Growth Versus Value: An Inflection Point?


Over time, Value stocks outperform Growth stocks. There are a number of reasons why this has held true over the history of the market. Value stocks may include sectors which are currently out of favor and inexpensive. Investors, on the other hand, are sometimes willing to pay too much for a sensational growth story rather than a boring, blue chip company. Often, those great sounding stocks flame out rather than shooting higher as hoped. The result is that the long-term benefit of value strategies has persisted.

Although the “Value Anomaly” is a historical fact, it hasn’t worked in all periods, and we’re at such a point in time now. Growth has actually outperformed value over the past decade. Even though growth beat value in only 5 of the past 10 calendar years, the cumulative difference is notable. Over the past 10 years, the Russell 1000 Growth fund (IWF) has returned an annualized 9.18% versus 7.10% for the Russell 1000 Value (IWD). And so far this year, Growth (IWF) is up 5%, whereas Value (IWD) has gained only 0.63%.

The last time growth showed a marked divergence from value was the 90’s. And at that time, we saw the valuations of growth companies rise to unsustainable levels. This largely occurred in the tech sector, where for example, we saw Cicso trade for more than 200 times earnings, and become the most valuable company in the world in 2000. Eventually, growth corrected with the bursting of the tech bubble, and we saw value stocks return to favor. These are the cycles of the market, as inevitable as the seasons, although not as consistent, predictable, or rational!

I don’t think we’re in bubble territory for the market today, but some popular growth names have certainly started to become expensive and value is looking like a relative bargain. Looking at the top 10 stocks in the both indices, the growth stocks have an average PE of 27, versus 17 for the 10 largest value companies. Some of that difference is Facebook, #4 on the Growth list, with a PE of 75. However, the difference in valuation is across the board. Two of the largest value companies, Exxon Mobil and JPMorgan Chase have a PE of only 11.

So, what are the take-aways from the Growth/Value divergence?

  • Growth has outperformed value in recent years. This will not continue forever.
  • Our portfolios are diversified, owning both growth and value segments. We have a slight tilt towards value, which we will continue. When value returns to favor, this will benefit not only pure value funds, but will also likely help dividend strategies, low volatility ETFs, and fundamentally-weighted funds.
  • As the overall market becomes more expensive, I would expect to see that we will move from a unified market, where all stocks move up or down together, to a more segmented market, where stocks move more based on their valuation and fundamentals. Global macro-economics have been the primary driver of stock prices in recent years, but this should abate somewhat as the recovery continues.

We won’t know if we’ve reached an inflection point, where value will overtake growth, until well after the fact. Growth can’t outperform indefinitely, and as investors become more cautious, value stocks will start to look more and more attractive. That’s what we’re seeing in the market today and why we started to increase our value holdings in 2015.

Source of fund data: Morningstar, through 3/27/2015

How Much Can You Withdraw in Retirement?


With corporate pensions declining in use, retirees are increasingly dependent on withdrawals from their 401(k)s, IRAs, and investment accounts. The challenge facing investors is how to plan these withdrawals and not run out of money even though we don’t know how long we will live or what returns we will receive in the market on our portfolio.

Pensions and Social Security provide a consistent source of income that you cannot outlive. When I run Monte Carlo simulations – computer generated outcomes testing thousands of possible scenarios – we find that the larger the percentage of monthly needs that are met from guaranteed sources, the lower chance the investor will run out of money due to poor market performance from their portfolio.

If you do have a pension, it is very important to consider all angles when deciding between a lump sum payout and participating in the pension for the rest of your life. It is not a given that you will be able to outperform the pension payments, especially if you are healthy and have a long life expectancy.

The most obvious way to avoid running out of money (called longevity risk by financial planners) would be to annuitize some portion of your portfolio through the purchase of an immediate annuity from an insurance company. While that would work, and is essentially the same as having a pension, very few people do this. You’d be giving up all control of your assets and reducing any inheritance for your beneficiaries. With today’s low interest rates, you’d probably be less than thrilled with the return. For example, a 65-year old male who places $100,000 in a single life immediate annuity today would receive $542 a month.

The problem with annuitization, besides giving up your principal and not leaving anything for your heirs, is that it doesn’t allow for any increase in expenditures to account for inflation. There are three approaches we might use to structure a withdrawal program for a retiree.

1) Assume a fixed inflation rate. In most retirement planning calculators, projected withdrawals are increased by inflation to maintain the same standard of living. After all, who doesn’t want to keep their standard of living? The result of this approach is that the initial withdrawal rate then must be pretty low. 20 years ago, the work of William Bengen established the “4% rule” which found that a withdrawal rate of 4% would fund a 30-year retirement under most market conditions.

On a $1 million portfolio, 4% is $40,000 a year. But that is just the first year. With 3% inflation, we’d plan on $41,200 in year two, and $42,436 in year three. After 24 years, withdrawals would double to $80,000. The 4% rule is not the same as putting your money in a 4% bond; it’s the inflation which requires starting with a low initial rate.

While we should plan for inflation in retirement, this method is perhaps too rigid in its assumptions. If a portfolio is struggling, we’re not going to continue to increase withdrawals by 3% and spend the portfolio to zero. We have the ability to respond and make adjustments as needed.

2) Take a flexible withdrawal strategy. We may be able to start with a slightly higher initial withdrawal rate if we have some flexibility under what circumstances we could increase future withdrawals. In my book, Your Last 5 Years: Making the Transition From Work to Retirement, I suggest using a 4% withdrawal rate if you retire in your 50’s, a 5% rate if you start in your 60’s, and 6% if retiring in your 70’s. I would not increase annual withdrawals for inflation unless your remaining principal has grown and your withdrawal rate does not exceed the original 4, 5, or 6%.

This doesn’t guarantee lifetime income under all circumstances, but it does give a higher starting rate, since we eliminate increases for inflation if the portfolio is shrinking. Under some circumstances, it may even be prudent to reduce withdrawals to below the initial withdrawal amount temporarily. That’s where having other sources of guaranteed income can help provide additional flexibility with your planning.

3) Use an actuarial method. This means basing your withdrawals on life expectancy. Required Minimum Distributions (RMDs) are a classic example of an actuarial strategy: you take your account value and divide by the number of years of life expectancy remaining. If your life expectancy is 25 years, we take 1/25, or 4%. The next year, the percentage will increase. By the time someone is in their 90’s, their life expectancy will be say three years, suggesting a 33% withdrawal rate, which may work, but obviously will not be sustainable. However, the more practical problem with using the RMD approach is that many people aren’t able to cut their spending by 20% if their portfolio is down by 20% that year. So even though it has a sound principle for increasing withdrawals, the withdrawal amounts still require flexibility based on market results.

But there are other ways to use the actuarial concept, and even my approach of different rates at different retirement ages is based on life expectancy. There’s no single method that will work in all circumstances, but my preference is to take a flexible strategy. But this does mean being willing to reduce spending, and forgo or even cut back inflation increases, if market conditions are weak.

We have a number of different tools available to evaluate these choices throughout retirement, but the other key factor in the equation is asset allocation. Bengen found that his 4% rule worked with equity allocations between 50% and 75%. Below 50% equities, the portfolio struggles to keep up with inflation and withdrawals become more likely to deplete the assets in the 30-year period. Above 75% equities, the portfolio volatility increases and rebalancing benefits decrease, increasing the number of periods when the 4% strategy would have failed.

When sorting through your options, you need candid and informed advice about what will work and under what circumstances it would not work. We hope for the best, but still have a plan for contingencies if the market doesn’t cooperate as we’d like. We will be able to consider all our options as the years go by and be proactive about making adjustments and corrections to stay on course. For any investor planning for a 30-year retirement, it’s not a matter of if the market will have a correction, but when. It’s better to have discussed how we will handle that situation in advance, rather than waiting until the heat of the moment.

Deferral Rates Trump Fund Performance, Rebalancing as Key to Retirement Plan Success


A study by the Putnam Institute, “Defined Contribution Plans: Missing the forest for the trees?” contends that while a number of variables, such as fund selection, asset allocation, portfolio rebalancing, and deferral rates all contribute to a defined contribution plan’s effectiveness — or lack thereof — it is deferral rates that should be placed near the top of the hierarchy when considering ways to boost retirement saving success.1

As part of its analysis, the research team created a hypothetical scenario in which an individual’s contribution rate increased from 3% of income to 4%, 6%, and 8%. After 29 years, the final balance jumped from $138,000, to $181,000, $272,000, and $334,000, respectively.

Even with a just a 1% increase — to a 4% deferral rate — the participant’s final accumulation would have been 30% greater than it would have been using a fund selection strategy defined as the “Crystal Ball” strategy, in which the plan sponsor uses a predefined formula to predict which funds may potentially perform well for the next three-year period. Further, the 1% boost in income deferral would have had a wealth accumulation effect nearly 100% larger than a growth asset allocation strategy, and 2,000% greater than rebalancing. Of course these results are hypothetical and past performance does not guarantee future results.

One key takeaway of the study was for plan sponsors to find ways to communicate the benefits of higher deferral rates to employees, and to help them find ways to do so.

Retirement Savings Tips

The Employee Benefit Research Institute reported in 2014 that 44% of American workers have tried to figure out how much money they will need to accumulate for retirement, and one-third admit they are not doing a good job in their financial planning for retirement.2 Are you? If so, these strategies may help you to better identify and pursue your retirement savings goals:

Double-check your assumptions. When do you plan to retire? How much money will you need each year? Where and when do you plan to get your retirement income? Are your investment expectations in line with the performance potential of the investments you own?

Use a proper “calculator.” The best way to calculate your goal is by using one of the many interactive worksheets now available free of charge online and in print. Each type features questions about your financial situation as well as blank spaces for you to provide answers. But remember, your ultimate goal is to save as much money as possible for retirement regardless of what any calculator might suggest.

Contribute more. At the very least, try to contribute enough to receive the full amount of any employer’s matching contribution. It’s also a good idea to increase contributions annually, such as after a pay raise.

Retirement will likely be one of the biggest expenses in your life, so it’s important to maintain an accurate cost estimate and financial plan. Make it a priority to calculate your savings goal at least once a year.

Today’s blog content is provided courtesy of the Financial Planning Association.


1Putnam Institute, Defined Contribution Plans: Missing the forest for the trees?, May 2014.

2Ruth Helman, Nevin Adams, Craig Copeland, and Jack VanDerhei. “The 2014 Retirement Confidence Survey: Confidence Rebounds–for Those With Retirement Plans,” EBRI Issue Brief, no. 397, March 2014.

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.

© 2015 Wealth Management Systems Inc. All rights reserved.

Three Things Millennials Can Teach Us About Money

Woman with Phone

As a financial planner, I spend a lot of time thinking about how to approach the different goals of my clients. While each client has a unique set of needs and circumstances, I’ve been studying and observing generational trends with a keen interest. Baby Boomers are approaching retirement, or newly retired, and are redefining what retirement means compared to their parents. Gen Xer’s (born 1965-1979), like myself, are mid-career and working towards myriad goals with cautious self-reliance. And then there are Millennials (born 1980-2000), who are now starting their careers and families and making their own stamp on financial planning.

Each generation has unique ways of doing things, and it’s not simply that today’s 30 year old has the same issues as a 65 year old had 35 years ago. We often hear about the financial challenges facing Millennials: student debt, living at home longer, less decisive about careers, delaying starting a family. There’s no doubt Millennials have been shaped by two recessions, a war, a housing bubble and collapse, and a difficult job market for entry level employees. But, there’s more than enough articles detailing those concerns. I want acknowledge three of the things they are doing right, because there are plenty of Millennials who have high expectations and are well on their way to becoming wealthy.

1) Millennials participate in their investing. Growing up with Google, cell phones, and the Internet, Millennials are going to gather information, confirm details, and find out what their friends and colleagues are doing. Comfortable with technology, they favor paperless banking and are more organized than previous generations, keeping track of their finances using online tools, mobile apps, and programs like Mint or Quicken. We can have meetings by video conference or webinar, and there will be no difference between having an advisor who is one mile away or a thousand miles away. Technology is here to stay, and is really only getting started as far as its impact on the planning process.

Millennials are more personally involved in their finances, seeking to be partners with advisors, rather than delegators. The more Millennials read about the rationale behind using index funds, the more indexing makes sense. They want to find an investment solution that works and are not as competitive about wanting to “beat the market”. Even when they use index funds, they want a plan which is customized just for them and their goals, and not a cookie-cutter plan. In that regards, they are actually more likely to value financial planning than Gen X.

2) Millennials are more frugal and less materialistic. They recognize that buying things you can’t afford with a credit card is a mistake. And while they want the financial freedom to express themselves as a unique individual, they are less interested in trying to impress others with a display of wealth. They understand that having more “things” doesn’t make you happier. Overall, Millennials are making good decisions as consumers and would likely have less debt than previous generations, if it weren’t for the dramatic rise in student loan debt in recent years.

3) Millennials recognize when renting is a better fit for their lifestyle than owning a home. They saw the effects of the housing crisis and likely know people who went through foreclosure and lost their homes. Unlike previous generations, they no longer consider home ownership as the definition of adulthood or as a sure-fire investment. Baby Boomers typically bought a house as soon as they could, upsized when possible, and used their home equity to fund their lifestyles. Millennials want community and convenience and are less willing to tolerate a long commute to the suburbs to afford the largest home possible.

For Millennials who are career driven, renting offers the flexibility to move anywhere in the country as their career dictates. This change reflects the new reality of today’s job market: employees aren’t going to have a career with just one or two companies. They need to move to where the jobs are located.

Millennials outnumber Gen X nearly 2 to 1, so they will have a significant impact on the development of our economy, business, and even the future delivery of financial planning. I don’t view the generational differences as right or wrong, or better or worse. Each is a product of their environment. What I am interested in is understanding each investor fully so that our plan can be as thorough and complete as possible in helping each achieve their goals. That’s my commitment to you and why I built Good Life Wealth Management: to provide the flexibility and resources to enable investors of any age to create and execute a plan that works.

And for those of use who are a little more experienced, keep an open mind – it’s never too late to learn a few new tricks from the younger generation!

Retiring Soon? How to Handle Market Corrections.

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I was recently asked “How would you protect a soon to be retired investor against the inevitable market correction that will occur in the next couple of years?” It’s a great question and I think it’s very important that investors understand the risks they take when investing. Having not had a significant correction in six years, we may be well overdue. Of course, some forecasters have been calling for a correction for a couple of years, and yet the S&P 500 was up 13% last year and 32% the year before. That’s the problem with trying to time the market – it’s not possible to predict the future and it’s too easy to miss good returns by sitting on the sidelines. So, how should investors position their money if they’re a couple years from retirement?

The first thing is to frame the investment portfolio in a broader context. Someone who is four years from retirement does not have a four-year time horizon, but more likely, a 30-year time horizon, so we want to focus on finding the best solution for the whole 30-year period. That means we have to balance the desire for short-term safety with the long-term need to keep up with inflation and not run out of money. While retirement may be a one-time event, retirement planning is an on-going process.

In addition to withdrawals from accounts, retirees will have other, guaranteed, sources of income, such as Social Security, Pensions, or Annuity payments. These may cover a significant amount of fixed expenses, which allows the investment portfolio to be used in a somewhat discretionary manner during retirement. With corrections occurring every 5 to 6 years on average, a retiree could experience five or more corrections over the course of a 30-year retirement.

The reality is that we have to be willing to accept some level of volatility in a portfolio in exchange for the potential for a higher long-term rate of return. We start with a risk tolerance questionnaire to get to know each client and help select a target asset allocation that will be the most likely to accomplish their financial objectives with the least amount of risk. There’s no magic bullet to give investors a great return and no risk, so it truly is a decision of selecting an acceptable level of risk that will fulfill their planning needs. Almost everyone needs to have a mix of safer assets and assets which offer an opportunity for higher long-term growth. Some of my clients have 50 percent or more in bonds, and that may work for their situation.

With the portfolio construction, I am very focused on creating a strong risk/return profile for each of my models. We diversify broadly to reduce correlation of assets and systematically rebalance each portfolio on an annual basis. Rebalancing provides a discipline of selling assets which have run up and buying assets which are cheaper. We can eliminate some types of risk altogether, including company-specific risks (by owning the whole market rather than a handful of individual stocks), and manager risks. We know that typically 65-80% of equity managers under perform their benchmark over five years, but since we don’t know which managers outperform in advance, choosing managers is simply not a good bet to be making. That’s why we use index funds rather than selecting “five star” fund managers for our core holdings – it puts the odds in your favor.

We buy Low Volatility ETFs for some client portfolios, and I think many investors would be interested in learning about ways to reduce market fluctuations. Low Volatility funds select a basket of the least risky stocks from a larger index. They’re designed to offer a return similar to traditional indexes over time, but with a noticeably lower standard deviation of returns. They’re fairly new strategy (available the last three years or so), but I think are one of the more compelling ideas in portfolio management today. Read more here:

Lastly, when working with a new client, we can dollar cost average over six months, so if we do have a pullback in the fall (as we did last October), we would have cash to put to work. The key is that even someone who is planning on retiring in the next couple of years needs to have a clear plan that addresses both their accumulation needs and a retirement income strategy. That’s our focus at Good Life Wealth Management and we’d be happy to meet with you and discuss how to accomplish your retirement goals.


4 Strategies to Reduce the Medicare Surtax


It’s tax season and we’re always on the lookout for ways to save on taxes for our clients. 2014 was the second year under the new Medicare surtax system, but there are still questions as to what the tax is and how to reduce its impact.

The Medicare surtax has two parts and is levied on earnings above $200,000, if single, or $250,000, if married filing jointly. The first part is a 0.9% tax on earned income (wages) that exceeds the thresholds above. Second, there is a 3.8% tax on net investment income above the threshold. Net investment income includes dividends, interest, capital gains, royalties, rental income, and other passive income. (It does not include Social Security, pension payments, or withdrawals from retirement accounts.)

Employers will withhold the additional 0.9% if your individual pay exceeds the threshold. However, employers don’t know a couple’s joint income, so in a situation where both spouses make $150,000 there would not be any additional payroll withholding, even though their joint income of $300,000 will trigger the surtax. In that situation, you may need to direct your HR department to withhold an additional amount for taxes or make quarterly estimated payments directly to the IRS.

With the top tax bracket back up to 39.6%, the surtaxes create a top marginal rate of 40.5% on earned income and 43.4% on investment income. With such high tax rates, it pays to make sure we turn over every stone in search of any possible way to reduce these taxes.

Below are four strategies which can lower your exposure to the new Medicare surtaxes. If you can reduce your taxable income to below the threshold amount, the surtaxes can be avoided altogether.

1) Maximize your 401(k) or employer sponsored retirement plan. Your pre-tax contributions will lower your taxable income. While that’s pretty obvious, we still find that many families are not contributing every dollar they’re eligible to invest. For example, make sure you are taking advantage of catch-up contributions in the year you turn age 50. For couples, make sure both spouses are making the full contribution amount to their retirement plan.

Deductions for Traditional IRAs are generally not available if you are subject to a Medicare surtax, unless both spouses are not covered by an employer-sponsored retirement plan. However, if you have self-employment income, you can contribute to a SEP-IRA for your self-employment, in addition to making contributions to a 401(k) at your regular job. And if you’re self-employed and have a high income, you may be a candidate for a Defined Benefit plan, which can offer a higher contribution limit than a Defined Contribution plan like a 401(k).

2) Health Savings Account (HSA). If you select an HSA-eligible high deductible health insurance plan, you can contribute to a pre-tax Health Savings Account. For 2015, the HSA contribution limits are $3,350 for a single participant, or $6,650 for a family plan. Holders age 55 or above can contribute an additional $1,000.

3) Choose Municipal Bonds. Interest from tax-free municipal bonds is not subject to the Medicare surtax. While their interest rates are lower than some other types of bonds, their tax-effective rate is attractive for taxpayers in higher tax brackets. Here at Good Life Wealth Management, we can help you select a municipal bond mutual fund, exchange traded fund (ETF), closed end fund, or even buy individual muni bonds directly for your account.

4) Employ a Tax-Efficient Portfolio approach. There are four ways we can reduce taxes from a portfolio. First, we can use low-turnover funds (such as index funds or ETFs) which do not distribute capital gains. Second, we can be judicious about buying and selling positions and creating unnecessary capital gains. Third, we can harvest losses annually to offset any gains. Lastly, we can use asset location to place income generating investments into a qualified account, such as an IRA, where the income will not create a taxable event. Tax-efficiency is not an afterthought for us, it’s a cornerstone of our investment process.

None of these methods are going to eliminate the Medicare surtaxes for everyone, but they can certainly help reduce your tax bill. It’s not too early to put these in place for 2015, so don’t wait until next January to take action if you might be subject to the Medicare surtaxes this year.

Proposed Federal Budget Takes Aim at Investors

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It was Presidents’ Day yesterday, a day to reflect on the great thinkers and leaders who founded our remarkable nation and have molded its course across the centuries. I try to avoid political commentary here on this blog as my job is to help clients find financial independence so they can be able to retire one day, send their children to college, and not spend the rest of their lives worrying about money.

However, I think my clients and readers should hear about the President’s proposed 2016 budget, which contains a number of never heard before provisions that take aim directly at middle-class investors. The administration says that they are looking to close “loopholes for the rich”, but these proposals aren’t going to increase taxes for Warren Buffet, Bill Gates, or the latest hedge fund billionaire; they’re going to be funded by working professionals who are trying to make a better life for their families.

When I think about closing loopholes to raise taxes, the first thing I think about are eliminating corporate incentives and subsidies, so I was shocked that these proposals are squarely aimed at the wallets of individual investors and primarily their retirement plans. Here are some of the proposals which would impact investors like you.

  1. The first proposal was to eliminate 529 College Savings Plans. I’m sure there are some wealthy elderly grandparents who use 529’s to reduce their estate taxes, but most of the 529 accounts I have seen are barely enough to pay for a year or two of state school, let alone pay for 4 years of SMU, Medical School, or an MBA. But instead of suggesting that we reduce the maximum caps on 529 contributions, the proposal was to eliminate the tax benefits altogether for everyone! Luckily, after widespread outrage, the administration nixed the proposal days later.
  2. Another proposal is to eliminate the “Back Door Roth IRA”. This has been one of my favorite strategies since 2010 and I look for any client who might be eligible. I’ve mentioned the Back Door approach a couple of times in this blog and described it in some detail here. I believe the government should encourage people to save more for retirement, but when you start taking away benefits, it makes it even more of a challenge.
  3. The 2016 budget would also require investors in a Roth IRA to take Required Minimum Distributions after age 70 and 1/2. Currently, you can let a Roth account grow tax free for as long as you’d like, and even leave those assets to your spouse or heirs income tax-free. The only relief the budget provides is that if all of your retirement accounts (all types) are under $100,000, you would not have to take RMDs.
  4. The 2016 budget would eliminate the “Stretch IRA”. Today, if you inherit an IRA from a non-spouse (such as a parent), you can take only RMDs and continue to let the money grow. Under the proposal, the Stretch IRA (also called Beneficiary IRA or Inherited IRA) goes away, and all the money must be withdrawn within 5 years. If it’s a sizable IRA, that could be quite a tax hit, pushing an heir into a high tax bracket. It means that more of your IRA will end up with the IRS and less with your heirs. Instead of encouraging heirs to manage the inheritance as a long-term program, it will force them to take the money out quickly.
  5. The proposed budget would cap the tax benefit of retirement contributions to 28%. So, if your family is in the 39.6% tax bracket (actually 40.5% when you include the 0.9% Medicare surtax), you will only get a partial deduction for the money you contribute to your 401(k) or IRA.

In all, there were a dozen proposals that would impact investors in retirement accounts. And since my business is focused on retirement planning, you bet I’m concerned. You should be too. Luckily the proposed budget is little more than a wish-list or starting point. Hopefully, few of these will make it into law for 2016. If they do, investors in the future are likely to have a different mix of retirement accounts and “taxable” accounts. Luckily, we’re already skilled at creating tax-efficient investment portfolios with low-turnover ETFs and municipal bonds.

In the mean while, you can still fund a Back Door Roth for 2014 (through April 15) and 2015, or take advantage of any of the current programs. I know what I would prefer to happen with these proposals, but no matter what does occur, we will learn, adapt, and still be successful. I still believe that there is no better place on Earth to become wealthy than America.

Get Off the Sidelines: 3 Ways to Put Cash to Work


I know there are many investors who have a lot of cash on the sidelines. They may have raised cash fearing a pullback in 2014. Or maybe they made contributions to their IRA and didn’t invest the money because the market was at or near a high. Others sold positions once they reached their price targets and have been sitting in cash ever since.

Looking at today’s valuations, it’s a lot tougher to find bargains that seemed plentiful a few years ago. Unfortunately, holding cash cost investors plenty last year, when the S&P 500 Index was up more than 13%. And that’s the problem with trying to time the market with your purchases: you can miss a lot of upside by being on the sidelines, even if you’re out for a relatively short period.

If you have a significant level of cash in your portfolio that will not be needed in the next couple of years, it probably makes sense to put your cash to work. And while there’s no guarantee (ever) that the market will be higher in a month or a year from now, that’s the uncertainty that we have to accept in order to make more than the risk-free rate over time.

I can understand that putting a lot of cash to work at once is daunting when the market is up like it is today. So rather than thinking in black and white terms of all-in or all-out, let’s consider three strategies to help you get that excess cash invested prudently.

1. Dollar Cost Average. We invest in three tranches, 90 days apart, investing 1/3 of the cash position each time. This gives us the advantage of getting an average price over time. If prices drop, we can pick up more shares at a lower price.

Dollar Cost Averaging worked well in the second half of 2014, as we had cash to invest in October when the market was down 7%. Of course, there are also times when the market rises, and the lowest prices were available at the first trade date. In that case, Dollar Cost Averaging can increase your average cost basis.

2. ETF Limit Orders. One of the advantages of Exchange Traded Funds (ETFs) compared to Mutual Funds is the ability to use limit orders. If you believe there might be a pullback in 2015, place a limit order to buy ETFs at a set price or percentage below the current values.

For example, if you think there might be an 8% correction, we could set limit orders that are 8% below the current price of each ETF. This way we have a plan in place that will automatically invest cash if the market does in fact drop. Even though there is no guarantee we will have such a drop, this is still a much better plan than saying “Let’s wait and see what happens”, because when the market is down, people don’t feel good about making purchases. And recently, any corrections in the market have been short-lived, so there has been only a small window of opportunity.

3. Use “Low Volatility” ETFs. If the primary concern is market volatility, there are Low Volatility products can help reduce that risk today. These are funds which quantitatively select stocks from a broader index, choosing only the stocks which are exhibiting a lower level of fluctuations and risk. Low volatility funds are available in most core categories today, such as large cap, small cap, foreign stock, and emerging markets.

Over time, a Low Volatility index may be able to offer  similar returns to a traditional index, but with measurably lower standard deviation of returns. These ETFs have been available for only a couple of years, so this belief is largely based on back testing, and there’s no guarantee this strategy will work in the immediate future.

We should also note that a Low Volatility strategy is likely under perform in Bull Markets (think late 90’s, or 2009), and could lag other strategies for an extended period of time. Additionally, Low Volatility does not prevent losses, so the strategy could certainly lose money like any other equity investment in a bear market.

With those caveats in mind, I am happy to use Low Volatility funds if they give an investor some more comfort with their equity positions and the willingness to put cash to work. Time will tell if these funds are successful in achieving their stated objectives, but in my opinion, Low Volatility funds are among the more compelling ideas offered to investors in the past several years.

Each of these three strategies has advantages and disadvantages, and there is no magic solution to the conundrum of how to get cash off the sidelines today. My role is to work with each investor to find the best individual solution to move forward and have a plan to accomplish your personal goals. Luckily, we have a number of tools and techniques available to help address your concerns.

Indexing Wins Again in 2014


2014 was another strong year for Index funds. According to the Wall Street Journal, only 13% of actively managed large cap funds exceeded the 13.7% total return of the S&P 500 Index for the year. It seems like each year, when index funds outshine active managers, we hear different excuses why. This time, market breadth was blamed, as a high correlation of returns meant that there were few stand-out stocks for managers to make profitable trades. In previous years, we heard managers complain about a “junk rally”, or that “our style is out of favor this year”. And of course, each year, we also hear why the new year is going to finally be a stock pickers market.

We use index funds as the core of our Good Life Wealth model portfolios. Indexing works. I think the misconception about indexing is that it means settling for average returns or that it’s a lazy approach. The reality is that using index funds actually increases your chances of achieving good performance. Index funds outperform 60-80% of actively managed funds over the long-term.

Of course, some actively managed funds do beat the indices. Why not just select those funds? Unfortunately, past returns are not a reliable indicator of future performance. We know this is true – and not just my opinion – through the Standard and Poors Persistence Scorecard, which rigorously measures the persistence of fund performance. Updated in December, the Persistence Scorecard found that of 421 domestic equity funds in the top quartile (top 25%) over five years, only 20.43% remained in the top quartile for the subsequent five-year period.

Top Quartile funds based on 5-year performance (as of September 2009). Over the next 5 years, through September 2014:

  • 20.43% of the funds remained top quartile
  • 19.95% fell into the second quartile
  • 22.33% dropped into the third quartile
  • 27.09% sunk to the bottom quartile
  • 10.21% of the funds were merged or liquidated

If long-term performance was a reflection of manager skill, why are so few funds able to continue to be above average? The results above suggest that instead of high-performing funds remaining at the top, their subsequent returns are almost randomly distributed. In fact, top quartile funds are more likely to be at the bottom (27%) than to remain at the top (20%). And surprisingly, 10% of those top funds don’t even exist in five years. Unfortunately, buying that 5-star fund that has been killing the market often turns out to be a poor decision in a few years time. Then the investor switches to a new hot fund, and the cycle of hope and disappointment begins again.

Indexing avoids these pitfalls. It’s a smart way to invest. And when you look at the tax efficiency of index funds compared to active funds, indexing looks even smarter. (Don’t even ask about the tax consequences of trading mutual funds every couple of years.) But using index funds isn’t a once and done event. We carefully create our asset allocation each year in consideration of valuations, risks, and potential returns for the year ahead. Even when we don’t make any changes to the portfolio models, we still monitor client portfolios and rebalance annually to make sure your holdings stay in line with our target weightings. Perhaps most importantly, the indexing approach allows investors to focus their energy on saving and planning decisions, rather than monitoring managers or searching for the next hot fund.