Tag Archives: Fixed income

Reading the Tea Leaves

We are not big fans of fortune tellers, preferring to stick with what we can observe in the here and now. The here and now tells us that the American economy is getting better slowly and sluggishly, trending upward, something we refer to as the “Plow Horse Economy.”

We do, however, pay attention to what others are saying and if it sounds reasonable, we’ll share it.

Tony Crescenzi of PIMCO has made some points that seem reasonable and in line with our observations. Discussing the market’s reaction to the Fed’s non-move, he says:

“Investment implications and lessons for investors from this year’s tumult in the global financial markets: Rates are likely to stay low for longer … the Federal Reserve has demonstrated that it is likely to take a very gradual and cautious approach to its normalization of interest rates. Policy rates, globally, are likely to stay low through the rest of the decade, supporting equity and credit markets, as well as real assets.

Volatility will result from the unwinding of crisis-era policies…

Economic growth, rather than liquidity, is needed more than ever to bolster asset prices… investors are likely to focus …on economic growth and company cash flows when making investment decisions.”

Of course we think that economic growth, cash flows and profitability should always be the real basis for making investment decisions, and that a change in Federal Reserve policy (especially if it is as gradual as we anticipate) will have very little impact on these fundamental factors.

We received a call from a client the other day asking if we had a secret formula for coping with the recent market decline. We replied our formula was not secret at all. We adhere to our asset allocation strategy, which puts “shock absorbers” on the portfolios during times of market volatility. This means that our objective is to go through market declines with smaller losses than the overall market. While that strategy means that most of the time our portfolios won’t go up as fast or as far as the stock market during good times, it also means that during times when the markets are heading in the wrong direction our portfolios should outperform the stock market and we won’t have as much ground to make up when it begins to recover.

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Dear Fed: Just Do It!

Get on with it already! Ever since the crash of 2008, the Federal Reserve has kept interest rates near zero. The theory was that low interest rates would stimulate economic activity. But we are now in the sixth year of economic recovery. The government tells us that unemployment is 5.1%. The average person buying bonds looking for income is treading water.  After taxes, and inflation they are slowly losing purchasing power.

Raising rates from 1/8% to 3/8% should be a no-brainer. The much anticipated rate hike by the Fed, perhaps as early as tomorrow, has everyone quivering with anticipation. Our suggestion is to ignore the announcement. There is no secret trading strategy that tells how to “play” the Fed’s announcement.

Let’s say the Fed does indeed raise rates by 0.25% tomorrow. How would the market react? There could be a sell-off. On the other hand the market could rally on the belief that the Fed thinks the economy is finally strong enough to allow a modest increase in interest rates. In fact, both could happen: a sell off followed by a rally.

Should the Fed NOT raise rates this could be interpreted that the Fed sees dangers ahead for the economy.

Our own position is that raising rates by one-quarter of one percent will have no actual effects on American economic activity. The basis for economic growth comes from the private sector. It will come from new drugs to cure diseases, new apps to make your life easier, more technology to increase the supply of oil and natural gas. The cost of gasoline has dropped to under $2.00 in our area, which has a big effect on the budget of the average family. This, not a modest increase in interest rates, will have a bigger impact on the economy than anything the Fed does in the short term.

We have no idea what the Fed will decide and no one else does either. No matter what happens, short term gyrations in response to the Fed are just noise, distracting investors from the fundamentals. For those who believe in free markets and capitalism, what affects you and your portfolio happen far from Washington DC.

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Setting Realistic Goals

How realistic are your goals?  Some people work hard and exceeded the goals they had when they were young.  Others find their goals forever out of reach.  For example, most people want to retire in their mid-sixties.  That’s a goal, but is it realistic?  Are they going to have a pension when they retire and, if so, how much is it?  When are they going to apply for Social Security, and how much are they going to get?  Will they need a retirement nest egg, and how much will be in it?

Career choices will have a big impact on these answers.  A financial plan will also provide many of these answers.  But a plan is only as good as the assumptions we put into it.  As the old saying goes: “Garbage in, garbage out.”

The rate of return you get on the money you put aside has a huge impact on whether you reach your goals.  Studies have shown that many people have an unrealistic expectation of the returns they can expect on their savings and investments.  With interest rates near zero percent, putting your money in the bank is actually a losing proposition after taxes and inflation.  Investing in the stock and bond markets may lead to higher returns.  But the long-term returns that many people assume they can get often leads to taking unreasonable risks.

There is nothing wrong with having high goals.  The best way to check to see if your goals are high, but attainable, is to talk to a fee only financial advisor.  Preferably one that is a CERTIFIED FINANCIAL PLANNER™.  They have the experience and the expertise to let you know if your goals are reasonable and what you can do to reach them.

Contact us for a “reality check” today.

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8 Common Reasons for Retirement Failure

1. Overspending.

-You won’t spend less in retirement.  The old saw that retirees only spend 80% of their pre-retirement income is a myth.

2. Elder Fraud.

-Seniors are becoming the favored victims of swindlers.

3. Health care.

-As we age the cost of medical care goes up.  Medicare is covering less and premiums are going up.

4. Starting a business.

-Investing capital in a business that fails can devastate retirement finances.

5. Adult children.

-Helping your children through a “rough patch” can become is one of the most common ways of ending up broke.

6. Second homes.

-The cost of maintaining that vacation home when you’re no longer working can drain your resources when your income drops.

7. Divorce.

-Couples sometimes wait until the children leave home to divorce.  When assets are split 50/50, retirement becomes a problem for both parties.

8. Investment mistakes.

-Making poor investment choices is one of the most common ways of ruining your retirement lifestyle.

If you are nearing retirement, don’t enter into it without a plan.

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Paying a million dollars in taxes?

It’s time to pay our taxes and for many people it’s a painful chore. Whether you’re getting a refund or sending the US Treasury a check, the amount of money the government takes from our hard-earned income is never pleasant.

But I have told people that one year I would like to actually have to pay the government $1 million in taxes. Why? Because it means that I probably earned in the neighborhood of $2 million and that’s a nice neighborhood.

I have had a number of conversations this year with clients who have to write big checks to the government. The question always comes up “is there a way to pay less?” The answer is “yes” but the trade-off is not always to their advantage.

Tax free bonds (“munis”) have been a traditional way of avoiding taxes. Unfortunately the Federal Reserve’s zero interest rate policy has reduced the yield on munis to the very low single digit range. A triple A rated Virginia muni maturing in 10 years yields a touch over 1.5%. Unless you are very taxaphobic the idea of tying your money up for a decade at a rate below inflation is not very attractive.

Exchange Traded Funds (ETFs) have been touted for their tax efficiency. That’s true, but unless you buy and hold them forever, at some point you will have to sell them to get money for living expenses.  That’s when the tax comes due. And the tax rate could actually be higher.

The same argument goes for buying individual growth stocks. At some point, you will want to turn them into cash that you can spend for, say, a new car, travel, or all the other things you need money for and that’s when the tax man wants his share. Keep in mind that today’s growth stock can be tomorrow’s bankruptcy. Trees don’t grow to the sky and at some point even Apple may find that there’s a worm in the core. Individual stocks are fine, but lack of diversification is one of the biggest risks to wealth.

The US tax rate reached 94% during WW II in 1944. In the years that followed the rate never dropped below 70% until 1981. Investments were offered whose primary goal was to shelter income from taxes. These were often extremely poor investments. One shelter I recall was an investment in an aircraft leasing company that owned used aircraft. When the price of fuel rose, these planes were sidelined for more efficient models.  Some of the used planes were sold for parts.  Most investors eventually broke even … after a decade or so. The lesson here is that you should not let tax avoidance drive your investment decisions.

Top federal tax rates
These “tax shelters” mostly dried up during the Reagan era when top tax rates dropped to 28% in 1988.

They have been rising gradually since then.

Regular garden variety mutual funds have been getting a bad press because their capital gains distributions are not predictable. However, they have two advantages: (1) they focus on the primary objective of growth of capital rather than secondary issues, and (2) they allow you to pay your taxes as you go. The benefit of that is that when you want to turn your mutual funds into cash to pay for groceries – or whatever is you need money for – most of your tax may already have been paid and the tax man will take a smaller bite.

The desire to avoid taxes is natural, but the best way to manage money is to focus on avoiding major losses and getting a fair return. If taxes bother you, vote for the candidate who you think will lower the tax rate. That’s the smart way to manage your taxes.

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Buy low and sell high

Remember the old adage about how to make money in the stock market? It’s “buy low and sell high.”

This is done over the long-term on a regular basis if you are disciplined and adhere to an asset allocation strategy.

Assume that your ideal portfolio is 50% stocks and 50% bonds. If stocks have a good run and the stock portion grows to 60% and bonds are now 40% you sell some of the stocks that have given you a nice profit and bring the portfolio back into the 50/50 balance.

Suppose the opposite happens: the stock market declines and the portfolio now consists of 40% stocks and 60% bonds. Now you sell some of the bonds to buy more cheap stocks, bringing the balance back to 50/50.

In this way it’s possible that you can make a fair return on your portfolio even if – over the long term – neither the stock or bond market actually rises but simply fluctuates.

For disciplined long-term investors, this shows “the importance of continuing to invest when the annual return stream is uneven and especially when stocks are down,” writes Carlson, an investment analyst at the Van Andel Institute in Grand Rapids, Mich. …

In plainer terms, a steady infusion of capital in good times and bad is better for portfolio performance than turning the spigot on and off in reaction to the inevitable ups and downs of the bourse. For Carlson, discipline in bear markets is more important than “optimizing” externals such as investment costs and tax efficiencies for separating “successful investors from the crowd.”

Interested in a disciplined approach to investing?

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Are you flunking the retirement readiness test?

A recent article in Financial Advisor proposed an interesting analogy: “Imagine boarding a jet and heading for your seat, only to be told you’re needed in the cockpit to fly the plane.”

That’s the situation many people are finding themselves in today.  Once upon a time, employers set up pension plans managed by investment professionals.  You worked and when you retired the pension checks began coming for the rest of your life.

That ended when 401(k) plans began replacing defined benefit pension plans.

Once, employers made the contributions, investment pros handled the investments and the income part was simple: You retired, the checks started arriving and continued until you died. Now, you decide how much to invest, where to invest it and how to draw it down. In other words, you fuel the plane, you pilot the plane and you land it.

It’s no surprise that many people, especially middle- and lower-income households, crash. The Federal Reserve’s latest Survey of Consumer Finances, released in September, found that ownership of retirement plans has fallen sharply in recent years, and that low-income households have almost no savings.

But it’s not only the low-income workers who lack basic financial wisdom.

Eighty percent of Americans with nest eggs of at least $100,000 got an “F” on a test about managing retirement savings put together recently by the American College of Financial Services. The college, which trains financial planners, asked over 1,000 60- to 75-year-olds about topics like safe retirement withdrawal rates, investment and longevity risk.

Seven in 10 had never heard of the “4 percent rule,” which holds that you can safely withdraw that amount annually in retirement.

Very few understood the risk of investing in bonds. Only 39 percent knew that a bond’s value falls when interest rates rise – a key risk for bondholders in this ultra-low-rate environment.

If you fall into this category and want to find out what help is available, contact us.  We’ll be glad to chat; no sales pitch and no pressure.

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Living on a fixed income has gotten a lot harder

At one time, living on a fixed income meant you were retired, received a pension and social security, and got some extra income from your savings. For our parents and grandparents, certificates of deposit, otherwise known as “CDs” were a guaranteed source of no-risk income. Back in 1981 you could put your savings in the bank and get nearly 18%. That was a period of high inflation when prices were also going up. But CDs and bonds paid investors high enough rates so that retirees were comfortable with putting their money into CDs or bonds.

But interest rates have been on a downward path since then. CD rates have dropped from about 11% in 1984 to 1% or less today.

CD rates history

 

Today, CDs and bonds, once the go-to choice of the thrifty retiree, pay a small fraction of what they once did, and provide very little income to supplement their other retirement income sources.
The Federal Reserve has been keeping rates close to zero for years to try to jump-start the economy, with limited success. But while it’s been good for businesses and home buyers who have have been able to borrow money at rates that we have not seen since the 1950s, the traditional saver has seen their income dry up, collateral damage of Federal Reserve policy.

Charles Schwab, in an article published in the Wall Street Journal states that:

U.S. households lost billions in interest income during the Fed’s near-zero interest rate experiment. Because they are often reliant on income from savings, seniors were hit the hardest. Households headed by seniors 65-74 years old lost on average $1,900 in annual income over the past six years, according to a November 2013 McKinsey Global Institute report. For households headed by seniors 75 and older, the loss was $2,700 annually.
With a median income for senior households in the U.S. of roughly $25,000, these are significant losses. In total, according to my company’s calculations, approximately $58 billion in annual income has been lost by America’s seniors since 2008.
Retirees depend on income from their savings for basic living expenses. Without that income, many seniors have taken on greater risk to increase the potential yield on their savings, or simply spent down their nest eggs. After decades of playing by the rules, putting off spending and socking away money, seniors have taken it on the chin. This strikes a blow at the core American principles of self-reliance, individual responsibility and fairness.

What’s a retiree to do? Let’s look at some of the alternatives that people on fixed incomes are being offered and what to watch out for. All of them involve risk that may not be readily apparent. There are traps for the unwary.

Continue reading

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Bond yields worldwide under 1%

Bank of America said that 45% of all government bonds worldwide yield less than 1%. Central bankers from around the world meet today to find a way of spurring economic growth. Most have adopted a low interest rate strategy. That’s good for stocks, but it’s devastating for savers who are making less than zero once inflation and taxes are factored in.

Speculation that the European Central Bank will start buying debt in the year ahead pushed German 10-year yields to a record low of 0.866 percent last week. The rally helped drive demand for Treasuries and other notes as investors sought higher interest payments than they can get in Europe.

“No one’s talking about rate hikes in Europe for several years,”

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Income from “Total Return”

When thinking about income from an investment portfolio many people focus on interest and dividend income. That can lead to problems. In times like these where interest rates are low, the desire to get income from bonds and high dividend paying stocks can be hazardous.

Bonds that pay high yields may be low grade “junk” bonds that are riskier than high grade bonds. Or they can be long-term bonds that will lose value when interest rates rise.

Stocks with unusually high dividends may actually be paying more in dividends that they earn. How long can that go on? Focus too much on dividend income and you could be like those who, in 2008, owned lots of bank stocks that were paying some of the highest dividends. Some of these banks failed and shareholders lost all their money. The survivors cut their dividends to – or near –zero.

Don’t misunderstand; getting income from bonds and stocks is not bad. But “reaching” to get income from these sources can be hazardous.

There is another way of getting income from an investment portfolio that does not focus on just interest or dividends. It’s called the “Total Return” system.

Total Return introduces a third factor into the income mix: growth.

Let’s use a stock as an example.

Imaging that we buy XYZ company stock at $100. It pays a dividend of $3. That gives us a dividend yield of 3%. But let’s assume we chose XYZ stock not just because of the dividend but because we believed it would grow. A year later, XYZ stock is now selling for $110. The “Total Return” on XYZ is the sum of the dividend and the growth in value.

Dividend:                    $3.00 (3%)
Growth in value :     $10.00 (10%)
Total Return:           $13.00 (13%)

Under these circumstances, we could take the dividend plus part of the increased value of the stock, spend it, and still have more wealth than we had before. Viewed from the Total Return principle, we could spend up to $13 and be wealthier than before.

This example is easier to accomplish using mutual funds, and it’s one of the strategies that we employ for those who are retired and those who are still building their retirement portfolio.
If you want to know more about the Total Return way of investing, contact us.

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