check out the advisor and their firm at:  

o   For CFPs:  www.letsmakeaplan.org 

o   For Commissioned brokers:   FINRA's BrokerCheck 

o   For Registered Investment Advisors:  SEC's Investment Adviser Public Disclosure 

·       Top questions to ask and other tools:https://www.napfa.org/financial-planning/how-to-find-an-advisor

  

How does your financial advisor stack up?

 Comprehensive Money Management

·       Certified Financial Planner?  YES Ö

·      Fiduciary?  YES Ö

·       Fee-only?  YES Ö

·       Track Record?  YES Ö 

·       Financial Planning?  YES Ö

·       Design and Implementation of Investment Policy Statement?  YES Ö

·       Routine Rebalancing?  YES Ö

·       Tax Loss Harvesting?  YES Ö

·       Timely Response to Your Needs?  YES Ö

·       Attention to Detail YES Ö

·       Comprehensive set of services including tax preparation?  YES Ö

·       Market-like returns with less than market risk?  YES Ö

·       Strong track record during periods of turmoil?  YES Ö

 

Thanks for trusting in me and thanks for being such a great client! 

 Bill

 

 

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Healthy, Wealthy and Wise

In recent months, many of my clients have experienced health issues that impact their enjoyment of life and plans for retirement.  Health and wellness have become a greater concern as Americans face an epidemic of heart disease, cancer, diabetes and obesity.  Long term financial planning starts with an assumption that you’ll be here to enjoy the long term.  This month’s blog, “Healthy, Wealthy and Wise” takes a detour from my usual financial topics and shares my own evolution in seeking greater knowledge of health and wellness.  I’d like my own life to be full of health, wealth and wisdom.  My goal is to help you achieve or maintain the same. 

More than 35% of the US adult population is clinically “obese”.  That figure is up from 23% in 1962.  https://en.wikipedia.org/wiki/Obesity_in_the_United_States 

It gets worse.  The percentage of the US adult population clinically diagnosed as simply “overweight” is even higher and rising very quickly.  It was 39% in 1997, 45% in 2004, 57% in 2007 and 66% in 2010.  The National Center for Health Statistics at the CDC says this figure is expected to reach 75% in 2020 and 85% by 2030.   

Obesity in the United States is a major health issue, resulting in numerous diseases, specifically increased risk of certain types of cancer, coronary artery disease, type 2 diabetes, stroke, as well as significant increase in early mortality and economic costs. While many industrialized countries have experienced similar increases, obesity rates in the United States are the highest in the world.

More than half of all Americans will eventually succumb to heart disease.  Another 1/3 to cancer, diabetes or stroke.  These “lifestyle diseases” are diseases of affluence.  They rarely occurred hundreds of years ago.  Today they are nearly unheard of in less affluent parts of the world such as rural China and most of Africa where the populations eat mostly unprocessed whole plant-based diets.  Americans spend more per capita on health care, yet our health outcomes are lower than most developed nations and many nations in the under-developed world. 

Nutrition is a very hot topic.  Diet books are perennially best sellers.  Almost every magazine and newspaper features nutrition advice.  Given the barrage of information, are you confident that you know what you should be doing to improve your health?  For most of us the answer is no.  There is too much conflicting information out there.  It’s easy to become confused.

Health and nutrition have been on my mind for some time.  While I am first and foremost a financial advisor, many of my conversations with clients often drift toward their health and wellness.  America has a health problem.  So do many of my clients. 

I’m a prolific reader.  For the past twenty years I’ve read (or listened to) dozens of books on financial planning, investment management and economics.  This probably doesn’t surprise you.  I’ve also read (or listened to) dozens of books on health, diet and healthy lifestyles.  That may be a surprise.

The most impactful of the financial books I’ve read was What Wall Street Doesn’t Want You to Know by Larry Swedroe.  The ground-breaking principles I learned in that book literally launched my career as an independent fee-only financial advisor and investment manager.  A Random Walk Down Wall Street by Burton Malkiel, The Investors Manifesto by William Bernstein, and The 7Twelve Portfolio by Craig Israelson are three more of my favorites.  These and other books helped me overcome years of misinformation and the effects of a steady diet of corporate ‘Kool-Aid’ designed to benefit their own bottom lines.  These books opened my mind to the smoke and mirrors that characterizes much of America’s financial services industry and made me a better financial advisor and investment manager in the process.  Wall Street and the financial news media have a financial interest in keeping us both entertained and confused.  They focus their efforts almost entirely on stock picking and fortune telling -- what Jane Bryant Quinn refers to as “investment pornography”.  They emphasize what is sexy and fund rather than what is truly important.  More knowledgeable investors focus their efforts on asset allocation, routine rebalancing and the use of low-cost, tax-efficient index funds and ETFs.  This doesn’t have sizzle and doesn’t line the pockets of Wall Street Wizards, but it works.      

In the financial world, there are a few simple truths.  Anything that deviates from those truths invites confusion.  The same is true in the world of health and wellness.  After dozens of false starts, I’m now confident enough of my knowledge in this area to share it with you.    

We are now in an era of lifestyle medicine – a trend toward eating mostly unprocessed whole plant-based foods combined with moderate daily exercise.  This simple yet powerful lifestyle combination can reverse or undo the most common chronic diseases as well as to help prevent them.  I’ve learned that decades of randomized controlled trials by dozens of researchers definitely prove that radically simple lifestyle changes can often have greater impact than do drugs or surgery, and without the negative side effects.  Most of the things we know or think that we know were brought to us by years of steady propaganda from the meat, dairy and pharmaceutical lobbies designed to benefit their bottom lines.  Let’s call that “nutrition pornography”.  Both the financial services profession and the nutritional community suffer from similar afflictions. 

I’m amazed and inspired by how and why these simple lifestyle changes are so powerful, how far ranging their effects can be and how quickly people can show measurable improvements – often in just a few weeks or even less.  Research is showing that many of our most chronic and debilitating diseases, and even aging at a cellular level, can be slowed, stopped or even reversed by lifestyle medicine.  This includes reversing severe coronary heart disease, reversing type-2 diabetes, reversing, slowing or stopping the progression of early stage non-aggressive prostate cancer, reversing high blood pressure, reversing elevated cholesterol levels, reversing obesity, reversing some types of early stage dementia, reversing some auto-immune conditions, and reversing emotional depression and anxiety.  Hundreds of compelling studies have been published in peer-reviewed medical and scientific journals and presented at the most well-respected physicians’ conferences. The world is beginning to take notice.

Science is a powerful tool for raising knowledge and awareness.  Peer reviewed scientific research is the best answer to what is often the biggest obstacle – skepticism that simple lifestyle changes can result in such powerful, far-reaching and measurable improvements and how fast you can look and feel better.   I’m taking the risk of laying out my convictions and sharing my own reading list in the hope you’ll take the first step of reading or listening to one or more of these books.  My hope and expectation is that they will inspire and empower you as each of these books did for me.  These books will help you rise above the noise and misinformation that we’ve fallen victim to when it comes to our own health and well-being.  Each book has something different to offer, but they share a common prescription – following a mostly whole food, plant-based lifestyle is the key to your long-term health and longevity.

Imagine a world where Pfizer or Johnson & Johnson came up with a single pill that prevented or reversed most common diseases and extended life an average of 12 to 15 additional years.  What would you be willing to pay for such a pill?  That outcome exists if you open your mind to the possibility that much of what you know or thought that you knew may be wrong.  Trust me when I tell you that a little humility and an open mind on this subject can be life-saving.  Take that first step and read or listen to one of these books or watch one of the documentaries listed below.

Note:  I listen to most of my books through an app at www.audible.com.  I find that much more convenient as I can cover a lot of ground while at the gym, shopping for groceries, or driving in the car.  The links listed by each title allow non-subscribers to download the app and listen to one book for free without joining.  These same titles are available in print or kindle at www.amazon.com.

Here are my favorites:

The China Study by T. Colin Campbell, Ph.D., biochemistry, nutrition, and microbiology.  Campbell is a senior science adviser to the American Institute for Cancer Research and sits on the advisory board of the Physicians Committee for Responsible Medicine.  http://a.co/2XKRTTS

The Engine 2 Diet, NY Times bestseller by Rip Esselstyn, former firefighter and world-class triathlete http://a.co/0aGFxOb

How Not To Die by Michael Greger, MD  http://a.co/bbWR5N

Eat to Live by Joel Fuhrman, MD http://a.co/ip35ZZe

Undo It! By NY Times best-selling author Dean Ornish, MD http://a.co/4VBLn2p

If you prefer to begin by watching a movie instead, here are some good choices available on YouTube, Netflix or Amazon

Forks Over Knives: “Medicine is not something that comes in a pill bottle, it’s what you put on your plate. Rather than treat the symptoms of chronic disease, a diet focused on whole, plant foods have the potential to reverse it altogether”.  Watch the trailer: http://amzn.to/2Bxhjk4

Vegucated: “Understanding the impacts of their choices can motivate people to make more permanent changes to their diet and the way they think about food”.  Watch the trailer:  http://amzn.to/2i0WKnB

Eating You Alive: “Once people make the connection between food and health, their world can be changed completely”. Watch the trailer: https://www.youtube.com/watch?v=M8sGE5n-i1

Food Choices: “Your relationship with food will likely be changed forever”.  Watch the trailer:  http://amzn.to/2AgfPwf

What the Health: “Focusing on the debilitating chronic diseases that an overwhelming number of Americans are experiencing, What the Health shares how a plant-based diet has the potential to completely change the health of a nation and the world”. Watch the trailer: http://amzn.to/2i4Lx5u

Plant Pure Nation:  “This documentary pulls the curtain back on the corporate interests behind the food industry and how that influences laws and social norms”.  Watch the trailer: http://amzn.to/2zRsQgY

Chow Down: “Highlights the journey of three people who attempt to reverse their heart disease and diabetes by adhering to a plant-based diet”.  http://amzn.to/2k8RJgR 

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Broken Eggs

We face a looming retirement crisis that will impact millions of elderly and soon-to-be elderly Americans, as well as our children and grandchildren who will have to bail out those generations.

The Facts:

Overall Population

·        78% of Americans live paycheck to paycheck.

·        1 in 4 don’t set aside anything for savings each month.

·        Nearly 3 in 4 say they’re in debt, and over ½ say they think they will always be.

·        Nearly 8 in 10 of Americans are “extremely” or “somewhat” concerned about affording a comfortable retirement while two-thirds believe there is some likelihood of outliving retirement savings. (Northwestern Mutual) 

Pre-Retirees

·         48% of households in America headed by individuals at least age 55 have no retirement savings. 

·        In order to maintain our standard of living post-retirement, we need to have saved at least 11 times our income by age 65. That means saving 15 percent to 17 percent of income across your working life. (Research done by Aon Hewitt and the University of Georgia)

·        60% of pre-retirees in America aren’t on track to achieve even 8 times projected income, a very conservative estimate of bare bones retirement preparedness (National Institute of Retirement Preparedness) 

·        We face a looming retirement crisis that will impact millions of elderly and soon-to-be elderly Americans, as well as our children and grandchildren who will have to bail out those generations.

·        By 2035, and for the first time in U.S. history, Americans over the age of 65 will outnumber our children.  With increasing deficits as far as the eye can see, its unlikely that our kids will be up to that challenge. 

·        The US government is currently spending $1 trillion more every year than it takes in.  With the bulk of that going to defense, social security, Medicare and interest on our $22 trillion in debt, it’s a mathematical certainty that taxes will be higher for future generations than they are today.

·        Even those who think that they are okay may be at risk.  More Americans in history have placed their retirement nest eggs in a single basket – US stocks.  The current bull market is now the second longest in US history and US stocks have never been this expensive by almost any measure.  That begs the question.  What will happen to their nest eggs when a recession strikes and they have no time to recover?

How Did This Happen: 

·        Steadily growing life expectancies is one reason.  Someone who retired in the 1950s probably didn’t expect to live beyond their late 60s or early 70s, but odds are now about 50-50 that someone retiring today will live into their 90s.

·        There has been a dramatic widening of the wealth gap between the top 20% and the rest of America.  While America as a whole has been getting richer, the vast majority of Americans have not.  The 540 billionaires in the US now control 64% of all US wealth.  These 540 people, which could easily fit in an average size movie theater, now have more wealth than the bottom 240 million Americans combined. 

·        For the majority of those 240 million people, the cost of living has risen much more dramatically than incomes.

Average Americans are treading water:  “Despite some ups and downs over the past several decades, today’s real average wage (that is, the wage after accounting for inflation) has about the same purchasing power it did 40 years ago. And what wage gains there have been have mostly flowed to the highest-paid tier of workers.”  --  Pew Research Center 

But the problem isn’t just the cost of living due to inflation; it’s that the “real” cost of raising a family in the U.S. has grown incredibly more expensive with surging food, energy, health, and housing costs.

Researchers at Purdue University recently studied data culled from across the globe and found that in the U.S., $65,000 was found to be the optimal income for “feeling” happy. In other words, this was a level where bills were met and there was enough “excess” income to enjoy life. (However, that $65,000 was based on a single individual. For a “family of four” in the U.S., that number was $132,000 annually.) 

Gallup also surveyed to find out what the “average” family required to support a family of four in the U.S. (Forget about being happy, we are talking about “just getting by.”) That number turned out to be $58,000.

Skewed by the 1%

The issue with the Census Bureau’s analysis is that the income numbers are heavily skewed by those in the top 20% of income earners. For the bottom 80%, they are well short of the incomes needed to obtain “happiness.” 

The chart below shows the “disposable income” of Americans from the Census Bureau data. (Disposable income is income after taxes.)

So, while the “median” income has broken out to all-time highs, the reality is that for the vast majority of Americans there has been little improvement. So, if you are in the Top 20% of income earners, congratulations. If not, it is a bit of a different story.

No Money, But I Got Credit

As noted above, sluggish wage growth has failed to keep up with the cost of living which has forced an entire generation into debt just to make ends meet.

While savings spiked during the financial crisis, the rising cost of living for the bottom 80% has outpaced the median level of “disposable income” for that same group. As a consequence, the inability to “save” has continued.

So, if we assume a “family of four” needs an income of $58,000 a year to “just get by”, that becomes problematic for the bottom 80% of the population whose wage growth falls far short of what is required to support the standard of living, much less to obtain “happiness.” 

The “gap” between the “standard of living” and real disposable incomes is more clearly shown below. Beginning in 1990, incomes alone were no longer able to meet the standard of living so consumers turned to debt to fill the “gap.” However, following the “financial crisis,” even the combined levels of income and debt no longer fill the gap. Currently, there is almost a $3300 annual deficit that cannot be filled.

This is why we continue to see consumer credit hitting all-time records despite an economic boom, rising wage growth and historically low unemployment rates.

The mirage of consumer wealth has not been a function of a broad increase in the net worth of Americans, but rather a division in the country between the Top 20% who have the wealth and the Bottom 80% dependent on increasing debt levels to sustain their current standard of living.

Nothing brought this to light more than the Fed’s own report on “The Economic Well-Being Of U.S. Households.” The overarching problem can be summed up in one chart:

More Money

Of course, by just looking at household net worth, once again you would not really suspect a problem existed. Currently, U.S. households are the richest ever on record. The majority of the increase over the last several years has come from increasing real estate values and the rise in various stock-market linked financial assets like corporate equities, mutual and pension funds.

However, once again, the headlines are deceiving even if we just slightly scratch the surface. Given the breakdown of wealth across America we once again find that virtually all of the net worth, and the associated increase thereof, has only benefited a handful of the wealthiest Americans. 

Despite the mainstream media’s belief that surging asset prices, driven by the Federal Reserve’s monetary interventions, has provided a boost to the overall economy, it has really been anything but. Given the bulk of the population either does not, or only marginally, participates in the financial markets, the “boost” has remained concentrated in the upper 10%. The Federal Reserve study breaks the data down in several ways, but the story remains the same – “if you are wealthy – life is good.”

The illusion by many of ratios of “economic prosperity,” such as debt-to-income ratios, wages, assets, etc., is they are heavily skewed to the upside by the top 20%. Such masks the majority of Americans who have an inability to increase their standard of living. The chart below is the debt-to-disposable income ratios of the Bottom 80% versus the Top 20%. The solvency of the vast majority of Americans is highly questionable and only missing a paycheck, or two, can be disastrous.

While the ongoing interventions by the Federal Reserve have certainly boosted asset prices higher, the only real accomplishment has been a widening of the wealth gap between the top 10% of individuals that have dollars invested in the financial markets and everyone else. What monetary interventions have failed to accomplish is an increase in production to foster higher levels of economic activity.

It is hard to make the claim the economy is on the verge of acceleration with the underlying dynamics of savings and debt suggesting a more dire backdrop. It also goes a long way in explaining why, as stated above, the majority of Americans are NOT saving for their retirement.

“In addition, many workers whose employers do offer these plans face obstacles to participation, such as more immediate financial needs, other savings priorities such as children’s education or a down payment for a house, or ineligibility. Thus, less than half of non-government workers in the United States participated in an employer-sponsored retirement plan in 2012, the most recent year for which detailed data were available.”

But more importantly, they are not saving on their own either for the same reasons.

“Among filers who make less than $25,000 a year, only about 8% own stocks. Meanwhile, 88% of those making more than $1 million are in the market, which explains why the rising stock market tracks with increasing levels of inequality. On average across the United States, only 18.7% of taxpayers directly own stocks.”

With the vast amount of individuals already vastly under-saved, the next major correction will reveal the full extent of the “retirement crisis” silently lurking in the shadows of this bull market cycle.

This isn’t just about the “baby boomers,” either.

Millennials are haunted by the same problems, with 40%-ish unemployed, or underemployed, and living back home with parents.

In turn, parents are now part of the “sandwich generation” who are caught between taking care of kids and elderly parents.

But the real crisis will come when the next downturn rips a hole in the already massively underfunded pension funds on which many American’s are now solely dependent.

For the 75.4 million “boomers,” about 26% of the population, heading into retirement by 2030, the reality is that only about 20% will be able to actually retire.

The rest will be faced with tough decisions in the years ahead.

What Can We Do?

·        First, individuals and families must make saving for retirement a priority. It can be difficult to think about your 401(k) or IRA when you're living paycheck to paycheck, but putting a little bit away each month will make all the difference. The earlier you start saving, the better off you'll be 

·        The long-term solution lies in the adage "time is money," or at least the opportunity to make money.  If you put in a little bit in savings each year starting at a young age, it will add up to a lot of money by the time you're 65 years old – and much more than if you start saving for retirement when you're 40 or 50 years old. 

·        A recent CNBC.com article showed the benefits of starting saving for retirement at 25 or 30 years old.  A $650 monthly deposit into a 5 percent compounding account will yield $1 million after 40 years.  A little over $10 dollars a day (the price of an average dine-in lunch) would yield half a million dollars.  Run those same numbers over a 20-year period, and the results are $267,000 and $132,000, respectively.  

·        The answer is obvious: start saving early, even if it's a small amount, and get regular tax-free savings.

·        The last day for 2018 contributions to your Roth IRA is April 15th.

   Congress must act as well. 

·        This retirement crisis is not news for policy makers. 

·        Senators Tom Cotton (R-AR), Cory Booker (D-NJ), and Todd Young (R-IN) have developed a bipartisan package of common-sense bills that would help boost retirement security for individuals and families. It was strongly endorsed by the Bipartisan Policy Center. I hope these bills are reintroduced in Congress this session because they are needed.

·        Congress needs to invest in hard working families by helping make sure they can save for retirement now, so they will be set up for success in later years. But it also must be careful to avoid further complicating an already overly-complicated retirement savings system.

·        The dirty little secret is that government can provide all the incentives in the world for workers and families to save for retirement. But none of it will matter unless those workers and families make saving for retirement a priority as well.

·        Lastly, and perhaps most importantly, inequities in our tax system – which were compounded by the Tax Cuts and Jobs Act of 2017 – made a huge problem even worse.  Fixing those inequities will need to become a priority if we hope to avoid serious economic consequences and social unrest.   

Prefer the cartoon version?  “Meet the Broken Nest Egg”:  https://youtu.be/kmtjJVC_niI?t=32

 

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What Do I Own and Why Do I Own It? 2019 Update

In times of economic turmoil and financial market upheaval, it’s a good idea to take a deep breath and reflect on this question.  Understanding what you own and why you own it is the first step toward building confidence and conviction.  Confidence and conviction are always tested during periods of market volatility.  The more you understand about the design of your portfolio, the better you’ll sleep at night when the world around us appears to be coming unglued.  

Before we look inside your portfolio, let’s first review a few principles.  It is important that you first have this foundation to fully understand what you own and the role it serves in your portfolio:

Principle #1: None of us can accurately predict the future.  This might come across as common sense, but deep down none of us really believe it.  We are all human beings who tend to follow our “gut”.  That in turn is heavily influenced by media reports, crowd psychology and an unfortunate human tendency to extrapolate recent trends well into the future.  If one of our investments drops unexpectedly, fear sets in and we emotionally project that it will go to zero.  When another investment rises to new highs, greed takes over and our gut tells us it will keep going to the moon. The truth is that nobody can reliably and consistently predict the future, but that never stops us from trying!

Principle #2: Human emotions always trump logic when they are at their most extreme.    Our gut feelings offer a false confidence that is heavily driven by consensus opinions that were likely formed by reading, listening and watching what the masses are saying.  It’s hard to go against the consensus.  Even if the consensus proves to be right, any advantage you might gain by following it was lost as the markets have long since re-priced to reflect consensus.  The expected result is already baked in.  Going against consensus, when you are right, can be quite rewarding.  

Principle #3: Attempting to ‘Beat the Market’ is a Fools Game.  The market is by definition the sum of all investors, each of which has multiple votes based upon the size of their financial commitment.  The sum of all investors set a price for each investment based on all the known information about that investment and all other known environmental factors.  The price is determined and constantly fluctuates in a tug of war between those who are bullish and those who are bearish, with the big players who have the greatest knowledge and resources dominating the game.  The rest of us are just casual observers.  It is foolish for any of us to think we can correctly guess the winner, not just once or twice, but time and time again.     

Principle #4: Diversified Portfolios = Safety.  If none of us can consistently and accurately predict the future, and if the prices of all investments already reflect all the known information that is available, the ONLY reasonable strategy is to spread our money around and not make any big bets.  Putting all of your eggs in one basket is a get rich quick strategy that rarely works other than for a very lucky few, most of whom later lose it all in the next round.  Diversification is known in investment circles as the only true “free lunch”.  It is a strategy to mitigate risk and to slowly and steadily move forward one step at a time, with only a few steps back every now and then.  It’s a strategy that avoids big losses and improves your likelihood of reasonable gains over the longer term.

Principle #5: Over time, the law of averages prevails.  Investors who stick with managers, allocation strategies and a rebalancing plan achieve better risk-adjusted returns and will end up richer.  Putting all your eggs in the stock market is great when it’s on a tear, but don’t be fooled by short-term results.  It’s the old fable of the tortoise and the hare.  Steady, disciplined and consistent always win over time.

Principle #6: Don’t obsess over the losers.  Diversification means that some of your investments will do very well and others may do less well or even poorly.  That is by design.  It’s impossible to know the outcomes in advance.  Expect this to happen and don’t obsess over the losers.  And whatever you do, don’t dump those that go down!  They are likely tomorrows winners as they are now out of favor and bargain-priced.  It’s a peculiarity of human nature that we feel better buying things that are now expensive and dumping things that are now cheap!  

Principle #7: The smartest guys in the room build disciplined models and follow them religiously.  Two of thesmartest in the universe are David Swenson who manages the $27 billion Yale endowment fund and Jack Meyer who does the same for Harvard’s $36 billion fund.  Their strategies are quite similar, so much so that many investors now refer to what they do as “The Ivy Portfolio”.  The Ivy Portfolio is famous for its simplicity and discipline.  It equally weights a large number of asset classes and regularly rebalances back to those equal weights.  Each asset class is chosen due to its lack of correlation to the other asset classes, not to the investment manager’s predictions for how well that asset class will do in the future.  In less formal terms, some are likely to zig while others are likely to zag.  Each asset class will respond differently to changing economic conditions, government policies and investor psychology.  Equal weighting is designed to combat our human tendency to tell ourselves stories about why one will do better than the other (predicting the future).  Equal weighting allows the markets to set prices based on all the known information.  Equal weighting acknowledges that to favor one asset class over another is another way of saying that you know better than the markets.  We do not.

Principle #8: Volatility is our new best friend.  Following a disciplined process reduces our reliance on emotion and prevents us from making bad decisions in periods characterized by the emotional extremes of greed and fear.  In fact, the volatility that brings out these emotions becomes our best friend.  Big drops in any one asset class require us to accumulate more while it’s temporarily cheap.  Big increases in any one asset class force us to take some of our chips off the table before it comes back down to earth.  

Principle #9: Learn from how the smart guys on the block manage their money.  Our current model portfolios embrace the Yale and Harvard methodology.  All of our model portfolios embrace diversification and require disciplined rebalancing back to the target percentages.  However, the design of the old models did occasionally make bigger bets in one direction or another (inflation versus deflation, dollar strength versus dollar weakness, etc.).  Sometimes that worked to our advantage, sometimes not.  Our newer models equally weight twenty different asset classes as the base case, with modest deviation from those targets based only on individual investor considerations.  The portfolio is highly diversified across asset classes (breadth) and highly diversified within each asset class (depth).  The strategy relies on a disciplined rebalancing process to maintain our weightings over time.  We sell what goes up and buy more of what went down.  We let the markets set the appropriate price without second guessing our equal weightings.  We let rebalancing do the work for us and make our buy sell decisions.  It is the opposite of a “predict the future” strategy.  We don’t have to constantly guess if the markets have it right or have it wrong.  

10 Twenty – Diversified Investment Portfolios with a Plan.  

Ten model portfolios are available for my diverse set of clients, each of which includes twenty distinct asset classes.  A chart comparing the models is attached as the last page.  Each asset class was chosen with an eye toward reducing correlation to the other asset classes.  The goal was to have some asset classes in the mix that would respond favorably to almost any potential future scenario.  The default model is called “Balanced” and requires an equal 5% weighting to each asset class.  The other models are more or less conservative or aggressive and make adjustments to account for individual investor risk tolerance, need for return, and other circumstances.  Rebalancing is performed primarily in tax deferred retirement accounts when possible.  We also look to harvest losses in the taxable portfolio to offset other positions that have taxable gains.

The asset classes are divided into the categories of equities, fixed income and real assets with all asset classes assigned to one or the other.

Equities – aka the “Engines”

Equities do especially well in periods of better than anticipated economic growth.  They do poorly when growth falls short of expectations.  Notice that it is the difference between the expectation of growth and the actual growth that drives the price of equities.  Equities can do poorly in periods of strong growth when their prices had already discounted strong expected growth.  Likewise they can perform well in periods of weak growth and when the economy is doing poorly as long as they perform somewhat better than the lowered expectations.  There are 8 asset classes in our model that fall under the category of equities:

Broad-based Companies

1.       Large U.S. companies (5%): U.S. large capitalization stocks have been the best performing asset class in the world in recent years after coming off a decade of flat performance that generated a measly 2% average return per year during the period from 2000 to 2010.  The strong recent performance is largely due to flight capital from Europe and Asia looking for greater safety in the U.S. dollar and our historically more stable economic and political systems.  By some accounts, this rally is long in the tooth as U.S. stocks (like Johnson & Johnson and Exxon for example) are at least 30% more expensive than their European counterparts (like Bayer and Royal Dutch Shell).  This defies logic since these companies have relatively equal prospects given that they sell similar products to the same customers all around the world.  The U.S. companies that make up the S&P 500 are trading at a price that equates to a 2% dividend yield, whereas the 500 largest European companies trade at a price that produces a dividend closer to 3%. Overemphasizing this asset class while its trading at premium valuations relative to others is making a big bet that U.S. companies will continually and consistently grow faster than the markets already lofty expectations.  That seemingly ignores the headwind of a higher U.S. dollar that will make U.S. exports more expensive to the rest of the world.  Meanwhile, international companies in similar business will see their exports to the U.S. surge as their prices become more competitive compared to their U.S. counterparts.  The allocation decision isn’t about patriotism; it’s about the laws of economics.  Rubber bands stretched too far tend to snap back, as do valuations of any one asset class when pushed to extremes. 

 

2.       Small and Medium size U.S. companies (5%):  Smaller companies tend to outperform larger companies over time, and value-oriented small stocks tend to outperform growth-oriented small stocks over time.  Those are well established truisms that have been accepted for decades.  We include small and medium sized companies in our portfolio to take advantage of these probabilities.  We also follow a value tilt when portfolio size justifies a larger number of separate investment assets in the mix.

 

3.       International developed market companies (5%): Currently priced at a 30% discount compared to their U.S. competitors, this asset class looks to be a better bet relative to U.S. equities at current prices. 

 

4.       Emerging market companies (5%): Despite greater instability and volatility, it is important to have some exposure to the portions of the world that are growing.  And some are on fire.  Literally and figuratively!  Latin America has added more citizens to its middle class in just over two years than Texas has residents.  Mexico, despite all its bad press, is a rising manufacturing power.  Frontier markets like the Philippines, Indonesia and Africa may well be the next big boom.  But right up front I will say we shouldn’t toss around the phrase “BRIC” – Brazil, Russia, India and China – as an investable class.  The acronym should stand for “bloody ridiculous investment concept”.  Those four countries couldn’t be more different in terms of education, history, natural resources, economic policies, work culture, respect for rule of law, demographic, or market outlook.  Russia and Brazil thrive on high energy costs; India and China suffer from them.  If treating that small group as homogeneous is silly; treating the other 150 or so developing and frontier markets as a unit is downright absurd.  The various countries of the world will follow their own unpredictable paths.  We will focus on the more stable “global blue chips” that know their markets better than any U.S. company could.  We also favor ETFs that focus on companies that closely tied to emerging market consumers.  Young populations of upwardly mobile consumers are part of the demographic trends that favor growth for these consumer-focused companies.

Natural Resource Companies.  Heavily leveraged banks and insurance companies come and go.  Software and other tech companies are only as good as their continued ability to innovate.  Retailing and the fashion industry is littered with winners and losers.  Natural resource companies, by comparison, are unique for their mundane, predictable and relatively stable businesses and strong stable and growing dividends.  They also provide a degree of inflation protection that most other equities do not.  These unique characteristics set them apart.  For these reasons, we carve them out from the universe of broad-based equities and give them a category of their own. 

5.       Energy companies (5%): Developed economies need energy to transport goods, feed people and provide all the benefits of modern lifestyles.  It takes ten times more energy to produce a meat diet than a diet based on rice alone.  Producing and delivering energy is a stable business that generates strong and growing dividends over time.  There is a reason that Exxon has grown to become one of the largest companies in the world. Unlike other industries, the original players are all still around in one form or another. We can’t say that about almost any other industry.

 

6.       Food and Farmland companies (5%): The big argument for it is easy to guess: the demand for food will continue to skyrocket as frontier and developing economies progress, and as rising middle classes of China, Africa and the Middle East demand better and more reliable sources of protein.  By one measure, if every person in China ate two extra eggs a week, it would require all the grain Canada currently produces just to feed the chickens!  And, food aside, farmland is also in demand for biofuel production.  Annual returns from farmland have been very strong in recent years, somewhere in the mid-teens when you include cash rents, profit-sharing income, and appreciation.  The inflation benefits are obvious, for both the annual income stream and, more importantly the residual value.  That leads some people to call farmland “gold with a coupon.”  The bad news is that there has already been a big move in prices, especially for the best located: prime Iowa acreage may be in a bubble, with prices reaching as high as $20,000 acre earlier this year.  On the other hand, the worldwide ratio of arable land per person keeps dropping, from almost three acres per person in 1960 to about one now, while developing demand for its output is nearly certain to rise.  

 

7.       Timber Companies (5%):  Timber companies provide strong income streams along with inflation protection.  The headline here is simple: Harvard has a $3 billion dollar allocation to timber, an enormous 10% of its endowment.  After tremendous success in the US woodlands market, buying from paper mills that needed cash and then selling out to other endowments and pension plans that awakened to the value, Harvard headed to Romania and New Zealand and reloaded.  It’s now stomping around the forests of Brazil looking for even more.  Timber is special.  It is perhaps the only asset class that can do four distinct jobs:  It’s an outstanding hedge against inflation.  It throws off a steady income stream with only modest effort.  It is a fundamental way to play the expansion of the world’s economies.  Finally, it’s a surprising play on green technologies as new and unexpected markets for wood products are continually developed.  Somewhat counter-intuitively, “green” regulations are creating a push toward timber as a “renewable energy resource.

 

8.       Water and Environment Companies (5%):

 

Water: All evidence seems to indicate that people really do enjoy water.  Too bad, because only about 1% of it on the entire planet is potable.  You already know that the supply is under incredible and growing pressure from increasing populations.  The exact reason that’s true, however, is a bit surprising.  It’s not so much that people drink more water, or even use it for other purposes like bathing.  It’s that as the demand for protein food sources increases, the need for fresh water to create it explodes:  from this point of view, in fact, eating a hamburger is the same as taking a 12 hour shower.  Given exponential growth needs, water may the ultimate liquid investment!

 

Environmental Services: More people on the planet living a middle-class lifestyle means more waste and more pollution, pure and simple.  Companies that clean up the planet will be in demand for eons to come. 

Fixed Income – aka the “Brakes”

Fixed income in the form of cash and bonds adds stability to portfolios.  They also provide much needed liquidity in times of market turmoil, becoming the fuel that we need to purchase other assets when they happen to be down.

9.       Cash (5%):  Cash is the first fuel we use when rebalancing.  It also provides liquidity for distributions for those who are retired from the workforce.  It grows naturally from accumulated dividends.  

 

10.   U.S. bonds (5%):  U.S. bonds offer deflation protection, but can be hurt significantly in periods of rising interest rates and increased inflation expectations.  For that reason, we have shortened the maturity (known as duration) of our bond holdings in general.  We also emphasize short and medium-term inflation protected bonds over nominal bonds that lack inflation protection.

 

11.   International developed market bonds (5%):  International bonds currently offer higher yields than their U.S. counterparts.  We limit our portfolio primarily to foreign government bonds and inflation-protected foreign bonds to mitigate default risk and inflation risk.  Foreign bonds also offer diversification away from the U.S. dollar which can at times be a plus and at other times a minus.  For that reason, we favor a mix of 50% currency hedged and 50% non-currency hedged international bonds.  

 

12.   Emerging Market bonds (5%): There are many reasons that emerging market debt instruments bear so much higher rates of interest than U.S. obligations.  Partly it’s the perceived safety of U.S. instruments, and partly, it’s fear of inflation in the issuing country. And then there’s the currency risk that you’re taking on in those foreign jurisdictions.  But it’s very hard to ignore four or five extra percentage points of interest these days.  Besides, these are not your father’s emerging markets.  Emerging market countries are actually in much better shape financially than their developed country counterparts.  Most are creditors, not debtors.  Additionally they have younger populations and fewer retirees to support, which should enhance their growth prospects when compared to the west. We favor 50% dollar denominated emerging market bonds and 50% in local currencies.  

Real Assets – the “Diversifiers”

Real assets are physical, as opposed to financial.  Even in periods of modest inflation, currencies (and the financial assets measured by them) lose value, real assets hold theirs.  

Real Estate and Infrastructure: 

13.   U.S. Real Estate (5%):  REITs are tax advantaged pass-through vehicles that collect rent and mortgage payments from every part of the real estate world including residential and commercial, with subcategories like health care, luxury resorts, shopping malls and even self-storage.  REIT dividend rates are higher than bond yields, which makes them susceptible to rising interest rates.

 

14.   International Real Estate (5%):  International REITs operate exactly like US REITs except that they own property outside the U.S.  They are currently paying significantly higher dividend yields than U.S. REITs due to the perception of greater safety in the U.S. than in European and Asian markets.  

 

15.   Global Infrastructure (5%):  In many parts of the world, infrastructure such as bridges, power plants and even airports are owned by public companies.  These generate returns over long periods of time from user fees, royalties, rents, and shares of government tax income.  The good news, and the bad, is that you usually have a governmental partner:  That can provide monopoly power, but also some uncertainty… politicians have been known to change their mind on occasion.  Outside the U.S., many smart folks believe infrastructure is the very best way to profit from the developing economies of Asia, Latin America, Eastern Europe and Africa.  Immature economies will suffer from fits and starts as they adjust to capitalism and therefore can be a roller coaster.  Long-term infrastructure projects might be safer, with water and energy infrastructure the surer bet.  

 

16.   U.S. Oil and Gas MLPs (5%): Master Limited Partnerships or MLPs are a unique and very underappreciated asset class.  Congress created special vehicles back in the ‘80s to spur energy infrastructure construction, and could almost say that they went overboard bestowing investor incentives to kick-start that effort.  MLPs trade publicly, do not pay entity-level tax, pay out nearly all of their net income directly to unit holders, and can actively manage energy businesses to grow distributions.  The most interesting sort of MLP for most investors are those active in the “midstream” sector.  These companies provide pipelines, storage facilities, and other plumbing to move energy products around the country.  That should keep revenue growth cooking and help this group maintain its long history off increasing distributions by something like 5% to 10% per year.  The yields they generate for investors are tax-favored since they are treated as a “return of capital”.  A 6% yield suddenly looks more like 8% or 9% after considering this tax benefit.  The annoying thing is that it’s harder to figure out how to buy each MLP.  Pure MLPs generate a K-1 and can be a little messy around tax time.  MLPs in the form of ETFs are much simpler to work with but do lose part of their tax advantage. 

 

Commodities and Alternative Strategies

17.   Precious Metals (5%):  Is gold a good investment?  I don’t know: Is insurance?  In both cases you’re spending dollars to protect against something you very much hope doesn’t happen.  Obviously, the one great and undeniable advantage of gold is that, over many centuries and indeed throughout human history, it has generally retained its value against the vagaries of paper currencies.  There is quite an active little argument about whether gold “is money”.  It certainly has some fantastic characteristics that make it a natural candidate for that role; it’s difficult to produce, there are limits on the supply, it is incredibly durable (98% of all gold ever found in civilization is still kicking around), its fungible, easily divisible, measurable, and transportable.  But it has also proven time and time again to be quite volatile.  So gold is insurance in our portfolio, nothing more.   Whether it qualifies as an investment, or merely a smart thing to do, is just semantics.  But do remember that nobody would recommend paying lavish insurance premiums without something to insure.  Same with gold.  It protects your financial assets from confiscation through devaluation at a time when many central banks are experimenting with unprecedented money printing on a scale never before seen.  Gold has risen by as much as 100% per year, and has fallen by as much as 25% per year, in just the few years that we’ve owned it.  I’ve come to believe that 5% in gold and other precious metals is enough insurance for most portfolios as too much can make for a bumpy ride. 

 

18.   Commodities (5%):  Physical commodities tend to behave differently than stocks and bonds, which is a good thing when you’re looking for diversification.  There have been many times in history when stocks and bonds were both declining in value, while commodities did the reverse.  Energy commodities were terrific performers during the 1970’s and early 1980’s even while world economies were stagnant.  Over time, energy should become more and more expensive as demand will increase with a growing middle class and the costs of extraction continue to rise.  There may still be plenty of oil and gas left in the ground, but it’s getting harder to find and more expensive to extract over time.  That suggests that energy prices should rise over time at something more than the rate of inflation.  

Commodities in general are a great diversifier.  They exhibit a low correlation to almost every other asset class.  That alone is enough of a reason to include them in our portfolio.  Increasing demand for agricultural and other food products, not to mention potential currency depreciation, add to their allure.  This category is also where we park other alternative strategies that may be appropriate from time to time including private equity, long short funds, merger arbitrage, and other hedging strategies.

19.   Thematic Strategies: We are entering a decade when technological innovation and powerful demographic trends are likely to significantly impact our world.  Companies are struggling to adapt to these new realities.  Some will be successful and others not.  Traditional investing focuses primarily on geography (US vs International) and company size (large, medium and small cap) as differentiators of performance.  A thematic approach shifts the focus to investments that stand to benefit from rapidly evolving demographic and technological changes.  We are heading toward a future that includes self-driving electric vehicles, genomic alteration that will extend life expectancy, robots that more efficiently and accurately perform functions than their human counterparts, and artificial intelligence that offers implications beyond our imagination.  Think of how Uber, Amazon and Facebook have already changed our lives.  There is much more to come.  Thematic strategies focus on identifying disruptive innovators with the potential to create exponential growth and profitability.  Such companies demand at least a modest allocation in any diversified portfolio.

 

20.   Hedge Strategies: For years, hedge fund managers have engineered financial strategies to protect portfolios from the bear markets that occur from time to time. These strategies come in a variety of flavors, but their common element is a goal of providing positive returns that are uncorrelated with stocks and bonds.  Common hedge strategies include 

a.       “long-short” equity strategies that take long positions in stock that are expected to appreciate and short positions that are expected to decline.  

b.       merger arbitrage strategies, also known as risk arbitrage, seek to profitably speculate on the successful completion of announced mergers by taking advantage of inefficiencies in the market prior to closing a transaction.

c.       relative strength/momentum investment strategies focus on buying stocks that are rapidly appreciating and quickly exiting the moment that they stop rising in value.

d.       private equity seeks to invest in privately held companies before they go public, hoping to cash in on their rapid growth before it is fully priced in the public markets.

Historically these highly engineered growth enhancing and risk mitigation strategies were only available to ultra-high net worth investors who often paid their hedge fund managers “2 and 20” (2% annual fee plus 20% of profits).  That has changed with the introduction of a low cost, high quality ETFs that replicate many of these strategies.  Our modest allocation to hedge strategies offer investment returns that are uncorrelated with public equity markets and can therefore enhance returns and reduce overall portfolio risk over time.  

Considerable thought has gone into the creation of our ten portfolio models.  The principles under which they were constructed are based on strong academic research that provides sound empirical evidence of a tendency toward superior performance and risk reduction in the real world.  If you’d like to read more about the research that underlies our strategy, I can suggest the following resources:

The Investors Manifesto by Dr. William J. Bernstein

The Ivy Portfolio by Mebane T. Faber, CAIA, CMT and Dr. Eric W. Richardson

7 Twelve – A Diversified Portfolio with a Plan by Dr. Craig L. Israelson

The Alternative Answer by Bob Rice, Bloomberg TV’s Alternative Investment Editor

Unconventional Success by David Swenson, Chief Investment Officer, Yale University

The Age of Deleveraging – Investment Strategies for a Decade of Slow Growth and Deflation – Dr. A. Gary Shilling

The Crash Course – The Unsustainable Future of Our Economy, Energy and Environment by Chris Martenson, PhD.

 

 

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Confessions of Your Investment Manager: I’m preparing for a Market Crash

As we enter the eleventh year of economic expansion, valuations in the US stock and bond markets have reached all-time highs.  Real estate construction is booming.  Cranes fill the skyline in every major city in the US and many around the world.  Unemployment is low.  Inflation is moderate.  Optimism is high. 

Meanwhile, consumer, corporate and government debt are extraordinarily high and rising, salaries are stagnant and tax revenues are falling.  These are unusual and unexpected occurrences for an economy in the later stages of a strong, central-bank-driven, economic expansion. 

Ten years after the “Great Recession”, we are witnessing the longest bull market in history, approaching ten years (or nearly 3,650 days). 

As market risks rise, complacency is in the air

After eleven years of mostly rising US stock prices, “expected future returns” (based on today’s current lofty valuation levels) are falling.  The demographics of an aging population and high levels of debt make it unlikely that future investment returns will be as strong as they have been in the past.  This is not news to those of us who are serious students of the economy and the markets. 

Each year four American institutions publish their long-term strategic economic views and market return expectations for the next 5 to 10 years.  Their predictions rely on an understanding of economic cycles, market valuation metrics, and behavioral science.  While forward looking projections into an uncertain future are rarely perfect, all four have accumulated a solid track record that adds to their credibility.  My quarterly emails always include a copy of the “Ivy Portfolio Index”, which provides historical returns of the assets classes we invest in, alongside the future “expected returns” for each of these four institutions.  This offers both a crystal clear “rear-view mirror view” of where we have been and a less clear but well-reasoned “front-windshield-view” of where we appear to be heading.   

Past and future returns

Historically speaking, a well-diversified portfolio that equally weights most major asset classes has returned between 6% and 8% for the past ten years.  However, all four institutions that publish their economic and market forecasts expect future returns to be significantly lower than that historical average:

·        Northern Trust expects a 60/40 global stock/US bond portfolio to average 5.25% for the 5 years.  

·        PIMCO expects a multi-asset portfolio to average 4% over the next 10 years.

·        JP Morgan Chase expects a well-balanced portfolio to average 5% over the next 10 years.

·        AQR Capital Management (a research firm that provides data utilized by pension plans) expects that a balanced portfolio will average 4% over the next 10 years.

There is no escaping the fact that these institutions are quite sanguine about future forward looking returns.  That reflects the current high starting prices.  In their commentaries, each institution references similar realities that impact their forecasts.  These include slowing economic growth based on aging world populations (especially in Japan, China and Europe), the end of economic stimulus and “extraordinary measures” by central banks, and (especially) the very high levels of debt around the world at a time of rising interest rates.  

Lower expected future economic returns will not be linear

It is likely that the next 5 to 10 years will witness both bull and bear markets.  There are likely to be some double-digit positive years as well as significant negative years.  That is consistent with these institutional projections – which are long term averages.  

One of my most important jobs as your financial advisor is to help reduce the negative impact of the next bear market or market crash, without exiting the markets entirely (an alternate solution that few of us can afford).

Risk management is now more important than ever

Diversification doesn’t pay off during bull markets.  It keeps you from having all your eggs in a single high performing basket.  However, diversification pays off big time when markets turn negative, as they inevitably and unexpectedly do from time to time.  

Diversification helps to limit the size of the losses when these downturns occur.  After a sizeable market loss, it can take nearly twice the percentage gain as the percentage loss incurred, just to get back to where you started.  A smaller loss guarantees a much more rapid recovery on the other end.  A smaller loss also allows you to sleep better at night when others are tossing and turning.  And it reduces the likelihood that you’ll bail out altogether.  

Minimization of losses is the most important factor in achieving strong long-term returns.  At this point in the economic cycle, wise investors and their advisors are focused primarily on risk, and should not be stretching for higher hoped for returns. 

Only one future will come to pass, but many are possible

Crashes most frequently occur after lengthy periods of economic success, when valuations are extended, optimism is high, and complacency is the norm.  After many years of strong returns, markets have become priced for perfection.  That’s nothing new.  Bear markets typically occur every 8 to 12 years when prices get ahead of themselves and investors become complacent.  Then, inevitably, something unexpected happens.  The immediate triggers vary.  Then paradigm shifts and the herd suddenly changes course.  

This is part of who we are as a species.  We move along the continuum between greed and fear at least once a decade or so.  It’s been a consistent story since time immemorial.  We’re taught this as children through stories like “The Emperor has No Clothes!” when a young boy clearly sees obvious facts that the herd chooses to ignore.  It’s illustrated in the childhood game of musical chairs when more and more players join the game only to lose their seat when the music suddenly stops.  An awareness of these all-to-human frailties is the first step in ensuring that you are prepared when old perceptions and new realities suddenly and violently come into conflict.          

Taking a few chips off the table

Of course, it would be foolish to think that I (or any investment manager) will be able to exit the markets the day before the next crash.  What I do aim to do however, is prepare and protect your portfolios as the probabilities of negative surprises rise.  It’s time for many investors (and especially those who have accumulated the majority of their total lifetime wealth) to take a few chips off the table.

After a market crash, journalists are fond of asking “What are you doing now?”  A better question might be “What did you do ahead of time to prepare?”  What a portfolio manager does ahead of a market changing event will have a much greater impact than their reaction after the fact.  The ability to successfully react and take profitable action after the event is limited (like grabbing a chair when the music stops).  

Despite our efforts, the economic cycle has not been repealed.  Nor has the ongoing battle between greed and fear.  Crashes will inevitably occur from time to time…

Crashes exist precisely because human beings are wired to become greater risk takers and increasingly complacent after long periods of strong market performance.  When logic suggests that we should take a few chips off the table, greed and complacency set in and many investors instead choose instead to double down.  This can cause the music to keep playing longer than expected.  Frankly, it may continue for some time.  As valuations become increasingly stretched and expectations rise to unsustainable levels, markets become increasingly vulnerable to unexpected negative events.  And then it ends.  How much sand can you add before the last grain of sand collapses the entire pile?       

Are we there now?  Perhaps not, but we’re definitely closer than yesterday.  At the crux of this debate is the fact that every bear market is different.  Soul searching, regulation and legislation is imposed after each episode, never before the crash occurs.  Post-crash models are developed to perfectly spot (with hindsight) the last crash, but often the focus point is no longer correct for the next crisis.  

The global system is complex and dynamic.  I’m confident that the next crash will result from a separate set of vulnerabilities than the last.  That said, the lessons of history are not to be dismissed out of hand.  I’m convinced that it’s important to study and understand market valuation tools and the history of economic cycles to help us prepare.

How will we know when a bear market is just around the corner?  

Economists cite four main indicators that can signal changing probabilities.  Right now, all four are flashing red or yellow.

The four main indicators:

·        Corporate behavior – Mergers and acquisitions, initial public offerings and corporate stock buy-backs are always good to keep an eye on.  There is strong evidence that most of the gains in the US stock market in recent years have been a direct result of financial engineering via stock buybacks.  Generally, markets do a pretty good job of determining prices.  That assumes there is a fairly diverse group of buyers and sellers and that each act in its own economic self-interest.  In real life, however, this is not always the case.  In recent years there has been a mind-boggling increase in corporate buy backs.  Corporations tend to buy back stock regardless of economic value, thereby distorting stock prices.  Buybacks offer a quick way to boost executive bonuses, regardless of the risks and rewards passed on to shareholders.  They can push up prices beyond their market determined true economic value.  

 

Between 2012 and 2015, US companies acquired $1.7 trillion of their own stock, with many companies going deeply into debt to purchase their shares on the open market.  More recently buybacks have been funded by corporate tax cuts and repatriated foreign cash.  This rocket fuel was in plentiful supply after the recent tax cut, but may now be largely spent.  With interest rates rising, the price of this rocket fuel is also going higher.  With leverage ratios high, and interest costs rising, stock buybacks are likely to be fewer and less frequent in the future than we’ve seen in the recent past.  If you want to understand why US stock prices are rising much faster than they are around the world, the first thing to look at is this “elephant in the room”.  http://www.areteam.com/blog/the-elephant-in-the-room-share-repurchases

 

·        Profitability metrics – Corporate profit margins are at all-time highs.  Theoretically at least, outsized profits eventually lead to greater competition as new entrants join the market to share in the riches.  Eventually these new competitors and employees themselves demand a greater share of the pie, thereby bringing margins back down to earth.  Those are factors that have, until recently, kept profit margins relatively consistent over long periods of time, always eventually reverting back to the mean.  If history is a guide, future profit margins will decline from these currently lofty levels.  The price-to-earnings ratio is a key valuation tool.  If earnings fall or are expected to fall, stock prices will likely follow.    

 

We also know that high stock market valuations do have a negative impact on future stock market returns.  Expensive valuations should still be considered as a warning sign.  Today, Schiller’s cyclically adjusted price-to-earnings ratio (CAPE) remains the highest it’s been in all of US history at 32.70 (i.e. US companies are currently valued at 32.7 times their ten year average earnings; a record high).  This indicates the U.S. equity market is quite rich by historical standards.  That begs the question—are we near the end of this bull market or will it go higher still?  Markets do have a way of defying logic from time to time, and attempts at timing rarely work out.  

 

While CAPE is not a short-term timing tool (according to Professor Schiller’s own admission), it does help us to shape our expectations for the future.  It narrows the funnel of doubt.  Professor Schiller is on record as stating that today’s market reminds him of the Roaring 20’s and the Tech Boom of late 1990’s, both all of which ended with significant economic pain.  https://www.cnbc.com/2018/10/01/bull-run-has-echoes-of-1920s-nobel-prize-winning-economist-shiller.html

 

·       Balance sheet and credit metrics – High debt levels are rarely a good thing!  It depresses investment and places a future drag on economic activity.  Consumer debt, corporate debt and government debt in the US are all setting new records.  If growth slows, that couldn’t come at a worse time.  Central banks around the world are reducing or reversing their extraordinary accommodative policies and interest rates are beginning to rise around the globe.  They have few tools left should economies falter.  

 

The US federal government could soon pay more in interest on its debt than it spends on the military, Medicaid or social programs.  The massive run-up in debt of the past decade combined with newly rising interest rates creates a one-two punch.  

 

A growing budget deficit, made worse by the recent tax cuts, in combination with steadily rising interest rates, will put a crimp on future growth and asset prices.  With less money coming in and more going toward interest, political leaders will find it harder to address pressing needs like fixing crumbling roads and bridges or to make emergency moves like pulling the economy out of future recessions.  Within a decade, more than $900 billion in interest payments will be due annually, easily outpacing spending on myriad other programs.  Already the fastest-growing major government expense, the cost of interest is on track to hit $390 billion next year, nearly 50 percent more than in 2017, according to the Congressional Budget Office.  I thought that fact deserved both bolding and underlining!https://www.nytimes.com/2018/09/25/business/economy/us-government-debt-interest.html

 

·        Positioning – Knowing where you are in the crowd is a very useful thing.  I always attend at least a few webinars each week and listen how other managers are positioned to ascertain what the herd is saying.  Right now, the herd is mostly “all in” and somewhat euphoric.  Even well-informed and anxious advisors are afraid to pare back their equity valuations, for fear of missing out.  The final stage of a bull market can be quite lucrative to investors.  It’s also quite dangerous to advisors who can be punished in the short term by their clients if their exit (in retrospect) turns out to have been premature.  In the game of musical chairs, nobody enjoys sitting alone in a chair while the music continues to play.     

The four main indicators are all flashing red or yellow.  What now?

The four indicators provide both kindling and fuel for a bear market. But, the list isn’t exhaustive.  Something is missing, i.e., the spark to ignite the fire is needed.  The spark in 2000 was the collapse of a handful of massively overvalued start-up Dot Com companies with no earnings (i.e. “the emperor had no clothes”).  The spark in 2008 was one too many no-down-payment mortgages (the “last grain of sand”) and the last renter on earth suddenly became a homeowner and there was no one left to buy at the new record high prices (i.e. “too few chairs when the music suddenly stopped”).  Could this be where we are with the US stock market today as the baby boomers continue to liquidate holdings to finance their retirement?

How bad can it get?

None of us can say for sure what the next catalyst will be or when it will occur, but the massive and growing size of consumer, corporate and government debt in the face of rising interest rates will likely make it more severe than most people currently expect.  History offers a sobering assessment:

·        On July 8, 1933, the Dow was down to 41.22, a 90% loss from its record-high close of 381.2 on September 3, 1929.  

·        The NASDAQ Composite fell 78% over the three weeks from it’s all time high on March 10, 2000.    

·        Recall that a 50% drop requires a 100% gain to get back to even.

How many people do you know that are mostly invested in highly priced US stocks?  Have they been bragging lately about how much better they are doing than you in the markets, with your globally diversified, lower risk (and currently lower return) portfolio?  Do they understand the risk they are taking for an extra few percentage points?

My final confession today: There is no perfect answer.

Having an awareness of the lessons of history can help us prepare for the next bear market.  It gives us an idea of what we need to monitor.  As markets rise beyond expectations, we can lean away from expensive assets while being mindful of the danger.  We can regularly rebalance out of the asset classes that are rising the fastest and into those that are falling or rising less quickly.  Those actions can significantly mitigate the losses when they arrive unexpectedly.  I’m currently leaning away from expensive US growth stocks in favor of less expensive value stocks that offer greater downside protection.  We also have lower exposure to US stocks than do most US investors.

It’s likely that none of us will be able to spot the exact turning point.  This is a fact that should be accepted.  But, I believe that a good process should have investors leaning out of risk assets as valuations rise and future expected returns decline, before the exuberant market psychology changes, and before the volume of debt and corporate stock buybacks collapse under their own weight.  

The best solution:  Diversify, diversify and diversify some more.  And pay off as much debt as you can.

Yes, that’s something we’re already doing.  We invest in a very wide variety of asset classes with a history of little correlation (or better yet, negative correlation) to the others.  It does little good to diversify among asset classes if they all go up and down together at the same time.  The underperformance of the laggards is the price we pay to avoid the really big double-digit declines that occur from time to time.  Diversification provides greater stability and predictability in long term returns with considerably less volatility.

True diversification also requires that we include a healthy dose of “real assets” that should do well when inflation returns.  Inflation is especially harmful to stock and bond prices.  It is a risk that is often ignored.  

Real estate, infrastructure, commodities, precious metals and inflation-protected bonds offer protection from this monster.  If you’re looking to finance your retirement over 30 or more years, inflation is the wild card that can derail even the best financial plan.  

And lastly, which is heresy for an investment manager to say:  Your best “risk adjusted return” may simply be to pay off debt.  Talk about shooting oneself in the foot!  Isn’t that a little like Macys telling shoppers to go to Gimbels (or Amazon to bring that analogy up to date?).  Perhaps.  But I’d rather sleep at night knowing that I’ve offered you the best possible advice even if it results in less assets under management for my firm.

Paying off a 5% mortgage or a 7% car loan is the same as a guaranteed 5% or 7% investment return.  When the best minds on Wall Street are projecting 5 to 10 year expected returns at 4% to 5% (and with the possibility of short-term loss), doesn’t paying off higher rate debt sound reasonable?

What’s next?

I’ll be making modest changes in your portfolio in the 4th quarter.  

These Include:

·        Adding more inflation-protection.  I’ll be rebalancing fixed income portfolios away from nominal bonds and toward inflation-protected securities, particularly those with shorter durations carrying less market risk.

·        Lowering portfolio costs.  I’ll be adding new ultra-low cost, no-transaction fee funds from State Street and others.  Under new arrangements with TD Ameritrade, many of the newest and lowest cost ETFs in the world are now available with no transaction fees.  I’ll work to lower your portfolio costs by replacing existing funds with these new funds, especially in tax-deferred retirement accounts where capital gains taxes are not a consideration.

·        Tax loss harvesting.  The recent downturn in international stocks and bonds relative to US assets offers an opportunity to harvest losses in these asset classes even as we keep allocations unchanged.  I’ll be selling investments in asset classes that have losses and replacing them with similar investments with identical performance characteristics, generating tax loss carryforwards.  That’s the equivalent of a “free lunch”.  It may not be as tasty as a free lunch made by Chef Jae, but it puts free money in your pocket thanks to the extra efforts of Chef Bill.    

·        Increased use of alternative assets.  Your current investment policy includes an allocation for “Soft commodities and Other Alternatives”.  Other alternatives include long/short funds, market neutral funds, S&P 500 put/write strategy funds and “thematic investments”.  Many of these funds are designed to produce positive returns regardless of the direction of stock prices.  Thematic investments include investments in companies that are likely to outperform most others during a market downturn.  These include innovative companies that offer new disruptive technologies, health care and biotech companies that benefit from an aging population, and those who are focused on high growth areas such as robotics, artificial intelligence and cyber security.  I’ll be increasingly adding new ETFs that specialize in “Other Alternatives” later this year.

·        Reviewing your asset allocation.  After years of cheap money and strong investment returns, it may now be time to take some chips off the table.  We can do this by making incremental changes to your allocation model.  That involves reducing exposure to highly priced equities and increasing exposure to fixed income and real assets that typically offer more stable and/or inflation-protected returns.  I’ll contact you before year-end if I believe that changes are in order given my knowledge of your financial resources, risk tolerance and long-term goals.

All my best,

Bill

 

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Comprehensive Money Management Services LLC (“CMMS”) is a Registered Investment Adviser located in Coral Gables, Florida. The firm is registered with the State of Florida Office of Financial Regulation. CMMS and its representatives are in compliance with the current filing requirements imposed upon Florida-registered investment advisers and by those states in which CMMS maintains clients.

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