#ZeroInterestRatesMatter – Party Like It’s 1999

What should an investor do? Markets are confounding.  They appear to be almost predictable. Until they’re not!

We are in an investment environment that reminds me of the technology bubble 16 years ago, and the markets are partying like it’s 1999. Today rather than focusing only on the technology sector, perhaps we should examine both the bond market and the equity markets in their entirety.

We have been trained and told over and over and over again since the 2008 financial crisis the Federal Reserve has our backs. Indeed they have engaged in unprecedented monetary policy never in my lifetime would I have thought possible.

In addition to the Fed taking on dual mandates established by the U.S. Congress of full employment and stable prices, it appears they have created numerous other policies: creation of a minimum of 2% inflation; not raising interest rates due to (fill in the blank) Brexit, various and sundry economic data, negative monthly payroll reports, concerns about foreign economies such as China, currency issues, etc.; controlling the stock market upward – Chairman Bernanke called it “The Wealth Effect.”

As a result we have been at near-zero interest rates (ZIRP) for eight years, seen the Fed buy 4.5 Trillion bond securities from money creation through various schemes called Quantitative Easing, Twist, etc. In addition we have seen major banks, both domestic and foreign, bailed out with unprecedented amounts of money. They’re even open to the possibility of NEGATIVE interest rates!

As a result of all this we have arguably the most distorted stock and bond markets in history! Both bonds and stocks are at all-time highs, and the stock market made another historic high as I write this article.

What should an investor do, and what’s not to like you may ask?

The distortion created by effectively zero interest rates can result in many unseen consequences.  The Mises Institute in “The Unseen Consequences of Zero-Interest-Rate Policy” names a number of them:

  • Conservative investors by nature come under increasing pressure with respect to their investments and take on excessive risks in light of the prospect that interest rates will remain low in the long term. This leads to capital misallocation and the emergence of bubbles.
  • The sweet poison of low interest rates leads to massive asset price inflation (stocks, bonds, works of art, real estate).
  • Structurally too low interest rates in industrialized nations due to carry trades lead to the emergence of asset price bubbles and contagion effects in emerging markets.
  • Changes in human behavior patterns occur, due to continually declining purchasing power. While thrift is increasingly mutating into a relic of the past, taking on debt comes to be seen as rational.
  • As a result of the structurally too low level of interest rates, a “culture of instant gratification” is created, which is among other things characterized by the fact that consumption is financed with credit instead of savings. The formation of wealth becomes steadily more difficult.
  • The medium of exchange and unit of account function of money increases in importance, while its role as a store of value declines.
  • Incentives for fiscal discipline decline.
  • Zombie banks are created: Low interest rates prevent the healthy process of creative destruction. Banks are enabled to roll over potentially non-performing loans practically indefinitely and can thus lower their write-off requirements.
  • Newly created money is neither uniformly nor simultaneously distributed amongst the population. This results in a permanent transfer of wealth from later receivers to earlier receivers of newly created money.

What does all this mean to investors? In my view there are two critical takeaways in analyzing these issues:

  • Extremely high stock valuations: Many corporate share buyback plans and dividend issuances have been done through the use of cheap debt, which has led to increases corporate balance sheet leverage. This will eventually end. Financial engineering like this has also reduced the amount of capital investment that results in growing companies in favor of elevating the stock price, reducing the outstanding share count, and showing better Earnings Per Share. However the dirty little secret not being discussed is we have seen 5 consecutive quarters of LOWER earnings in the S&P 500. Here is a chart from “Q3 EPS Expectations Just Turned Negative: Six Consecutive Quarters Of Declining Earnings” at Zero Hedge:

q3 eps factset_0

As a result of this distortion, the Debt-to-Earnings ratios are at the highest point of the CENTURY:

debt to ebitda ratio

  • Historically high government debt, corporate debt, and personal debt in this country. As any financial planner knows, the more debt one has the less flexibility one has in many ways, even beyond financial. That’s where we are today. I won’t bore you with a chart of U.S. Government Debt, but here’s a chart that shows the credit created since the financial crisis in “What Happens When Rampant Asset Inflation Ends?” by Charles Hugh Smith:

bank-credit2-16a

As a result of record high valuations, we look to place more emphasis on the return of your money than a significant return on your money. While there are many ways to reduce risk, here are five to consider:

  1. Reduce equity exposure in your Asset Allocation
  2. Reduce risk in the equity allocation you continue to own – some techniques are large-cap stocks vs. small-cap, reduce emerging or international markets, etc.
  3. Reduce credit risk in the bonds/fixed income you own – we already have begun to see signs of stress in the fixed income markets – we are VERY wary of any positions below Investment Grade
  4. Reduce Interest-Rate Risk – pay close attention to the maturities of bonds and fixed income in your portfolios – reduce the length of maturity to reduce interest rate risk
  5. Maintain greater than normal Cash positions – while rates are still ridiculously low, remember we are focusing on a return of your money

If you have a trusted financial advisor, we recommend reaching out to them before the end of the summer. If you’ve been partying like it’s 1999, at least get a designated driver. It’s time to reassess where you are in your own financial journey in context with where we are in the markets. If you don’t have a trusted financial advisor, we recommend a professional with the Garrett Planning Network.

Of course we are always happy to help at Financial Freedom Planners in an objective, fiduciary manner without conflict of interest!

“It doesn’t take a fortune to build one”

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Six Questions Every Proactive Investor Should Ask Their Financial Advisor

And Some Basic Math!

I felt compelled to write this article after recent meetings with two different clients. In each case, they entered into investments where high fees virtually guarantee they won’t be able to reach the projected returns, let alone their own personal goals. We’ll get to the basic math portion in a moment.

According to an article by noted attorney and investment education advocate, James W. Watkins, III, there are 19 different questions to ask your current or prospective financial advisor.  Given 19 is a rather large number, we are going to focus on six of these questions. We did touch on this in our recent post, Avoiding The Wolf of Wall Street, and this is an effort to give you additional support in this important area.

  1. Will you be acting in a fiduciary capacity in working with my account(s)?
  2. Would you be willing to agree to fully and completely disclose in writing any and all actual or potential conflicts of interest in connection with any advice or recommendations you provide?
  3. Would you be willing to disclose, in writing, both the nature and amount of any compensation, of any kind, that you receive in connection with any advice and any product recommendations you make, including commissions, fees, 12b-1 fees, referral fees, finder’s fees, trips and conferences?
  4. Are you willing to disclose, in writing, the terms of any and all revenue sharing arrangements that you, your firm, or your broker-dealer have with any other companies?
  5. In cases when you do recommend proprietary products of your firm, your broker-dealer, or an affiliated company, would you be willing to provide me with a list of comparable no-load mutual funds and/or exchange traded funds?
  6. Regardless of the eventual outcome, have you or your firm ever been the subject of a legal or a regulatory action? If so, are you willing to provide, in writing, the date(s) of such proceeding(s), the parties involved in the proceeding, the court or regulatory body in which the complaint was filed, the nature of the claimed offense, the eventual outcome and the amount of any judgment or settlement paid?

In question #1, the Fiduciary Question has received quite a bit of notoriety due to the Department of Labor recent rule. It’s purpose is to “Address Conflicts of Interest in Retirement Advice, Saving Middle-Class Families Billions of Dollars Every Year.” This is something we have covered and discussed most recently in “Is Your Financial Advisor Working For You?”

Questions 2 – 5 all are related to costs, fees and compensation, and this is where we get into the aforementioned Basic Math. I’m not going to pick on any particular financial services company, but what I’m about to describe represented $237 billion in investment in 2015, and about the same amount in 2014. That’s approximately $474 billion invested in the last two years (yes, that’s the beginning of Basic Math)! The product is annuities, and I’m going to illustrate two real-life variable annuities, some of which was in an IRA.

More math:

  • The financial advisor/agent received a commission of approximately 6-7% of your investment up front. If you invest $100,000, that’s $6 – 7,000. While they are quick to point out it doesn’t come out of your original investment, you are confronted with steep “surrender charges” in the event you want to take your money out. Typically these start out at 8 – 8.5% in the first year, and they decline by about 1% per year. In other words if you invest $100,000 and for whatever reason which to take the funds out in year 1, you will pay about $8,000. There are other strategies to get your money out that lessen this charge, but you need to keep you money in this investment for a longer time period.
  • While most people understand at least roughly the above expenses, here is where additional Basic Math is brought to bear. The following are Annual Expenses in a Variable Annuity, and are very common:

So using this as an example, if you invest $100,000 in this, you will be paying approximately $3,390 PER YEAR! If you consider the return of the S&P 500 in 2015 of 1.40%, that means you would be losing -1.99%! Obviously in better markets you would receive a positive return, but keep in mind you have 3.39% (or more) deducted each year.

In fairness, some of these expenses go into various riders and guaranteed annuity payouts, etc. However Basic Math illustrates how difficult it is to make money in these investments. In particular from our perspective, these have no place in any Qualified Retirement Plan such as an IRA.

There, I got it out of my system. Here’s a good resource piece written by a fellow CFP®, Jonathan Duong, “Variable Annuity Fees – A Guide to Help you Understand How Much You are Paying.” He outlines a concern we hear frequently, “how come my account isn’t growing?” and the reason for this article.

Please, seek out a second opinion before investing your hard-earned money into one of these investments. There are at times a place for them, but they are dramatically overused in my opinion. When looking for a second opinion, my recommendation would be a colleague from the Garrett Planning Network, and certainly we’re happy to assist you at Financial Freedom Planners!

“If you want to work the rest of your life, that’s your business.  If you don’t, that’s ours.”

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Is Your Financial Advisor Working For You?

It may be a shock the answer to this question is in many, many cases, NO. Let me explain.

There is currently much controversy in the government right now over what’s called the “Fiduciary Standard.” The word “fiduciary” comes from the Latin “fiducia,” which means “trust.” A fiduciary adviser should be looking out for the best interest of the client, and have a relationship built on total trust and honesty.

We wrote in “What Your Financial Advisor Doesn’t Want You To Know” and “The ‘F’ Word You Should Be Aware Of” about the different ways Financial Advisors are structured, and the significant difference it can make to you, the consumer. I’ve seen numerous articles talking about how few Financial Advisors and Financial Planners actually are held to the Fiduciary Standard. The general answer is NOT MANY!

The truth of the matter is: Many financial advisors and financial planners are not fiduciaries; they are brokers who are subject to a “suitability” standard. With suitability, the SEC says the financial advisor “must have a reasonable basis for believing that the recommendation is suitable for you.” This is a much lower standard than being a fiduciary, which demands that the advisor place his clients’ interests ahead of his own. This may not look like much of a difference, but it’s huge.

According to a Market Watch article, “here’s a typical example: Suppose an advisor can either sell a high-commission product or recommend a no-commission fund, both of which are suitable for the client. The fiduciary advisor will always choose the no-commission fund, because he always puts the client’s interests ahead of his own. But the non-fiduciary advisor could go either way because both products are suitable. Of course, the client will probably be worse off if the advisor selects the high-commission product, since the added costs — often in the 3%-6% range — tend to reduce total investment returns.

Think of it: You invest $1 million, your advisor makes $60,000 in an instant (based on a 6% commission), and you’re worse off. Yet his conduct is just fine under the suitability standard since the investment was suitable for you.”

That’s why you should always invest your hard-earned money with an advisor who operates according to a fiduciary standard. Your interests should always come first.

We are constantly counseling clients who have made a similar mistake, and working with them to remedy it to improve their situation. It is estimated that conflicts of interest like the above example cost investors $17 Billion per year.

Getting back to the government, there is a move under way by the Department of Labor (DOL) to require the Fiduciary Standard of anyone giving advice on a retirement plan. Most people are truly incredulous this isn’t already a requirement, but it’s not. Needless to say the financial services industry is in an uproar over it, and fighting tooth and nail to stop this.

Some insurance companies are threatening to get out of the annuity business, and one already has announced it is doing so. Not only is the industry against it, as reported by Reuters, believe it or not the “U.S. Chamber of Commerce is ready to sue over the retirement adviser rule” (fiduciary requirement).

U.S. News & World Report reports some don’t believe the fiduciary rule goes far enough: “Susan Fulton, founder of FBB Capital Partners in Bethesda, Maryland, says broker commissions, and human nature itself, impede transparency under the suitability model. Like many other RIA founders, she left the broker-dealer world to become a fiduciary, establishing her firm in 1989 before the RIA model was well known. She says there are too many inherent conflicts left unaddressed by the suitability standard.”

As a consumer, what should you do? It is our belief the all advisors should be fiduciaries. The client should always come first. So do some homework either on your current advisor, or someone you’re considering (or both). Here are some pointers from MarketWatch:

  • Ask your advisor: “Do you always act according to a fiduciary standard? Are you legally bound to act in my best interest?”
  • Look at the advisor’s documents: Is the advisor’s adherence to a fiduciary standard clearly stated in writing?
  • Look at your account statements: Make sure you are not invested in proprietary funds (created or sponsored by the advisor’s firm) or products that charge commissions when your objective could be just as effectively met by non-commission funds.

When searching, we recommend considering someone from the Garrett Planning Network. The founder of the Garrett Planning Network, Sheryl Garrett, was recently quoted in an Investor’s Business Daily article, “How To Pick The Best Financial Advisor To Plan For Retirement.”

“Because everyone faces unique circumstances, Garrett argues that an advisor who excels in serving one type of client may not prove equally great for another client. It’s better to vet candidates by focusing on their credentials and retirement planning expertise.

Advisors with a certified financial planner (CFP) designation have undergone “a rigorous training and education process,” Garrett says. Other professional certifications, such as chartered retirement planning counselor (CRPC) and certified retirement counselor (CRC), further indicate an advisor’s commitment to understanding the complexities of retirement planning.

When evaluating an advisor’s ability to help pave the way for your retirement, take a holistic view. Look beyond your projected investment returns.

“Think in terms of your lifestyle, not just your retirement nest egg,” Garrett said. “You need someone who knows about all aspects of retirement life, from issues tied to aging to health care to home renovations if your mobility is challenged.”

Be careful out there, and we can help at Financial Freedom Planners!

“If you want to work the rest of your life, that’s your business.  If you don’t, that’s ours.”

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Stocks – Is It 2008 Again? 3 Things To Do In Today’s Market

Are stocks a bargain right now?

Those who have children or have been a child are familiar with questions from the back seat on a long car trip, “are we there yet?” Many of us feel the same in regard to the stock market’s recent and abrupt decline so far this year. Are we there yet…at or near the low?

As we outlined in “Advice for 2016 – Reduce Risk,” we may well be in a year where we need to focus on the return of your money rather than the return on your money. For our client newsletter at year end, the title was “Going Nowhere But Getting There Fast.” We discussed the volatility that seemed to be on the increase, with sharp ups and downs. Unfortunately we have been going primarily down so far this year, and getting there fast.

Sellers were back in the market Friday as Wall Street weighed a weaker-than-expected January jobs report.

The Nasdaq slumped 3.2%, the S&P 500 gave up 1.9% and the Dow Jones industrial average fell 1.3%. Preliminary data showed NYSE volume coming in lower than Thursday’s levels. Nasdaq volume rose a bit. For the week, the Nasdaq lost 5.4%, the S&P 500 fell 3.1%, the Dow gave up 1.6%.

3 Things to Do In Today’s Market

The key question is what to do in these types of markets. Here are some thoughts that should help:

  1. Get Back to Basics.
    • Have a plan, be it financial, investment or both, If you don’t have one, spend some time putting one together. If you are doing it yourself, one place to go is “How to Create an Investment Plan” to get started. If you are seeking professional help, we recommend a member of the Garrett Planning Network.
    • Once you have a plan, it’s time to take a look and compare where you are now with where you should be on your plan.
  2. Have the right Balance – Make sure you understand how much RISK is in your portfolio.
    • Remember the market is always going to go up and down.
    • Make an assessment of where you are right now.
    • As we wrote over a year ago in BALANCED INVESTING IS PART OF A BALANCED LIFE, it’s very important to give your overall investments a risk assessment.
    • After you have a general idea of what your Asset Allocation is, see if it matches your attitude toward risk. Consider how many more years you have to save and invest toward your goals. Obviously the shorter the time period, the less risk and exposure to stocks you should have. Make sure you have the right balance.
  3. Don’t Panic!
    • I’m reminded of a quote from the renowned investor, Peter Lynch: “The key to making money in stocks is not to get scared out of them.”
    • Shut off the television and financial websites. The pundits are out in force writing the epitaph of the market, the economy, and are encouraging panic. The “noise” always goes up during extreme times.
    • Speaking of extremes, check out the CNN Money Fear & Greed Index. CNN uses 7 factors and each factor is weighted to calculated the weight average of what it defines as greed and fear on a scale between 0 – 100. These factors include:
      • -Market momentum
        -Market volatility
        -Put & call options
        -Stock price breadth
        -Stock price strength
        -Junk bond demand
    • Not surprisingly the Fear & Greed Index now shows Extreme Fear. This is where it was recently:

  • Just how bad is it? The index has a 100 point scale — with 0 indicating nightmare level fear and 100 signaling “buy everything in sight” greed. Yesterday the Fear & Greed Index fell to 18, and likely went below that after today. While an imperfect measurement, clearly we may be closing in on an opportunity…certainly not a time to panic.

We’re encouraging people to take a deep breath, look at the bigger picture, and not be overly concerned about a week or a month or two. Be intentional about investing. You will find it removes much of the stress you may be feeling after a week like this.

If you have a trusted advisor, touch base with them to take a look at how much sensitivity your portfolios have to market risk. If you don’t, give us a call – we’ll take a quick look under the investment hood and let you know at no charge. You can also schedule a free 15 minute phone conference by clicking this LINK and schedule a time. We’re here to help.

“It doesn’t take a fortune to build one”

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How To Factor Health Care Risks Into Your Retirement Plan

Many of us have been impacted by having to care for a parent or loved one due to health issues, myself included. Here we’re going to discuss health care costs beyond whatever is considered “normal” today.

There is no question non-recurring health care services are a risk that needs factored in to retirement planning.  These services include home health care, nursing home stays, etc.  While possible a couple may experience lower incremental expenses than a single person, we do not factor that into our planning metrics.  In our view the purpose of planning is to help our clients prepare for possible or likely future events.  We don’t believe it’s possible to determine if one spouse may be able to assist in caring for the other in the future.

As a result we plan according to each individual, be they partners or single.  We then incorporate this risk into all retirement plans to determine if a client (or clients) has sufficient assets to cover a long-term health event post retirement.  To accomplish this we utilize state-specific data from Genworth to project health care expenses beyond a client’s baseline.

For planning purposes, we average the 6 costs measured in the aforementioned survey, ranging from home care to a nursing home with a private room. For example, the average in Virginia is $53,654 (for 2015) in incremental expenses for an individual, regardless whether we’re counseling a couple or an individual.  We round up to $55,000 per year, and use an inflator of 3.64%, a bit higher than the inflation experience in Virginia for the last five years.

The next phase in our analysis is modeling a future scenario for our client.  Our default assumption is a health event occurring in the last 4 years of life, utilizing the above number for incremental health care expenses.  We can change that depending on the discussions with our client.  However this is generally viewed as reasonable.

After this we analyze what their cash flow analysis looks like if they experience a health event in their last four years of life.  We treat a couple in the same way, and analyze the cash flow and the commensurate result on their available assets.  If the analysis illustrates this creates a financial future problem for them, we look at various ways to solve it.  Even if you have sufficient assets, we discuss whether you may want to protect their assets if they are looking at legacy goals.  These goals may range from passing assets to heirs, gifting goals, etc.

The bottom line is long-term health issues are likely in any planning horizon, and should be considered in a retirement plan. We suggest professional help in working through all these issues, such as a CFP® from the Garrett Planning Network. Call….we can help!

“It doesn’t take a fortune to build one”

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Advice For 2016 – Reduce Risk

As we wrote in our end-of-the year newsletter, in the equity markets we “Are Going Nowhere, But Getting There Fast.” We have had very favorable markets over the course of the last 4-5 years. At least part of this can be attributed to the unprecedented monetary stimulus by the Federal Reserve Board.

A prominent and respected portfolio manager, Bill Gross, recently said in his Investment Outlook “central banks are casinos. They print money as if they were manufacturing endless numbers of chips that they’ll never have to redeem. Actually a casino is an apt description for today’s global monetary policy.”

Last week, as expected, the Fed raised interest rates for the first time in 9 years.  After having their foot HEAVILY on the accelerator during this time, they appear to be slowly changing directions. Bill Gross went on to say “the faster and faster central bankers press the monetary button, the greater and greater the relative risk of owning financial assets. I would gradually de-risk portfolios as we move into 2016.”

We agree with his assessment. We look to place more emphasis on the return of your money than a significant return on your money. While there are many ways to reduce risk, here are five to consider:

  1. Reduce equity exposure
  2. Reduce risk in the equity allocation you continue to own – some techniques are large-cap stocks vs. small-cap, reduce emerging or international markets, etc.
  3. Reduce credit risk in the bonds/fixed income you own – we already have begun to see signs of stress in the fixed income markets – we are VERY wary of any positions below Investment Grade
  4. Reduce Interest-Rate Risk – pay close attention to the maturities of bonds and fixed income in your portfolios – reduce the length of maturity to reduce interest rate risk
  5. Maintain greater than normal Cash positions – while rates are still ridiculously low, remember we are focusing on a return of your money in 2016

If you have a trusted financial advisor, we recommend reaching out to them either before the end of the year, or the beginning of the new year. It’s time to reassess where you are in your own financial journey in context with the new direction of interest rates. If you don’t have a trusted financial advisor, we recommend a professional with the Garrett Planning Network.

Happy New Year!

“It doesn’t take a fortune to build one”

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