Investment Insights

This week many of the major U.S banks reported earnings. These quarterly reports were exactly what they should be for a bank, which is very boring. They are reporting higher revenue and earnings than 1 year ago.  U.S. banks have now become cash cows.

There are still many investors who believe that banks can’t thrive when interest rates are low. These investors have failed to realize that the low interest rate environment has been a boon for profitability. Even though interest rates have been very low, banks are extremely profitable. In the past, banks had trouble making money when interest rates were low. This was because of something called net interest margin. The net interest margin for a bank is the interest rate spread between deposits and loans. The higher the spread, the higher a bank’s profits. This spread is very important for a bank. Banks can create more profit by borrowing cheap in the short-term and lending high in the long-term. They prefer a larger yield differential, or a “steeper” yield curve.

Bank stocks will tend to rise on days when interest rates rise. I believe that this is now the incorrect way to value a bank. If banks had it their way, they would prefer for the economy to be exactly the same way as it has been for the past 5 years. It is much more important that there is stable employment and a strong housing market. The low interest rate and slow growth economic backdrop have been a great combination for a bank’s profitability. Banks can now generate more income from fees and they rely less on the spread between interest rates.

Ten years ago, before the credit crisis hit, banks were highly leveraged, had lower capital ratios, and they didn’t have solid underwriting standards. Now fast forward a decade, banks have rebuilt their balance sheets, have tightened lending standards, and have diversified their revenue streams. The operations inside of a bank have also become much more efficient. Banks have closed branches, lowered headcount, while continuing to invest into technology.

A well-known bank analyst reported that banks are swimming in so much excess cash that they don’t know what to do with it. Most banks have been returning cash to shareholders in the form of rising dividends and share buybacks. The largest U.S banks are now buying back shares at a greater rate than many cash rich technology companies.  I expect that this pace of buybacks and dividend increases will only increase over the next few years.

I will continue to favor banks as long as the housing market stays strong and the unemployment rate remains low. I’m much less focused on falling or rising interest rates than most other investors. The banking system has helped to facilitate economic growth and should continue to do so as long as banks keep their future earnings reports very mundane.

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Professionals and individuals alike make major financial decisions based solely on past investment returns. This is a huge mistake. Given that the average 5-year return of the S&P 500 now stands at 15%, these hypothetical returns show unrealistic promises of high returns.

Most financial advisors use market hypotheticals in their presentations to make the case that their investment model is superior.  They hope that the unsuspecting investor will ignore the warning “past performance is not an indicator of future outcomes” in fine print and will chose the investment or financial advisor that shows the greatest return potential.

Throughout my career, I’ve seen the worst investment mistakes made when people chase past performance. Here are five helpful tips on how to avoid this mistake:

Gimmick – There is a very large presentation book filled with charts and graphs that show hypothetical performance and no actual performance.

Tip – Make your decision based more on the investment philosophy and experience of the advisor or firm who will be managing the money. Is the investment process repeatable? What are the qualifications of the advisor?  

Gimmick– A mutual fund fact sheet is shown with very high returns.

Tip – Ask the advisor for the worst 1, 3, and 5 year returns for that same investment. 

Gimmick – A model portfolio based on risk and no actual returns is presented.

Tip  – Request to see actual returns of clients. If real returns are not available, ask to see a client reference list.   

Gimmick – A proprietary mutual fund is selected by the financial advisor. This is an investment managed by the company that you are meeting with.

Tip – In 99.9% of the cases, this mutual fund has much higher expenses and has likely underperformed its benchmark. Ask to see if there is an exchange-traded fund equivalent with lower fees and higher returns.

Gimmick – An annuity is recommended by showing you hypothetical returns with income expectations for life.

Tip – Request to see what the total expense will be for that annuity over a 5 and 10 year period. Determine when the original investment principal is exhausted. 

At this point in the market cycle, investors need to be very cautious on selecting their investments based on past returns. I have seen more and more hypothetical investments from other financial advisors that will not be repeated. It is very easy to construct models that are backward-looking and misleading. My recommendation is to tear them up and recycle the paper.

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I recently finished a book titled Zero to One, which was written by Peter Thiel. Peter is an entrepreneur and investor, who started PayPal in 1998. After he took the company public, he made the first outside investment in Facebook, and since that time has been an investor in hundreds of startups. The book stems from a course on startups that he taught at Stanford in 2012.

He wrote that successful people find value in unexpected places and they do this by thinking about business first from principles instead of formulas. The same could be said of all successful investors. Making investments based on formulas or technical analysis does not lead to successful investment outcomes over fundamental analysis.

This week Bill Gross wrote (and underlined) in his April Investment Outlook that “equity markets are priced for too much hope, high yield bond markets for too much growth, and all asset prices elevated to artificial levels that only a model driven, historically biased investor would believe could lead to returns resembling the past six years, or the decades predating Lehman. High rates of growth, and the productivity that drives it, are likely distant memories from a bygone era.”

Bill also wrote that “Northwestern’s Robert Gordon has long argued that lower productivity may now be a function of having picked all of the “low hanging fruit” such as electrification and other gains from 20th century technology.”

Bill has one of the greatest bond investment track-records, but I know that Peter would not agree with much of this statement. Peter wrote in his book that new technology tends to come from new ventures – startups. These startups build a different plan for the future.  They are both imagining and creating the new technologies, while questioning received ideas and rethinking business from scratch. Peter believes in the power of planning and he writes that long-term planning is often undervalued by our indefinite short-term world. In July 2006, Yahoo! offered to buy Facebook for $1 billion. Mark Zuckerberg scoffed at the idea. The rest is history.

I believe that this way of thinking can be applied to many of the companies that have been the big winners in our economy. Eight of the top 10 companies in the S&P 500 companies are continuously innovating. Of these top companies – Apple, Google, Microsoft, Amazon, Berkshire Hathaway, J&J, and Facebook – all share the similar characteristic of being a monopolistic power. Peter defines a “monopoly” as a kind of company that’s so good at what it does, that no other firm can offer a close substitute. He believes that the reality is that there is an enormous difference between perfect competition and a monopoly. Either a business has it, or it doesn’t.

The cash flows for these monopolies require much less capital investment and more human capital. Outsized profits come from these monopolies, in turn, leads to higher stock appreciation. To paraphrase Peter, creative monopolies give customers more choices by adding entirely new categories of abundance; they are powerful engines for making it better. A company such as Apple only becomes a monopoly when people will pay even more money for a product. A search engine such as Google’s cannot be replicated. Hasbro is one of the most popular companies in our local area and they have been a very creative monopoly. I have a few clients who work there and you would be surprised that none of them think of their company as a toy company, rather it’s a technology company that specializes in entertainment.

Geopolitics and what happens in government is important, but not nearly as much as investing long-term in companies that are developing creative monopolies. There is a premium to own many of these types of businesses and this will likely remain the case even through these volatile markets.

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I’m continuously evaluating potential market risks that can derail the market. I’m also always searching for new investment opportunities and the next big idea. There is one new technology that will have an enormous impact on the economy. My father just purchased a new car and he can’t stop talking about all the high-tech features. He is most excited about the driver-assist technology such as lane-assist features, and the adaptive cruise control that maintains a steady distance from the car in front of him. This is the next big idea. It’s not marijuana penny stocks. I’ve had many people looking for marijuana stock ideas, but I’ve found more companies that I’d like to bet against. I’m sure that there might be one or two big winners, but good luck finding them in the weeds.

The computer has evolved from your desktop, to your phone, and is now going into your car. The autonomous vehicle technology is going to change the automotive industry and disrupt transportation industries for years to come. Similar to the iPhone, which reshaped the telecom industry, I expect autopilot to have a substantial impact on the automotive industry. All the major technology companies are spending massive amounts of money to develop their own version of an autopilot system. Even self-driving trucks will become common on roadways. According to estimates by the American Trucking Association, there are approximately 3.5 million professional truck drivers in the United States. While these jobs are not currently at risk, there could come a time when this once stable industry is disrupted.

There is much debate over how safe these driverless cars are. The U.S. crash investigation into Tesla’s driver-assistance autopilot ended up suggesting that the feature actually increases safety. According to the data that Tesla provided investigators and data from a Bloomberg article, “installing Autopilot prevents crashes—by an astonishing 40 percent.” The group of people that this technology will benefit the most, are the elderly or people with physical disabilities. Florida’s roadways might one day be filled with more self-driving cars than actual real drivers.

There have already been many winning investments in this area. To name a few, companies such as Google, Tesla, STMicroelectronics, NXP Semiconductors, Apple, Nvidia, Mobileye, Delphi Automotive, Bosche, Tesla, Nissan Mercedes-Benz, Uber and Audi are the current leaders creating prototype vehicles. For select companies, investors are willing to look past quarterly earning misses and are focusing more on the potential for future market share.

I’ve been researching the companies with the most cutting-edge technologies. Even though we are still in the early infancy of developing this technology, many of these companies are already trading at rich valuations. As a value investor, I prefer to buy investments at a much lower price. If we get a market sell-off, this is one area that is at the top of my shopping list for my clients who have a higher risk tolerance.

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My grandmother is 105 years old. In her 90’s, she could name every single U.S. president. I never thought she would be adding Donald Trump to that list. I must have inherited my love of history from her. I’ve read over 30 presidential autobiographies. And yes, I hope to also be able to name all the U.S. presidents in my 90’s.

This week, $1 trillion of value was wiped from bonds, while global stocks gained $1.3 trillion. Investors scrambled to re-balance portfolios from the ‘Clinton’ portfolio to the ‘Trump’ portfolio. For those investors in a U.S. balanced portfolio, this week was almost a wash. The table below shows the weekly change of the potential winners and losers of a Trump presidency.

These wild moves in the market may prove to be premature as actual policy remains uncertain.  President-Elect Trump doesn’t even know yet what he is going to be able to accomplish.  I believe that a Trump presidency just increased the level of risk in investors portfolios, but also the potential for higher returns.  Donald Trump‘s win on Election Day is no different than Britain’s stunning vote to leave the European Union. This global movement towards more isolationism will continue to spread globally. I expect more global uncertainty as this movement continues to unfold.

In September, Trump said that the Federal Reserve’s ultra-low interest rates created a “false economy” and that “at some point the rates are going to have to change.” He pointed out that the Fed’s policy created a speculative stock market bubble. Trump is going to have to change this rhetoric if he wants to accomplish his agenda. This week, the 10-year Treasury yield jumped the most in 3 years from 1.82% to 2.12%. The hope is that interest rates will remain low as overseas buyers step in to buy our Treasuries because their rates are closer to zero. Bond investors fear that his plan to stimulate the economy could result in a balloon to the budget deficit and an increase in inflation.

In the past, Congress has been reluctant to challenge the bond market’s power. James Carville, who was the lead strategist for President Bill Clinton, coined one of the best quotes that summarizes this point,

“I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter,” he said. “But now I would like to come back as the bond market. You can intimidate everybody.”

I believe that the only thing in the world that can intimidate President-Elect Trump, is the bond market. His entire agenda from cutting taxes for corporations, changing the tax code, building walls, removing trade agreements, creating massive infrastructure spending, forcing companies to build factories in the U.S, and adding tariffs will not only need a check written by Congress, but it will also need the bond markets approval.  The early vote from the bond market isn’t looking positive. If interest rates rise sharply, Trump’s vision of a “false economy” better morph into a “real economy”, or the stock market will have disappointing inflation-adjusted returns in the years ahead.

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

The challenge that many retirees face, is constructing a portfolio to meet their funding goals. This challenge becomes even greater with interest rates near all-time lows and market values near all-time highs. Millions of baby boomers are discovering that their nest egg is not going to generate the income that they need to meet their budgets in retirement.

The question that everyone wants to know, is how much money they can withdraw from their portfolio without depleting their life savings. There is only one chance to get this question right.

In retirement, preserving the portfolio while managing for risk is essential for a successful outcome. The reality is that there will be a test along the way from a significant market correction that will cause second-guessing on whether or not the asset allocation is correct.

I believe to make matters worse, more and more retirees have bought into the notion that passive management is a far superior way of investing than active portfolio management. Indexing has become the rage as most major benchmarks have had enormous gains. Leading the way is the S&P 500 (SPY), with an average 15.36% return over the last 5-years. There is no shortage of commentary praising the merits of indexing. Almost a decade ago, Warren Buffett made a million-dollar bet that the S&P 500 would beat the gains earned by a high-powered hedge fund with a team of managers at the helm. It looks as though he is going to win this bet by 40% as the hedge fund managers have struggled.

It goes without saying that investors have very short-term memories. Investing in only the S&P 500 or having a large overweight would have been viewed as imprudent just a few short years ago. For example, a 65 year old, who retired back in 2000 over the course of their retirement years, would have experienced the following 5-year average returns of the S&P 500.

• Jan 2000 to Dec 2004 = -10.96%
• Jan 2007 to 2011 = -1.27%
• Jan 2004 to Dec 2008 = -10.48%

In this example, investing in only the S&P 500 would have resulted in major budget shortfalls 8 out of 16 years. With the market near an all-time high, investing in only passive investments with no focus on active management is not the most appropriate advice for a retiree. This lousy investing advice perambulating the internet is setting up for future disappointment. I believe that diversification through both active and passive investing, with an eye on valuations, is the best way to manage a portfolio. Similar to politics, the best solutions are usually found somewhere near the middle and not at the extremes.

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.

If a financial advisor ever recommends that you buy an annuity, you should immediately seek a second opinion. Nobody hates annuities more than Suze Orman.  Suze believes that annuity salespeople prey on fear, especially of the retired. Moreover, Suze thinks it is the worst investment that you can make.

In rare circumstances, I believe a small allocation into an annuity might fit into a financial plan. This buyer doesn’t care about leaving an inheritance and they could benefit from more discretionary income. Otherwise, I do not recommend annuities for the following reasons:

• They are complicated products that can be confusing to the buyer. Even the sellers of many of these annuities don’t understand the features. Last month, MetLife was levied a near-record $25 million fine for errors in understating the value of replacement contracts. According to the Wall Street Journal, MetLife said that the company’s registered representatives weren’t provided “adequate training or guidance on how to conduct a comparative analysis” of products and that “deficient systems and procedures” were evident. If the salesperson doesn’t understand the product, there is no way for the buyer to grasp how the product works.
• The surrender fees often start at 7% and there is no liquidity.
• The sales commissions for annuities are very high and range between 6% to 7%.  Most financial advisors wouldn’t sell many of these poorly designed products unless they received this huge commission.
• Annuities are terrible from a tax standpoint.  They are not subject to the long-term capital gains rate; rather, they are subject to ordinary income taxes.
• The time to lock into a fixed guaranteed income is not when interest rates are near historical lows and inflation could be on the rise.
• The guaranteed withdrawal benefit (GWB) that is sold as a benefit is really a gimmick. At the age of 65, a variable annuity offers a 5%-6% guaranteed lifetime income. This guaranteed withdrawal income is based on nothing less than a life expectancy calculation. If an annuity holder lives well beyond their average life expectancy, they can beat the annuity company but their heirs most likely will receive no inheritance. If the annuitant dies early in retirement, the annuity works in the favor of the annuity company.

I offer second opinions for anyone seeking advice before they make an annuity purchase. I will most likely tell you the reasons why not to buy it. There are many other investments that you can make that offer above average dividend yields with the potential for gains. Yes, the market risk will be higher, but a well balanced portfolio can help to diversify away some risk.  Diversification does not prevent losses, but it will help to hedge against inflation and can create a more stable income stream.

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.

Proper tax planning can help you save money in retirement. When you combine all sources of cash flow in retirement, some retirees find that they may owe more to the government. Your income for retirement may come from multiple types of accounts – trusts, pensions, IRA’s (Roth or traditional) Social Security, annuities, and taxable accounts.

There is a pecking order for which account you want to withdraw from first to minimize your taxes. Even in retirement, everything comes down to the correct timing. Creating a retirement income plan will help you minimize taxes by properly managing your cash flows. The information that I have read online on this topic is very general. There are many important personal considerations that you need to consider.

Here is a list of 10 questions that will help you with your retirement planning:

1. What will be your tax bracket in retirement vs. while working?
2. Will you be forced to take a large IRA withdrawal at any point in retirement?
3. Do you own a Roth IRA vs. a Traditional IRA? What are the benefits to converting to a Roth IRA?
4. How will an IRA withdrawal affect your Medicare premiums? What state do you plan on living in retirement and do they count IRAs as assets when applying for Medicaid?
5. How much money do you want to protect from Medicaid if you ever need long term care? How important is asset protection for your estate?
6. What are the after-tax cash flows required to maintain your lifestyle/budget in retirement?
7. How much money do you plan on leaving as a legacy? What types of accounts do you currently own and will you be passing down?
8. Will your IRA withdrawals increase your Social Security taxes?
9. How is your health and do expect to live long in retirement?
10. Are you going to be receiving any significant inheritances while in retirement?

After reading these questions, you may find that retirement planning can be complicated. Tax planning really comes down to your personal circumstances and goals. The general rule of thumb is that you will take money from taxable accounts first. These are the least tax efficient types of accounts.

If you own both a Roth IRA and a Traditional IRA, it’s best to withdraw from the Roth IRA last. These earnings are tax-free and there are no required mandatory distributions. Roth withdrawals do not increase your adjusted gross income (AGI), which keeps Social Security taxes lower. Your beneficiaries will also thank you, because they will not owe any federal income taxes. For IRA withdrawals, I find it’s best to spread them out over time to minimize any large withdrawals. Once you’re older than 70.5, you will be required to take out a minimum distribution.

You have worked hard to save for retirement and you do not want to make a mistake and give away money to the government. Proper tax planning and understanding how your personal circumstances impact your retirement plan will help you minimize your tax burden.

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.

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.