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Posts Tagged ‘Asset Allocation’

When you’re on an airplane and hit turbulence or rough weather, the flight crew tells you to stay seated and buckled.  Unfortunately, when the markets hit bad weather, there is rarely such a warning.

You might want to call it “Black Thursday.”

Yesterday, the markets around the world went into a tailspin reacting almost violently to the ongoing drumbeat of dour economic news.

On the radar, we’ve seen the storm clouds moving in for a while now:

  • lower than expected GDP in the US last quarter,
  • downward revisions of the GDP to a negligible 0.4% for the first quarter,
  • lower business and consumer confidence surveys,
  • sharply lower than expected new jobs created,
  • higher unemployment,
  • foreign debt crises weighing down our Eurozone trading partners.

There was a temporary distraction over the last couple of weeks as we in the US focused on the debt ceiling debate to the exclusion of all else.  Self-congratulatory press remarks by politicians aside, nothing done in Washington really changed the fact that we are still flying into a stiff head wind and storm clouds that threaten recovery prospects.

Eventually, though, the accumulation of downbeat news over the past few weeks seems to have finally come to a head yesterday.  No one thing seems to have caused it.  It just seems that finally someone said “the Emperor has no clothes” and everyone finally noticed the obvious: global economies are weak and burdened by debt and political crises.

All of this has been creating doubt in the minds of investors about the ability to find and implement policies or actions by governments or private sector companies.  And doubt leads to uncertainty.  And if there’s one thing we know for certain, it is that markets abhor uncertainty.

While many commentators may have thought that the “resolution” of the debt ceiling debate in Washington would have calmed the markets, it seems that upon further review of the details the markets are not so sure.  And in an “abundance of caution” market analysts who once were so OK with exotic bond and mortgage investments are now reacting overly negatively to any and all news and evidence of weakness by governments or companies.

What’s An Investor to Do?

Don’t panic.  It may be cliché but it’s still true.  If you hadn’t already put in place a hedging strategy, then what is past is past and move forward.

So the Dow has erased on its gains for 2011 and has turned the time machine back to December 2008.

If you sell now — especially without a plan in place — you’re setting yourself up for failure.

Here’s a simple plan to consider:

  1. Hold On:  You can’t lose anything if you sell.
  2. Hedge: As I’ve said before in this blog and in the ViewPoint Newsletter, you need to put in place a hedge.  There are lots of tools available to investors (and advisers) to help:  Exchange Traded Funds (ETFs) on the S&P 500, for instance, can be hedged with options or you can use “trailing stop-loss” instructions to limit the market downside; another option – inverse ETFs that move opposite the underlying index. These aren’t buy-hold types of ETFs but can be used to provide short-term (daily) hedges.
  3. Rebalance:  If you’re not already diversified among different asset classes, then now’s the time to look at that. You may be able to pick up on some great bargains right now that will position you better for the long-term.  Yes, every risky asset got hit in the downdraft but that’s still no reason to be bulked up on one company stock or mutual fund type.
  4. Keep Your Powder Dry and in Reserve:  Cash is king – an oft-repeated phrase still holds true now.  Take a page from my retirement planning advice and make sure you have cash to cover your fixed overhead for a good long time.  With cash in place, you won’t be forced to sell out at fire sale prices now or during other rough times. This is part of what I refer to as “Buy and Hold Out.”
  5. Seek Professional Help:  Research reported in the Financial Planning Association’s Journal of Financial Planning shows that those with financial advisers and a plan are more satisfied and overall have more wealth.  Avoiding emotional mistakes improves an investor’s bottom line.

As a side note:  The old stockbroker’s manual still says “Sell in May and Go Away.”  Probably for good reason.  Historically, the summer months are filled with languid or down markets and volatile ups and downs.

 

While it’s tempting to give in to the emotional “flight” survival response that you’re feeling right now, don’t give in.  Stand and fight instead.  But fight smart. Have a plan and consider a professional navigator.

If you are seeking a second opinion or need some help in implementing a personal money rescue plan, please consider the help of a qualified professional.

 

Let’s Make A Plan Together:  978-388-0020

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Investors are always looking for the next big thing. By the amount of time and energy devoted to talking heads divining tea leaves and spouting stock tips on news programs, cable TV and the internet, you would think that the only market that counts is the US stock market.

In fact, the global bond market actually dwarfs the stock market by a factor of two to one. According to the December 2010 Asset Allocation Advisor, the amount of outstanding debt in the world tops $91 Trillion compared to the $52 Trillion market value of all stock markets around the globe. Of this all US stocks are valued at only $17 Trillion.

There is a mistaken belief among investors that bonds are only for “conservative” investors or those who are retired. Stocks are exciting.  Bonds are boring.  If we have learned anything from the financial collapse triggered by mortgage bonds in 2008, bonds are anything but boring.  The important lesson is knowing that bonds are not to be ignored and can play an important role in a diversified portfolio when done right.

What’s an investor to do?  Build a better mousetrap.

Most investors, if they have any bond exposure at all, will buy them through a mutual fund.  While mutual funds offer instant diversification and professional portfolio management, there are limitations.  In no particular order, these are: costs, inability to control for taxes, lack of customization and what is known as “NAV” risk.

For actively managed bond mutual funds, the average operating costs (or expense ratio) can exceed 1% per year.  For index or passive bond mutual funds, the costs can be less (sometimes as low as 0.2% per year) but you will only have access to a statistical sampling of bonds.  With either option you lack the ability to customize the holdings to match your specific needs for generating income or control the timing of sales which may be important from a tax perspective.

Another problem, NAV risk, is little understood by consumers.  Mutual funds are priced daily.  A value is determined for each of the mutual fund’s investments (closing price times number of shares or units owned).  And this total is divided among the total number of mutual fund units outstanding.  This Net Asset Value is the number you see in the charts and tables on line or in the newspaper.

With a mutual fund there is a constant flow of money coming in to buy more units or flowing out to cover redemptions made by other investors.  Sometimes there is a mismatch between these flows.  If there is a “run on the bank” and lots of redemptions occur, the mutual fund may be forced to sell holdings at “fire sale” prices intended for long-term investment to raise cash to meet the demands caused by redemptions.  For those investors who hold on, they can be punished in the near-term by seeing the NAV fall and dragging down the value of their holding. That’s the NAV risk.

In the next part of this blog, I’ll talk about the ways to help reduce the impact and costs of these problems by building your own portfolio of bonds.

For additional information or help with investing, call Clear View Wealth Advisors at 978-388-0020 or 617-398-7494.

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It’s easy to get tripped up in retirement.  I’m reminded of the expression by the octogenarian to the recent newlywed fretting about life but rejecting out of hand the advice of his experienced senior:

A long time ago I was where you are now.  And later you’ll be where I am now.  But just as you haven’t been your age before, I’ve never been old before.

So for new retirees who “not been there or done that” it’s a whole new world filled with possibility and pitfalls.

Transitioning

Most retirees have an imperfect vision of retirement at best.  And if it hasn’t been discussed or communicated, it could be vastly different from that of your spouse.

Finding meaning in a post-work world can be a real challenge.  If your identity has been wrapped up in what you do, then you might now feel lost.  Your social networks might change.  Your activities might change.

It’s important to reassess your values and envision how you want to live in this next chapter of your life.

Initially, there may be more travel to visit family, friends or places.  You may want to tackle that “bucket list.”

But to live a truly fulfilling and rewarding retirement may require you to take stock in yourself, your values and what gives you meaning.  You may benefit from working with a professional transition coach or group that can help guide you through this period of rediscovery.  One such resource can be found here at the Successful Transition Planning Institute.

Lifestyle Budget

Typically, most retirees may take the rule of thumb bandied about that you will need from 60% to 70% of your pre-retirement income to live on in a post-retirement world.  This is because it is assumed that many expenses will drop off:  business wardrobe, commuting to work, professional memberships, housing, new cars, etc.

The reality is far different.  According to research conducted by the Fidelity Research Institute 2007 Retirement Index, more than two-thirds of retirees spent the same or higher in retirement.  Only eight percent spend significantly lower and about 25% spend somewhat lower. The Employee Benefit Research Institute  reported in its 2010 Retirement Confidence Survey that while 60% of workers expected to more than half of retirees didn’t see a drop in retirement expenditures while 26% of this group reported that their spending actually rose.

It all depends on your goals, lifestyle and what curve balls life throws at you.  If you have adult children who end up in a financial crisis of their own caused by job loss, health issues or divorce, you may be spending more than you expected to help out. Maybe the home you live in will require higher outlays for maintenance or to upgrade the home so you can live there independently. In reality all of that travel and doing things on your bucket list will cost money, too.  So it’s more the rule than the exception to expect spending to increase while you’re still healthy to get up and go.

Over time, the travel bug and other activities will probably decline but even after that these may be replaced by other expenses.

Healthcare

There is an old saying that as you get older you have more doctors than friends.  This is a sad reality for many including my parents.

My father is on dialysis and has complications from diabetes.  His treatments probably cost Medicare (and ultimately the US taxpayer) more than $30,000 each quarter as I figure it.  He takes about 13 prescriptions each day and enters the dreaded “donut hole” about mid-year each year. At one time their former employers (a Fortune 500 company) provided medical insurance benefits to retirees but that became more and more cost prohibitive for their employer and for my parents as premiums, co-pays and deductibles rose.  So now they rely on a combination of Medicare and Blue Cross/Blue Shield and a state program called Prescription Advantage.

As private employers and cash-strapped state and municipal governments tackle the issue, you can expect to pay more for your health care in retirement.

Wealth Illusion

It’s not uncommon to feel really rich when you look at your retirement account statements.  (Sure, the balances are off where they may have been at the peak but it’s probably still a large pot of money). The big problem is that retirees may have no comprehension about how long that pot of money will last or how to turn it into a steady paycheck for retirement.

In reality the $500,000 in your 401k or IRA accounts may only provide $20,000 per year if you plan on withdrawing no more than 4% of the account’s balance each year. Then again if you take out more early on in retirement, you could be at risk of depleting your resources quickly.

Misplaced Risk Aversion & The Impact of Inflation

So as you get older, you’ll be tempted to follow the rule of thumb that more of your investments need to be in bonds. Although this may seem to be a conservative approach to investing, it is in fact risky.

Setting aside that this ignores the risks that bonds themselves carry, it is ignoring the simple fact that inflation eats away at your purchasing power.  Even in a tame inflationary world with 1% annual inflation, a couple spending about $80,000 a year when they are 65 will need over $88,000 a year just to buy the same level of goods and services when they turn 75.  Given the potential for higher inflation in the future that may result from a growing economy and/or current monetary policy, investments need to be positioned to hedge against inflation with a diverse allocation into stocks and not just bonds even when in retirement.

The other risk is trying to play catch up.  As a retiree sees the balances on his accounts get drawn down, he might even be tempted to “shoot for the moon” by investing in illiquid investments like stocks in small, thinly traded markets or in sectors that are very speculative.

Ball games are one by base hits and consistency on the field and at the plate.  Home runs are dramatic but not a sure thing.

Underestimating How Long You’ll Live

We all want a long and productive life.  Many will even say that they don’t want to live to be a burden to their families.  But here again the reality is that most folks do a bad job of guessing how long they’ll live.  A report by the Society of Actuaries notes that 29% of retirees and pre-retirees estimate that they’ll outline the averages but in fact there is a 50% chance of outliving them.

So while they may have enough resources to carry them through the average life expectancy, they will not have enough when they live longer than the averages. And if a couple attains the age of 65, there is a better than 50% chance that at least one of them will live into their 90s.

Given the fact that most women become widows at the age of 53 (Journal of Financial Planning, Nov. 2010), this has a big impact on the availability of resources for retirement.  Too often, a short-sighted approach to maximize current retirement income from a pension is to choose the option that pays the highest but stops when one spouse dies. All too often this puts the widow who may live longer without a reliable source of income to provide for her.

Conclusion

Too often people underestimate how long they will live in retirement, how much they will actually need for living in retirement and how to invest for a sustainable retirement paycheck using appropriate product, asset and tax diversification.

Many people do not save enough for their own retirement.  The social safety net providing support for old age income and healthcare may not be enough to maintain a desired lifestyle.  Women need to understand the risk of living long into retirement and manage resources accordingly.  And because more than 40% of Americans are at risk of retiring earlier than expected because of job loss, family care needs or personal health, there is a real need for proper planning to address these issues.

While retirees will benefit from having a good plan and road map before the final paycheck ends, it’s never too late to start. And for the newly retired with the time to address these issues, now’s as good a time as any to speak to a qualified professional who can help.

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Just when you thought it was safe to get back into the investing waters, talk of deflation has creeped back into conversation.

Why does it matter? Well, how you position your portfolio to deal with these two scenarios will make a big difference to your personal bottom line.

With inflation, your money is worth less the longer you hold onto it. So you’re more likely to spend in the now because prices may be moving up.

With deflation, your money may buy more later the longer you hold onto it as prices continue to drop. (Not good for a seller but a better deal for a buyer – just ask someone trying to sell a house in Florida these days).

Since consumers respond differently to these two opposing forces, the ultimate direction of them can have a decidedly different impact on how the recovery progresses because of the way consumers react and business respond to their actions. Ultimately, this will impact how to position an investment portfolio accordingly.

The Right Hook
During a fight a boxer may expect to be hit from both the right and left. It’s just not known when and with how much force. But a good boxer, like a Boy Scout, knows to be prepared.

First the economy has been peppered with jabs from the right that could result in higher inflation: expanding money supply, ballooning government deficits, higher commodity prices, weak currency value.

Given the huge inherited, current and projected government deficits here and abroad, the conventional thought has been that all of this government stimulus will ultimately result in “crowding out” private investment and raise the ugly head of higher inflation down the road. The prospect of higher taxes to pay for these past deficits also lends support to these thoughts.

Recent run-ups in certain commodity prices like oil and energy products have resulted in a rise in consumer prices in January bolstering fears of inflation.

The Left Hook

Now comes the left hook – the deflationary threat: asset prices continuing to fall, increasing slack in industrial capacity, and continuing pressure keeping a lid on labor expenses because of high unemployment.

Credit is still tight with bank lending down. While dollars have been pumped into the economy through the TARP program, it’s mostly sitting in bank vaults. Money that isn’t circulating isn’t a cause of inflation.

Recent economic reports have indicated that core consumer prices actually are flat, well below the 10-year average of 2.2%.

Despite some recent reports, housing prices and rents are down and still expected to fall in key markets, dampening the immediate threat of inflation.

Defensive Portfolios: Lessons from Spencer

The best and strongest home depends on your environment and the threats faced.

Each evening before putting our infant son, Spencer, to bed, we read a story. The favorite for now is


    The Three Little Pigs
(undoubtedly because of Spencer’s dad’s animation).

We all know the story: Three pigs, three houses built from different materials, one pig survives because of his well-built brick house.

The same can be said for portfolios. Heck, a house of sticks can provide some shelter in some circumstances but what happens if a big bad wolf shows up?

Since we don’t know which type of bad wolf will be showing up at the door (inflation or deflation), it makes sense to be positioned to survive either threat.

The elements of a portfolio will likely be the same regardless of an investor’s mind-set. The differences will be in the proportion of the components used.

Inflation Protection Portfolio
To protect this type of portfolio consider elements more likely to retain value even as inflation increases. Example: Commodity funds or ETFs; inflation-linked fixed income funds that include TIPS and/or floating rate notes; Real Estate Investment Trusts or REIT funds (10%); Cash to take advantage of higher short-term interest rates.

Deflation Protection Portfolio
The majority of this type of portfolio is positioned in long-term Treasurys followed by cash and municipal bonds. As consumer prices and interest rates fall, the fixed income stream from the bonds would be worth more.

To protect against surprise inflation, a smaller proportion would be set aside into TIPS, commodities and higher-quality/large cap US stocks.

Little Pig, Little Pig, Let Me In
Not sure where the market will go? Not sure which threat to expect? Learn from the third little pig: Build the strongest house possible.

If there is inflation, the economy will be expanding. As such equities will be the place to be. So consider an allocation of 20% to 25% in the US and a like amount in foreign equities. A portion of these equities should include high-quality firms that are dividend-paying. Commodities and cash will likely benefit from inflation so a 10% allocation to each is prudent. The fixed income component can include some exposure to TIPS (5%) as well as intermediate high-quality bonds (20% – 30%).

To hedge against the risk of deflation, a portfolio with exposure to municipal bonds (5%) and long-term Treasurys (5% – 10%). And some of the equity portfolio should include exposure to consumer staples that tend to do well in such an environment.

To provide some added diversification consider adding positions in companies that focus on infrastructure and firms that can maintain pricing power like utilities, pipeline operators and the like.

Taking these steps should allow an investor to sleep better at night. At least it works for Spencer.

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