Mispriced Safety-Oriented Investments

Attractive opportunities can still be found in dividend-paying equities and select fixed income sectors. However, the events overseas has mispriced many interest sensitive assets. The doom and gloom overseas has driven the 10-year Treasury bond this week to a record low of 1.35%. There has been a conundrum that has emerged between bond yields and equities. The bond markets are signaling a recession while the equity markets are pricing in future prosperity. So which will be right?

I believe that you need to toss out the old economic textbook. We find ourselves in a unique market environment. This time a flatter yield curve is not signaling a higher likelihood of a recession, but a slowdown in Europe. U.S equities rallied this week as the U.S economy created 287k jobs in June vs. a 175k expectation. More people are reentering the workforce, and employers are raising wages to attract skilled workers. The median price of an existing home continues to test record highs. This is a very bullish backdrop for U.S stocks. All major U.S asset classes have performed well this year, while countries around the world are still fighting deflation.

The search for yield in a low-yield world has pushed investors into dividend-paying equities. From a risk management perspective, this makes balancing risk much more difficult. Even DoubleLine Capital’s bond guru Jeffrey Gundlach said it was not prudent to buy 10-year Treasurys at these yields, calling them the “worst trade location” ever. The alternative to bonds is investing into a stock market near an all-time high. Can this trend continue and for how long?

I have communicated to my clients to brace for more upside and downside volatility. The low rate environment has made portfolio construction and risk management much more important. Going forward, I believe that the biggest market risk is if interest rates continue to move lower. Earlier this year, when oil prices were at their lowest point, I wrote that the biggest risk to the economy was if oil prices kept falling. Markets did recover as oil prices rallied. If interest rates do continue this downside trend, it could be a signal that a major financial institution in Europe is in distress. The U.S economy needs to avoid falling into the same deflationary spiral that is plaguing Europe. Interest rates will need to stabilize soon in order to prevent mispriced securities forming into a new threatening asset bubble.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Chasing Dividends

Global stock markets lost a record $3 trillion in two trading days only to recover much of those losses. The UK vote did not turn out to be the catastrophic event that many expected. The market rebounded when investors realized that the easy money polices and era of low interest rates would continue through the middle of 2017. Bond yields continued to fall even as stocks rallied. The yield on the 10-year and 30-year Treasury notes hit record lows on Friday. The expectation is that the Bank of England will be forced to lower rates in order to fight off a recession.

As interest rates dropped, investors began to take more risk. The most popular investments this year continue to be high quality, U.S dividend paying companies. These types of investments have been my largest  holdings. The economic outlook for Europe remains impossible to predict. Many countries are caught in a deflationary spiral that is lowering economic growth. No one really knows what the long-term impact will be with a whopping $10 trillion in total negative-yielding sovereign bonds. To put this in perspective, 26% of the total value of J.P. Morgan’s global government bond index has a below-zero interest rate. If Europe is unable to fight off deflation, U.S interest rates should continue to drop. This economic backdrop is very bullish for the interest sensitive U.S housing market.

The situation in the UK remains very fluid. There have been rumors that the UK might never leave the EU. U.S Secretary of State John Kerry was quoted as saying that there are still “a number of ways” Britain could walk back from Brexit. Even if the UK does leave the EU, negotiations are expected to be drawn-out over a number of years. Many EU governments are going to take a tough stance because they want to set a example for the other countries that are contemplating voting on their own referendum. German Chancellor, Angela Merkel, set the tone for the negotiations by saying that there will be more favorable trading terms for countries that remain in the European Union.

I expect that market volatility will continue as investors digest new political and economic information. Markets remain very vulnerable. My market outlook continues to be that U.S markets will move sideways while investors wait and see how this European saga ends. This trend has been in place for the past few years and I believe that you should at least be paid an above average dividend while you wait.

Happy 4th!

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Is Brexit a buying opportunity?

The UK shocked markets and voted to leave the European Union. The biggest risk for markets going forward is the UK political crisis turning into a full-fledged economic crisis. Unlike the events that unfolded over 2008-2009, this is not a liquidity crisis. The uncertainty created by this vote will actually add more liquidity into the markets. The Federal Reserve and other Central Banks around the world will add liquidity to the markets in order to stabilize prices. The British pound hit its lowest level since 1985 against the dollar and posted its largest move to the downside ever. The biggest downside of the UK protest vote will be the negative long-term consequences created in their own economy.  The UK now has a very high probability that their economy will go into a nasty recession. T. Rowe Price Group believes that the risk of a global recession overall is now more than 50%. CNBC noted, depending on how you measure it, the EU as a whole ranges from the first to the third largest economy in the world. And in terms of trade, the bloc easily topped the U.S. and China in both imports and exports. So a slowdown there would mean a global slowdown. One that could last months — if not years. During a CNBC interview on Friday, former Fed Chairman Alan Greenspan said the U.K. vote to leave the European Union ushers in a period that’s even worse than the darkest days of October 1987. He noted, “This is the worst period, I recall since I’ve been in public service.”

The good news is that the U.S economy is in a much better position to withstand this external shock than it would have been during the Great Recession of 2008. The silver lining of this turmoil is U.S interest rates will be kept artificially lower for a longer period of time.  The low interest rate environment has fueled the median price of an existing home sold in May to a record of $239,700. Before the epic housing crash, the median price of a home was around $230,000. The UK vote to leave yesterday has driven bond yields even lower, which could cause U.S housing to become even less affordable for new buyers. I expect that even more people will begin to put their trust in buying homes over investing in the market.

The difference between the economic risks in 2008 vs 2016, is the recent strength in the housing market and lower unemployment rate, which, taken together, has allowed U.S banks to rebuild their balance sheets.  According to Marketwatch, the Federal Reserve said Thursday that 33 of the nation’s biggest banks could weather an estimated $526 billion in losses without breaking rules for minimum levels of capital. The same article also pointed that the banks have added a cumulative $700 billion in equity capital since 2009. With a stronger banking system and housing market, the U.S economy could become the destination for money looking for higher interest rates or dividend yields.

Looking ahead, markets will continue to focus on the political climate in Europe.  It’s now in the politicians hands to negotiate a new financial agreement with the EU. All of the important details will be in the terms and conditions of the withdrawal to leave the EU. The legislation that was signed in 2007, which describes the steps that a EU member state takes to leave the EU is called Article 50. This article states that a country will have two years to reach an agreement to leave. If these talks drag on over the next few years, it may help to heighten uncertainty. Britain is the bloc’s second-largest economy after Germany and it will take time to come up with all new trade agreements. The best outcome would be if Britain negotiates a less restrictive condition sooner. The referendum is not legally binding and the UK could shock markets again if they begin to negotiate to stay in the UK. The worst case scenario is that other countries will follow UK’s decision and vote on their own referendums to leave, or even worse, European leaders who favor globalization will get voted out of office in the upcoming elections. The risk of a domino effect is my biggest worry. However, the leaders in the EU could begin to redesign a new structure of government entirely, which would be viewed as very positive news. Over the next few weeks, I expect some of the uncertainty will go away as new information enters the market. It is safe to say that the interpretation of this information will cause more market volatility to the upside or downside depending on the degree of unity between the remaining EU members.

My exposure to the overseas markets has been minimal to none at all for most clients. Over the last few years, I’ve had no confidence in overseas markets, but these recent events could become a buying opportunity if the political and economic picture becomes more certain. If unexpected positive news enters the market, Europe could become a buying opportunity not seen since 2009 when U.S markets recovered from its recession. Similar to the U.S recovery, it will be the meaningful decisions of government leaders that will lead to the market recovery.  Time will tell whether they can pull together and begin to make the right decisions in order to become a stronger economic union.

If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Why is there so much market uncertainty?

“Uncertainty” is the word that best describes the current domestic and global backdrop. Janet Yellen used this word multiple times during her press conference after the Federal Reserves decision not to raise interest rates. Market participants are clearly frustrated with the lack of economic growth and instability in the markets. The market volatility has scared many investors to the sidelines even though the S&P 500 is up 2.35% YTD (through June 17).  According to BofA, fund managers’ cash levels are at their highest in nearly 15 years. High cash levels normally signal a market bottom, but the market is slightly off the all-time high. This year investors have purchased higher quality dividend-paying investments, and have shunned growth stocks. The Nasdaq 100 is down -4.52% YTD (through June 17).

The divergence in returns is the result of investors trying to lower portfolio volatility by purchasing companies with high dividends and steady cash flows. This has been the focus for my clients this year. The three reasons why the Fed didn’t raise interest rates this week are as follows:

  1. The Fed is uncertain on the upcoming United Kingdom (UK) referendum vote on Thursday, June 23. The UK is deciding whether or not to stay or leave the European Union (EU). Overseas investors are now most fearful of a UK vote to “leave” the EU. If this were to occur, other countries could begin to contemplate leaving the EU as well. A decision to leave will have major implications for both international politics as well as the global economy. If the vote is to “stay”, markets could begin to gain some positive momentum. At the current time, it is impossible to say which way the direction of the vote will go. The oddsmakers though have the vote heavily in favor of the UK staying.
  2. The Fed pointed to the U.S job growth abruptly slowing in May to the lowest levels since 2010. There are signs that the job market is still strong. Going forward, job growth might appear slow because it is becoming more difficult to find qualified workers. The unemployment rate is at the normal equilibrium level of 5% and there are less people looking for work. Companies are competing to find qualified workers by raising wages.
  3. The Fed also didn’t want to push U.S interest rates higher when there is $10 trillion in debt overseas yielding negative interest rates.  The 10-year German bond went negative for the first time ever this week.  Investors in Europe are holding cash in fear of the UK leaving the EU.

The negative market sentiment and high cash balances signal that many investors have been planning and hoping for the worst. These investors will always see dark clouds on the horizon. The expectation is that future market returns could be lower in the years ahead.  This makes selecting investments with higher dividend income all that much more important.  I continue to position my clients’ portfolios into areas with above average dividends and mostly in U.S. markets. However, European markets are now beginning to look undervalued after the drop over the last few weeks. The outcome of the referendum vote will decide the direction of the global markets next week.

If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Watch the Unicorns

There are billion-dollar startups reshaping the economy and disrupting business models. A unicorn is defined as a start-up that does not have an established operating history but fetches an estimated valuation of more than $1 billion. The list of 174 unicorn companies can be found here.

We are now in a technology boom that is driving economic growth. The next phase of growth will be artificial intelligence (AI). According to Fortune, AI is expected to explode into a $70 billion industry by 2020. The CEO’s of all the largest technology companies are predicting major changes to society over the next few decades.  These changes will be positive for investors and the economy. I believe that it is important to monitor these changes because the pace of innovation is highly correlated to the growth of the economy.

One of the fastest growing companies is Uber, which now sports a valuation of over $62 billion. The #3 company on this list is Airbnb. The company was founded in 2008 and now has a value of nearly $25B. In comparison, Marriott,  even with all its real estate, is valued at around $17B. The business model of Airbnb is quite simple. They allow you to rent a room in your house to a stranger for a night. Airbnb now offers more rooms than most of the largest hotel groups in the world–Hilton, InterContinental and Marriott—which each maintain just under 700,000 rooms.  They doubled the amount of rooms in just 2 years. The projections are staggering on the number of rooms they will have available given their growth rate. It won’t be surprising when Airbnb offers more rooms than all the major hotels combined.

There are many ways that innovation in the technology sector could impact a more conservatively held portfolio. Here are a few examples:

  • There are less IPO’s because these private companies no longer need capital to grow. They can maintain their lofty valuations because of access to private money (sorry we can’t invest in Airbnb). When these companies try to go public, it might be a warning sign that markets are overvalued.
  • In the past, you could buy into a publically traded Small Cap Growth index and expect to buy a diversified basket of the most innovative growth companies. Investing in this exchange-traded fund does not give you the exposure that you would expect investing in small growth companies. The value of these start-ups have increased significantly, yet, over the last year, the Russell Small Cap Growth index is down -7.51%.
  • The management teams of unicorn companies care less about profits and more about taking market share. They are disrupting many sectors of the economy, which is causing pricing pressures in blue chip investments. The profit growth is slowing at an alarming pace in some sectors.
  • The business models of these unicorn companies are centered on generating more revenue per employee. For instance, Airbnb maintains 1 million rooms through computers and a few hundred programmers versus a hotel chain of 1,000’s of staff and the cost to maintain these properties. The job growth in many sectors might unexpectedly slow. This could cause volatility to remain high.
  • The top engineers and highly sought after employees are moving to these well-capitalized firms at very competitive wages. I expect wage inflation to pick up as employers are forced to pay higher wages to remain competitive. The economic data might begin to show anomalies as wage growth increases, but with less job growth. If this scenario occurs, it might cause a conundrum at the Fed on whether they should increase interest rates.

The best way that I believe to take advantage of these changes, is through a well diversified portfolio. I expect market volatility to remain high because the valuations of many companies are fluctuating as fast as the pace of innovation.

If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

A Day of Reckoning?

As polarizing as politics are these days, I feel that investment markets are much the same. Some believe that a day of reckoning is near while others are much more optimistic. The debate centers around what will happen to the economy when the Federal Reserve begins to tighten monetary policy by increasing interest rates.  Many commentators and guru investors believe that rising rates will trigger a market meltdown.  The S&P 500 is up around 10% from the February low but remains positive 2.57% for the year. The low prices hit in February were also the same level reached during the selloff last August and prior to that in October 2014.  The bad news for the optimists is that we are up 10% from those levels. However, market valuations are not flashing signs of overvaluation. According to FactSet, the forward 12-month P/E ratio for the S&P 500 is 16.3x. This is at a normal level given that 71% of the S&P 500 companies beat EPS estimates for Q1 this year. The price of oil also has rebounded over 88% since February and is back near the $50 mark.  The unemployment rate in April stood at 5.0%, which is also a normal level.

The housing market has continued its strong recovery and is back to normal levels.  The chart below illustrates how the combined rate of existing- and new-home sales broke the 6 million level in April for the first time in nine years. Housing supply remains very low and the available lots to build is even lower. Given the strength in housing and normal employment levels, I believe that there is a risk that inflation begins to pick up over the next 12-months. The Fed has its eyes on the same data. The extent of inflation will depend on whether oil prices keep rising and whether housing prices stay overheated.

housing

The equity markets have been volatile of late because of fears of slower growth in China, negative interest rates overseas, and the UK’s EU referendum being held on June 23.  Dire warnings are also being cast by market gurus Bill Gross and Carl Icahn. Both warn that a “Day of Reckoning is Coming”.  Bill Gross believes that there are major risks in the fixed income markets and Carl Icahn thinks that equity markets will crash,  so much so that his investments are positioned short 149% more than the value of his long position for the “day of reckoning”

These investors have done a good job of grabbing headlines and they both share similar warnings that the anticipated policy change of higher rates will lead to a market meltdown.

On the other hand, Warren Buffett has said, “that the Fed’s low interest rates were not merely in place to pump up a stock market bubble and that, based on where interest rates are today, stocks should actually be higher than where they are now.”

I believe that the “day of reckoning” all depends on how fast interest rates rise from almost 0%. The economy is addicted to low interest rates but maybe rates are too low. The biggest risk is that the housing market could slow significantly if mortgages rates rise. In 2008, poor underwriting of loans and rising interests rates contributed to causing the great recession. The uncertainty now hinges on the pace of the rate increase. There is the possibility that the day of reckoning” never comes to fruition and markets move sideways much like the past few years. There is also a chance that higher interest rates actually improve economic growth. Many of my retired clients’ income would stand to benefit from higher interest rates. For my clients portfolios, I have remained cautiously optimistic and believe that diversification into higher quality investments has been the best way to lessen the volatility while maintaining a higher dividend income.

If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Disrupted Economy

According to Bank of America Merrill Lynch, the cumulative outflow from equity funds over the past five weeks was $44 billion. The “equity exodus,” saw the largest redemption over a 5-week period since August 2011. The economy is growing very slowly and this is causing alarm with many investors. I believe that investors might be confusing a slow growing economy with how our economy is being disrupted with new technologies. For compliance purposes, I would like to note that I am not making a buy or sell recommendation on any of these companies discussed in this article.

It is clear to investors that value is outperforming growth this year. The margin is close to 8%. I believe that the reason for the divergence has to do with a changing U.S. economy, and investors chasing dividends. Conservative investments have been the big winner over the past 12 months. Investors have been seeking higher dividends and focusing on the companies that are able to maintain their competitive advantages and keep higher barriers to entry. They are selling the companies that are being disrupted by technology.

The public companies which are disrupting the economy includes Facebook and Amazon. Both are trading near all-time highs. Amazon has single-handedly destroyed most retailers in the mall space. The retailers that you grew up shopping at such as Sears, Nordstrom, Macy’s, JCPenney, and Gap have lost a significant amount in value in the past few years. Facebook has had a similar effect on many of the large media conglomerates. On the private equity side, the two big winners are Airbnb, which is disrupting the lodging sector, and Uber, which is disrupting the transportation sector. Even the wealth management business is being disrupted with automated investment advice.

All of these disruptors have one thing in common, they are replacing middle-class jobs with machines. Wealth is now being concentrated into a smaller number of people at an alarming rate. Airbnb and Uber are a few examples of companies accelerating the changing business models of entire industries. This year investors have been buying boring businesses that are more insulated from these disruptors. These sectors include Utilities and Consumer Staples, which have outperformed the broader market. At some point, valuations will become too extreme for the disruptors and too cheap for the more capital intensive businesses. The defensive sectors that have the highest barriers to entry, such as Utilities, REIT’s, and consumer stocks, are beginning to look very pricey. There will come a time when investors begin to lose interest in the disruptors. The reversal of this trend could have major implications on your portfolio over the next year. A few years ago, I believed that Emerging Markets and commodities were going to become extremely volatile. The current trend that is worth watching is how these disruptors are impacting the economy and changing the valuations across sectors that were once thought of as defensive.

If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Emerging Markets Volatility

Volatility has returned to the global markets. Every morning it seemed the U.S. futures market was signaling to open lower because of falling markets overseas. China’s economy is slowing considerably and nobody knows for sure if they will be able to transition from a manufacturing led economy to one more driven by the middle-class.  Since the February market low, Emerging Markets (EM) has led the recovery with about a 16% return. Jeffrey Gundlach, who is a widely followed investor that founded DoubleLine Capital, warned during his asset allocation conference call that Emerging Market equities had seen eight short squeezes greater than 20% in the last 5 years. The trading pattern below is a very good example of extreme volatility. The week was really no different with a -4.54% drop.  I warned all of my clients last year that EM could implode. Looking back, the crash actually could have been much worse if oil prices didn’t rebound. At the time, there was a high probability that many EM economies were on the verge of collapse. I believe that the next 20% move could go in either direction.  Now, all eyes are on China to see whether they can financially engineer an economic rebound.

doubleline

The volatility in commodities, EM, and currencies has spilled over into U.S. equity markets. According to Bloomberg, daily moves in the S&P 500 have averaged 0.84 percent since August, versus 0.55 percent in the prior two years. I believe that EM has been the driver of the increased volatility in the U.S. equity markets.  This year investors have been seeking lower risk investments. They are crowding into Utility stocks, REITs, and any other high quality companies that pay above average dividends.

I believe that the expectations for future market returns have come down substantially. Many investors have accepted that we are in a low growth, low inflation environment, where interest rates are below 0% in major overseas countries. The negative interest rate environment has caused global investors to scramble to seek yield. Gundlach’s new warning is that the Utility sector is looking overvalued relative to other sectors. Utilities and REIT’s are two very popular sectors for retirees looking for stability and income. There are warning signs emerging that the focus on yield could be setting up for unexpected volatility ahead.  The underlying cause of the credit crisis in 2008 was that investors were stretching for yield. Many foolish investors focused 100% on the dividend they received and paid zero attention to the price they paid.  We are not yet at this stage of exuberance, but there is a bubble forming in what appears to be lower risk investments.  The trigger that could begin to deflate this bond bubble may be when the Federal Reserve begins to raise interest rates. Another event which could cause a sharp rise in interest rates would be when overseas central banks remove their negative rate policy. This is unlikely to happen soon, but this shift could be the next test for markets.

If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

What do I do with my old 401k or IRA?

Over the past 10 years, private companies have shifted the market risk to their employees. It is now very uncommon for a new employee at a private company to be offered a pension plan. In most cases, pension benefits have been cut or terminated. Now that the majority of savings are inside of IRA’s or 401k retirement plans, the question that many people are asking is how do I manage this money? The answer to this question is a personal one. Each individual has different goals, risk tolerances, time horizons, tax status, and values. They also have different market expectations, knowledge, and experiences.

My tip for investing your old 401k or IRA is to first create market assumptions and second, create your own investment philosophy. You need to start with these two key investment assumptions – what is the expected inflation rate and market return.  Vanguard founder Jack Bogle believes that stock returns will be as low as 4% before inflation over the next decade. If you believe these predictions, your old 401k or IRA is not going rise as fast as the historical average rate of 8%-9%. Having expectations will help you select the most appropriate investment strategy and asset allocation.

The next step to answering this question, is creating an investment philosophy. If you don’t have a philosophy, I highly recommend you either find an advisor who makes you feel comfortable, or start reading some investment books written by Jack Bogle or other legendary investors. Similar to ideologies and political beliefs, many investors feel strongly one way or another about investing.

I believe that the secret ingredient to investment success is having an investment philosophy. An investment philosophy is a set of core beliefs that is applied to how one invests and thinks about markets. My investment philosophy has been born from my own personal experiences and what I have learned from very successful investors. My core beliefs start with what not to do. Below is my philosophy for investing my clients’ wealth.

  • Do not invest in a company without a recurring positive free cash flow.
  • Do not invest in something you don’t understand.
  • Do not invest in complex mutual funds and ETFs.
  • Do not invest if you don’t understand downside risk.
  • Do not invest if there is no possibility for a future income/dividends.
  • Do not invest if you don’t understand the costs.
  • Do not invest if you are promised abnormal returns.
  • Do not invest in individual international and emerging market companies.
  • Do not invest in a new company that sells only one product.
  • Do not invest in to concentrated positions.

A well-defined investment philosophy could help you become a less emotional investor and give you more control in volatile markets. There is no way to predict what the market will do tomorrow, but you may become more prepared to take advantage of new investment opportunities. If you prefer to work with a financial advisor, be sure that they follow similar core beliefs that align to your own convictions.

If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

Should you change your investment strategy in retirement?

The way that you have managed your investments during the asset accumulation phase really should not be that different when you retire. This advice might contrast what you may have previously learned. The textbook advice is that in retirement, you need to focus on income and keeping pace with the increasing cost of living. Your investments in retirement should be liquid and conservative. In the earlier accumulation years, your portfolio should be aggressive and be overweighed towards growth companies. Young investors should buy growth stocks and older investors should buy value stocks. Many large investment companies, mutual fund companies, and financial planners have built their entire businesses providing this lousy advice. Their solution is to put you in a model portfolio based on your age or invest you in a particular market style.

I believe that better advice can best be summarized by what Warren Buffett wrote in his letter to Berkshire Hathaway shareholders in 2000:

Market commentators and investment managers who glibly refer to “growth” and “value” styles as contrasting approaches to investment are displaying their ignorance, not their sophistication. Growth is simply a component – usually a plus, sometimes a minus – in the value equation.

Buffett also wrote about this argument back in his letter to the Berkshire Hathaway shareholders in 1992,

We view that as fuzzy thinking (in which, it must be confessed, I myself engaged some years ago). In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

Buffett’s advice is that you need to understand the value of the investment that you are buying. It doesn’t matter if you are entering retirement or saving for retirement. In just the past 10 years, many retirees have been burned twice chasing yield. Many nest eggs have been destroyed chasing dividends. In 2008-2009, the market sectors known for paying the highest dividend yields fell the most. Banks and REITs where among the worst performing sectors dropping well over 70%. In 2014-2015, many retirees got caught again buying energy MLPs. These high dividend paying energy companies fell over 80%. All you need to do is search for MLPs and arbitration awards and you can see the amount of pending litigation.

The companies that pay the highest dividends are often the most leveraged companies. They have a combination of high amounts of debt on the balance sheet and very low growth rates. These businesses are viewed as more conservation because they generate their profits in highly regulated industries.

This week many analysts began to warn about the high valuations in the Utility Sector. Historically, this sector has done very well when interest rates fall, but struggles when rates begin to rise. It may be no coincidence that the Utilities Select Sector ETF fell 3% this week as the 10-year Treasury began to move higher. Time will tell whether Utilities will appreciate in value if interest rates continue to move higher.

If you are either saving for retirement or already in retirement, I recommend that you pay more attention to the price of what you are buying rather than whether it pays you a large dividend or has a high growth rate. Many of the portfolios that I manage for clients whether young or old, have similar allocations. There does tend to be more bonds and conservative investments in my retirees’ portfolios, but the equity positions are the same. If I believe an investment is undervalued, the only difference is the size of the position that I will hold. Retirees have less time to recover from difficult markets. The market risk can be somewhat managed by taking smaller positions and through diversification.

The next time a wealth advisor or financial planner tries to put you in a model portfolio or tells you to buy only dividend sectors, your next questions should be: is this at a good price and what is the interest rate risk?

If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.