Growth, The Big Picture

Posted On September 18, 2023 By Scott Stratton, CFP(R), CFA In Financial Planning, Portfolio Management / No Comments

With all the noise in today’s markets, it is easy to miss the big picture about growth. 2022 and 2023 have been two of the strangest years in a generation for investors. As a result, it is easy to feel uncertain about investing right now. And that uncertainty often leads investors to make bad choices. So, we are going to step back and look at the 30,000 foot view of what really matters for investors.

In 2022, we saw inflation rise to 9% and the Federal Reserve start the process of slowing the economy. As the Fed raised interest rates, stocks dropped 20%, briefly entering Bear Market territory. In the bond market, rising interest rates snipped the price of bonds, sending the US Aggregate bond index down double digits. For diversified investors, 2022 was a perfect storm where diversification failed and both stocks and bonds were down an uncomfortable level.

Now in 2023, we have seen the Federal Reserve continue to raise rates up to the present moment. At the start of the year, I saw one report that said the probability of a recession in the next 12 months was 100%. 100%, a certainty! And while the full 12 months are not up yet, we have not had a recession. In fact, the S&P 500 Index is up 15.83% this year. While the yield curve remains inverted, a favorite predictor of recessions, it now appears that the likelihood of a 2023 recession is diminished and might not happen at all.

Don’t Time The Market

Comparing 2022 and 2023 doesn’t make sense. The market “should” not be up 15% this year. And yet here we are, with a very welcome gift of an amazing performance in the first seven and a half months of the year. The consensus economic forecasts at the start of 2023 were lousy. If we had listened to them, we would have sold our stocks and hid out in cash. We would have missed out on the gains that we have had for 2023!

There are often compelling historical precedents to entice investors to think we can predict what is going to happen over the next 12 months. Making changes to your investments feels obvious, a smart choice, and low-risk. Unfortunately, history shows us that it is hubris to try to time the market and more often detrimental than beneficial.

It is a challenge to actually stay the course and maintain your discipline. It is difficult to ignore the forecasters and not think that there is an opportunity for you to either protect your principal or rotate into a better performing investment.

Timing the market continues to be a bad idea. I didn’t hear any forecasters in January predict that stocks would be up 15% by August. If we had listened to their predictions, although well-intentioned, we would have made a mistake. Thankfully, we didn’t try to time the market this year. Here is how we manage a portfolio:

Establish a target asset allocation for each client’s individual needs and risk tolerance.
Rebalance portfolios when they drift from the targets.
Adjust our portfolio models annually based on the valuation and expected returns of each category.
Use Index Funds and manage each client’s portfolio to keep costs down and minimize taxes.

Rebalancing

The funny thing about rebalancing is that it often means doing the opposite of what you might expect. When stocks were down 20% last year or in 2020, we were buying stocks. Now, when stocks are up 15-20% and there is a lot of optimism for a soft landing, we are trimming stocks and buying bonds. In hindsight, this looks pretty logical. However, in real time, rebalancing often feels like not such a good idea. And sometimes it isn’t – there’s no guarantee that rebalancing will improve returns. But, what it does offer is a disciplined process to managing an investment portfolio, versus the behavioral traps of trying to time the market. The bizarre markets of 2022-2023 certainly reinforce the potential benefits of rebalancing.

Average Versus Median

Do you remember from high school algebra the difference between Average and Median? Average is the total sum divided by the number of items. Median is the data point in the middle. And there can be a big difference between Average and Median. Stock markets are cap weighted, so the larger stocks move the index more than the smaller stocks. Still, let’s consider how the “average” return of an index can be quite different from the median returns of its component stocks.

The year to date return of the S&P 500 Index ETF (SPY) is 15.83% as of August 16. But that is not the median return of the stocks. Of 504 components of the S&P 500, only 135 have done better than 15.83% YTD and 369 have done worse than the overall index. If you had picked a random stock from the S&P, there was a 73% chance that you would have done worse than “average” this year.

And what is the Median performance of the S&P 500 this year? Only 3.36%, an under-performance of more than 12% than the overall index. Even worse, 212 stocks in the S&P 500 are down, negative for the year.

What is the big picture of growth in stocks? Trying to pick individual stocks is extremely difficult. Don’t think that using an index fund means “settling for average”, the reality is that over time, the index return has done much better than the median stock.

This year has been such a frustrating year for investors because stocks are all over the place. If you don’t own a few of the top performers, you are likely lagging the benchmark by a wide margin. What is a way to make sure you own the winners today and tomorrow? Own the whole market with an Index Fund. Realize that if you pick a stock from the S&P 500, it is not a 50/50 coin toss that you will beat the market average. The chance is lower than 50% because the market average typically does better than the median stock. The stocks which do outperform will move the index disproportionately and they will be fewer in number.

There is a lot of noise and confusion in the markets today, and that’s okay. We are in uncharted waters and seem to be going from one “unprecedented” event to another. Thankfully, I don’t think we need to have a crystal ball to be successful as long-term investors. What I believe can help is stepping back to remember the big picture: don’t time the market, stick to an allocation and rebalance, and use index funds. That’s our roadmap. When in doubt, we can recheck our directions and keep going.

What You Can Control

In the short-term, stock markets can be very volatile. As a result, I believe a lot of inexperienced investors mistakenly think that their success depends on their ability to game the markets. They think that growth is achieved through trading or superior returns.

Unfortunately, trying to outsmart the market often makes your performance worse, rather than better. Active management doesn’t work, at least not consistently over 10 or more years. We stick to passive, low-cost index funds or ETFs for our stock market exposure. And we remain invested in a long-term asset allocation.

Once that investment decision is out of the way, the main determinant of success is your savings rate. How much are you investing each month? That is what you can control. If you want to be more successful in accumulating your wealth, you don’t need to worry about the Jobs Report this week, or what was in the Federal Reserve meeting notes. You need to focus on how can you can save an extra $100, $500, or $1000 a month and make that a habit.

Instead of worrying about your YTD performance, calculate how much wealth you will have in 10 or 20 years, with an average rate of return. Because in the long-run, an average rate of return is excellent. And then what you can control – your savings – is what actually matters more. Growing your wealth is largely a factor of savings and time. Chasing investment performance is a distraction.

Develop Your Saving Habits

Make savings automatic. Put your investing on autopilot with monthly contributions to your 401K, IRA, and investment accounts.
Save More. Don’t just do the 401(k) match, try to put in the maximum to each account. And then ask where else can you invest? Do the math of how much money you want to accumulate. (I can help with that.)
Keep the big expenses down. Living beneath your means is easy if you are smart about your housing costs and your cars. Many Americans who are not frugal in those areas do not have anything leftover to invest.
Develop your career. If you can expand your income without increasing your expenditures, your savings can increase dramatically. If you ever have a chance to work for a company with stock options, go there. I have seen over the years, tremendous wealth accumulated from stock options.
Be an Entrepreneur. This can be high risk, but when they are successful, entrepreneurs earn and save much more than employees. Besides a salary, an entrepreneur is growing a business that has value.

As a financial planner over the past 19 years, I’ve gotten to look at a lot of families’ finances. The difference between those who were struggling and those who were wealthy was seldom just income. I’ve seen a lot of high income folks who were living hand to mouth. Other families who had similar incomes were millionaires or well on their way. The difference was their saving rate. You can’t grow what you don’t save.

There is no substitute for saving. We have to make savings automatic and increase our savings whenever possible. It may help to work backwards: start with your goal and determine how much you need to save and for how long. Then you can see saving as the solution and beneficial process rather than as a sacrifice. Some Americans are saving very well. But the Big Picture is that the average American isn’t saving enough. We need to be talking more about saving, because for too many families, it is the step that they cannot get past.

Our recipe for Growth is simple. Save monthly and dollar cost average into Index funds. You can do this in your 401(k), IRA, or taxable account. The account is less important than the process. The more you save, the more wealth you can accumulate. The younger you start, the better. The faster you increase your saving, the sooner you can reach your goals. Saving is growth and investing is secondary.

Investment Taxes Eat Your Growth

Taxes matter. We work hard to establish a good portfolio and get a respectable rate of return. And then the government wants their cut. How about 37% for Federal Income Taxes (increasing to 39.6% in two years). And another 5% for state taxes. Don’t forget 15.3% for self employment taxes for Social Security and Medicare (or half that number if you’re an employee). Then, if you do well, how about an extra 3.8% in Medicare surtax (“Net Investment Income Tax”).

Once you have your “after-tax” money, it’s all yours, right? Well, not quite. You get to give the government another $5,000, $10,000, or more in property taxes. And when you want to buy something with your after-tax money, you get to pay 8% in sales tax.

The point is that it doesn’t matter how much you make, it matters how much you keep. That is why tax planning is such a big part of our wealth management process. As your portfolio grows, the tax implications can become a significant annual expense and a drag on returns.

What continues to shock me is how many Advisors are making huge mistakes with client portfolios and creating tens of thousands of dollars in unnecessary taxes. Taxes which could have been avoided or reduced substantially through better planning. Sometimes this is because they use a model portfolio that doesn’t attempt to have any tax efficiency. But other times, it is laziness and having too many clients to manage individual portfolios in a tax-efficient way. It’s easier to stick people into a model and let the computer automatically rebalance the portfolio.

This is the big picture for wealthy Americans: Your after tax-return matters more than your pre-tax returns. You have very little control over taxes on a monthly basis, but a great deal of control over taxes in the long run. Here are the mistakes we often see and how we can do better:

Portfolio Tax Efficiency

Mistake 1: Mutual Funds in Taxable Accounts. Mutual Funds have to distribute capital gains annually. Each December, many investors get a surprise tax bill from their funds. BETTER: hold Exchange Traded Funds (ETFs) in taxable accounts. ETFs rarely, if ever, have capital gains distributions.

Mistake 2: Short-Term Capital Gains. Short-Term Capital Gains (less than 1 year) are taxed as Ordinary Income, up to 37%. BETTER: Hold for Long-Term Capital Gains (more than 1 year), which are taxed at lower rates (0, 15 , or 20 percent). Trading which creates ST Gains should be avoided in a taxable account. We are very careful about the tax implications of our rebalancing trades, as well.

Mistake 3: Bonds and REITs in Taxable Accounts. Bond income is taxed as ordinary income (up to 37%). BETTER: Hold bonds in IRAs, which are tax-deferred. Also, IRA distributions will be taxed as ordinary income, so bond income isn’t treated worse in an IRA, unlike capital gains. When you have a LTCG on a stock ETF in an IRA, all that growth will be taxed as Ordinary Income. Traditional IRAs will have the highest tax rate, so it is better to allocate the low growth bonds to IRAs and high growth stocks to Roths and taxable accounts. This process is called Asset Location.

Mistake 4: Not harvesting losses. BETTER: Harvest losses annually in taxable accounts. Losses can be used to offset gains that year, and $3,000 of losses can be applied against ordinary income. Unused losses will be carried forward without expiration.

Mistake 5: Not asking about charitable giving. 90% of Americans are not itemizing and not getting any tax benefit from charitable donations. BETTER: We can get a tax benefit two ways, without itemizing: A) make donations of appreciated securities from a taxable account. Or B), if over age 70 1/2, make Qualified Charitable Distributions (QCDs) from your IRA.

Mistake 6: No Plan for Managing IRA Distributions. BETTER: Do Roth Conversions in low income years before RMDs start at age 73.

Mistake 7: Not understanding Taxes that will be owed by Beneficiaries. BETTER: Working with your Advisor to consider inter-generational taxes in your Estate Plan. For example, taxation of trusts, step-up in cost basis, charitable giving, and Beneficiary IRAs.

Mistake 8: Not doing a Backdoor Roth IRA. I’ve had advisors tell me it’s not worth their time to move $13,000 to $15,000 into a TAX-FREE account each year for a married couple. Not worth it for the advisor, I guess (no additional revenue). BETTER: Although the numbers are small annually, we have been doing back-door contributions for clients for many years, and it does add up.

The Changing Retirement Picture

Did your parents retire with a Pension? Maybe they worked for 30-40 years for the big company in town, or for a municipality, school district, military branch, or government agency. When they retired, they had a pension and Social Security which fully covered their expenses. They might have also had retirement health benefits which paid for deductibles and co-pays which were not covered by Medicare.

You probably don’t have the same benefits. How much is a Pension worth? Well, we can easily compare a Pension to the cost of a Single Premium Immediate Annuity, or SPIA. A SPIA works the same way as a Pension – it is a guaranteed monthly payment for life. For example, let’s consider a 65 year old female who has a pension which guarantees her $2500 a month for the rest of her life. We could buy a SPIA with the same guaranteed $2,500 a month for life, for a cost $437,063. So, a $2,500/month pension is worth $437,063.

To have the same retirement funding as your parents, you may need $400,000 or more in assets than they had. And that is just to replace one modest pension. If your parents had two pensions or had a bigger pension, you might need much more than $400,000 to get the same retirement income.

And you probably won’t buy a SPIA and would prefer to keep your money in an IRA. At a 4% withdrawal rate, you would need $750,000 in your IRA to get $2,500 a month. So maybe you need $750,000 more than your parents, not $437,000, to replace their pension! These pensions were worth a lot. It will take a worker 30 years of saving to build up their 401(k) to $750,000. It’s not impossible, but the big picture is that most Americans aren’t doing a good job of saving. The average 401(k) balance for workers age 55-64 is $207,874. The median balance at 55-64 is only $71,168, meaning that half of all 401(k) accounts are less than $71,168.

I’m afraid the promise of becoming wealthy through your 401(k)s has proved elusive for the average American. It’s a wedge that is driving wealth inequality in our country. But I don’t think Pensions are coming back – retirement preparation rests squarely on the individual’s shoulders. You certainly can get to $500,000 to $1 million in a retirement account, but you have to aim to put in the maximum, not just get the company match. Then you have to not withdraw it and let it compound for 30 to 40 years. That recipe will work, but it’s not easy, it requires some sacrifice and a lot of discipline.

Counting on Social Security

The Social Security Trust Fund will be depleted by 2033. After that, revenues will only cover about 70% of promised benefits. After kicking the can down the road for 20 years, Washington needs to get its act together soon. We can either reduce benefits or increase taxes. It may be a combination of both, but one thing is for sure: keeping the status quo is not going to be an option. The Social Security budget for 2023 is $1.30 Trillion. The Department of Health and Human Services (Medicare, Medicaid, and other health agencies) have a budget of $2.10 Trillion for this year. These two programs, largely for Retirees, have become the biggest portion of government spending.

There will have to be a reckoning in the years ahead about these programs. Something has to change, they are unsustainable in their present form. I think there will be changes in inflation adjustments, a gradual increase in the full retirement age, and probably some means testing which will reduce benefits for high net worth families. Or there could be a whole new system. As difficult as it is to imagine, the system is so broken that starting over from scratch might be better than continuing to try to put new band-aids on this fiscal cancer.

The big picture for the future of government retirement programs is very uncertain. These are not the only issues facing the government. Our debt is growing. This year, the interest payments alone on US Treasury Debt will be $964 Billion. We may top $1 Trillion in interest payments next year. And there is no plan to ever repay this debt, only to grow it every single year. When you look at debt projections, it only reinforces the need to reign in the expenses which are growing the fastest.

In our planning process, we include Social Security projections. But we had better be prepared for benefits to potentially be a bit less than promised. So, once again, it may be that more of your retirement income needs to be self-funded. If you don’t have a pension, the burden of funding your retirement has been shifted to you. Have you calculated what that will cost? That’s what we do with our retirement planning software, MoneyGuidePro. We create an ongoing plan for your retirement needs, which adjusts over time, and where we can continue to refine assumptions and expectations.

I hate to be such a downer, it’s really not my nature. But a lot of Americans are going to have worse retirements than their parents, because they don’t have a pension. The burden of saving for retirement has shifted from the employer to the employee. Now instead of everyone getting a good outcome, many Americans are under-prepared for retirement. And then we have to look ahead at the uncertainty that is facing Social Security and Medicare. It looks like we will have more individual responsibility for our outcomes and less universal assistance.

The Forest For The Trees

The Big Picture for Growth can be hard to see because the fog of current events makes it hard to see the long-term horizon. Here are our four pillars of The Big Picture:

Don’t time the market. Stick to your asset allocation and rebalance. Use index funds.
Once you’ve made the shift away from performance chasing, focus on what really matters: how much you save.
Taxes hurt returns. Tax planning helps.
You are responsible for your own retirement savings and financial security.

I’m sure things are going to change. We don’t really know how, when, or why they will change. While some may find uncertainty to be paralyzing, it doesn’t have to be. Even if the future is a moving target, planning is not a waste of time. Not at all! Being well prepared also includes the flexibility to adapt and evolve.

A lot of my day to day work is focused on the small details of implementing our plans. But the growth is created when we step back and take a long, hard look at The Big Picture. We should all be having more of those conversations, with our spouses and children, our bosses and colleagues, and especially with your financial professional.

Cash Back Credit Cards

Posted On July 20, 2022 By Scott Stratton, CFP(R), CFA In Financial Planning /

I am a big fan of cash back credit cards for good reason: this past year I’ve gotten back $1,294.18 from my two personal credit cards. Both cards have no annual fee and I pay my balances off every month and pay no interest charges. We are moving away from cash payments with our spending today and so it makes sense to get cash back on money you would have spent anyways.

This has certainly been a big spending year, with our wedding last October and a trip to Europe this August. Additionally, we spent over $20,000 in renovations and furnishings for our two new Airbnb properties in Hot Springs. You can check out our listings here: The Owl House and The Boho Loft. So, all the spending adds up.

Two Percent Cash Back

There are a lot of cards that offer 1 to 1.5% cash back, and those should be pretty easy to find. Today’s top cards offer 2% cash back, and there’s a good list of 2% cards on the Nerdwallet site. I’ve had the Fidelity Rewards Visa Card for years. It has no annual fee and gives me 2% cash back, deposited automatically into a Fidelity brokerage account each month. I can then transfer the cash out to my checking at any time. (My brokerage accounts are all at TD Ameritrade – I only keep the cash back at Fidelity.)

I don’t really worry about the interest rates on these cards since I never carry a balance. If you do have a balance, you’re probably better off finding a zero-interest balance transfer card and working on paying off your principal. I do prefer a card with no annual fee. And I’m not a big fan of hotel points or airline miles. I know others who are loyal to one airline and prefer an airline credit card, but I believe the airlines have made it harder to redeem points in recent years. (If you’ve had a great – or a terrible – experience with airline cards, I’d love to hear about it. Please send me a message.)

Discover 5%

I’ve also had a Discover Card since 1999. It provides 1% cash back on everything and 5% cash back on a category that changes each quarter. So, I use my Visa for most purchases and the Discover card for the 5% categories. Here is the 5% Cashback calendar for 2022:

January-March: Grocery Stores and Gym Memberships
April-June: Gas Stations and Target
July-September: Restaurants and PayPal
October-December: Amazon and Digital Wallets

I don’t spend as much on Discover, except for the 5% categories. Customer service at Discover has been excellent.

Store 5% Cards

There are a number of store-branded credit cards which offer 5% discounts or credits. These may not be cash back, but if you frequent these stores, they may be a better deal than your 2% cash back credit card. Presently, the only one I have is the Target Red Card. The Red Card gives me an instant 5% discount off my purchases at Target. I set up the card to autopay from my checking each month and don’t think about it after that.

I’m also looking at three other 5% store cards. The Lowe’s Advantage Card gives a 5% discount on purchases. That’s definitely worth it if you are doing some big projects. Please note that if you get the 10% Military discount at Lowe’s (like my Dad), you cannot stack the 5% on top of the Military discount. However the 5% discount will apply to appliances, unlike the Military discount.

The second card I would consider is the TJX Rewards Card which offers 5% back in certificates to use at the store on future purchases. The card and rewards can be used at TJ Maxx, HomeGoods, or Marshalls. We’ve spent a bit there in the past year, but I’m not sure we need it going forward.

And third is the Amazon Prime Rewards Visa. It offers 5% back at Amazon and Whole Foods, plus 2% back on restaurants, gas stations, and drug stores. There’s 1% back on everything else, and no annual fee as long as you are already an Amazon Prime member. This one may make the most sense for us, given how much we use Amazon.

Spend Wisely

Cash Back Credit Cards are a good deal for consumers. I’ve been getting 2-5% cash back on my spending for years, and it helps. I’ve also added a 1.5% cash back card for my business this year, which I probably should have done years ago! Some people are worried that opening new credit cards will hurt their credit score, but this will probably have little or no effect. And if you aren’t planning to buy a house soon, you shouldn’t worry at all.

It pays to do a little research and find the right card for you. Over time, cash back cards put money back into your wallet. And then you can contribute more to your Roth IRA like I’ve been suggesting, right? Helping you become intentional with your money goals is important to me, even if it is something as small as which credit card you use. Little decisions create good habits that keep you moving forward.

Why Index Funds Are Better

Posted On May 22, 2022 By Admin In Financial Planning /

Twice a year, Standard and Poor’s provides an analysis of why index funds are better than actively managed mutual funds. Their report is known as SPIVA, S&P Index Versus Active. It is compelling evidence that investors would be better off using index funds. We’re going to look at the most recent data, discuss the perils of fund benchmarks, and then explain our approach of using Factor-based strategies.

Most Funds Lag Their Benchmark

Looking at 2021, 79.6% of US stock funds did worse than the overall market, as measured by the S&P 1500 Composite Index. It was a spectacularly bad year for active managers, even worse than most years. I focus on the long-term results, which are fairly consistent from year to year. For the 10 years ending 12/31/2021, 86% of US stock funds under-performed the market. Some of the funds which did out-perform did so by taking on much more risk. When we consider risk-adjusted returns, 93% of funds lagged.

The data is compelling and persistent. 80% or more of actively managed funds cannot keep up with their index over 10 or 20 years. And since that is the time frame that matters for long-term investors, the odds are in your favor if you use index strategies rather than active funds. It is extremely difficult for active managers to beat the index. There are many thoughts why this is the case:

Higher expenses. The cost of running a fund seems to wipe out any value they create through research and active management. Overall, market participants add up to the entire return of the stock market. That is the benchmark. But instead of being average (or actually Median) at 50%, the additional costs mean that 80% of funds trail the benchmark
Chasing performance. Active managers pay too much for hot stocks and ignore cheap stocks which are out of favor. Or they miss the handful of top performing stocks which are often the biggest drivers of market returns. Stocks, categories, and sectors go in and out of favor.
No information advantage. Today, analysts are smarter than ever and information is disseminated instantly online. The markets may have become so efficient that there are no “secret” stocks for active managers to uncover.
The 10-20% of managers who do outperform may have done so through luck, as they are typically unable to sustain out-performance from one period to another. Do we have data for that? Yes. It’s the S&P Persistence Scorecard.

Which Benchmark?

There are a lot of benchmarks and unfortunately, this can be confusing for investors. Sometimes, we might be comparing a fund to the wrong benchmark and not be making the most accurate comparison. Consider, for example, the Fidelity Contrafund. At $126 Billion in assets, it is one of the most successful active funds in history. And over the last 10 years, it has slightly beat the S&P 500 Index: FCNTX is up 282% through April 22, 2022, compared to 279% for the Vanguard 500 (VOO).

Unfortunately, that’s not the most accurate benchmark, because the Contrafund is a Growth Fund. As a better benchmark, you could have been invested in the Vanguard 500 Growth Index (VOOG). And VOOG was up 333% over the past 10 years. In this case, the active fund actually trailed the correct benchmark by 50% over 10 years. With Growth strategies dominating over the past 10 years, a lot of Growth funds look good compared to the S&P 500. But when we consider a Growth benchmark, you probably would have been better off in the index fund. (And for taxable accounts, the after-tax return of active funds are very often much lower than an ETF.)

Here’s another poor benchmark situation. This week, I was comparing two US Low Volatility ETFs with very similar strategies: the SPDR Large Cap Low Volatility (LGLV) and the Invesco S&P 500 Low Volatility (SPLV). Looking at a Morningstar report of 5-year performance, it showed that LGLV was in the 60th percentile while SPLV was better, at the 40th percentile. Unfortunately, the report was using two different benchmarks: large blend for LGLV and large value for SPLV. Their actual 5-year annualized returns were 14.01% for LGLV and 11.36% for SPLV. With different benchmarks, LGLV looked worse (60th percentile), even though it had actually out-performed SPLV by 2.65% a year! Which benchmark you use matters.

Using Factors To Look Forward

Although SPIVA shows why index funds are better, the harder part is deciding which index fund you want to invest in. You could just choose a World Index stock fund, like the Vanguard Total World Stock ETF (VT). And I am confident you would do better than most active managers over the next 10 or 20 years.

But, we don’t invest in an “all-in-one” fund.

Rather, my role as a portfolio manager is to determine the asset allocation for each model and level of risk. We decide which categories we want to own (large growth, small value, emerging markets, etc.) and what percentage to invest in each category. And rather than looking backwards at performance, we use today’s valuations to evaluate future performance. Once we have an asset allocation model, I can select an index fund to use to fulfill each category. It starts with the blueprint, not the funds themselves.

Rather than using generic index funds like a Total World Index fund, we buy 5-8 Index funds that invest using a “factor” strategy. This is a quantitative way of sorting stocks, using a characteristic such as Value, Size, Quality, or Low Volatility. They represent an Index or Benchmark, but have an additional screen to create a portfolio with specific qualities. There is evidence that Factors can outperform a benchmark over time, but clearly, they do not do so every year.

Today, we are concerned about some stocks’ high valuations. We have tilted our portfolios away from the large cap growth and technology names which have had such terrific performance that their values are so expensive today. Some of these stocks, such as Facebook (now called “Meta”) are down 45% year to date. That’s what can happen when a stock becomes too expensive and the market winds change direction.

Instead, we are looking ahead in anticipation of a reversion to the mean in categories such as Value, Small Cap Value, International and Emerging Markets. That’s no prediction that any of these will be up this year, it’s a long-term proposition. When I look at the S&P 500 Index today and see how expensive some of the names have become, I find it hard to stomach. And so, we are looking for ways to take advantage of passive, low cost, tax-efficiency of ETFs, but in a smarter manner than just throwing it all in a generic, market cap weighted index fund.

Once we understand why index funds are better, we are still left with two questions. Which benchmark to use and how do we want to invest? We are fortunate today to have easy access to many low cost index funds. Factor-based funds can help us establish potentially positive characteristics to our portfolios even compared to regular index funds.

We Bought An Airbnb

Posted On April 4, 2022 By Scott Stratton, CFP(R), CFA In Financial Planning /

In January, we bought a house in Hot Springs, Arkansas and have listed it on Airbnb. This is a new venture for us and I wanted to share my evolving thoughts about debt, inflation, cash, and real estate. Although the stock market has been down so far in 2022, don’t think that this means I am giving up on stocks as an investment. Not at all!

If you want to check out our property, here is the listing on Airbnb. My wife, Luiza, has done a great job of decorating and furnishing the house. And I owe a big thank you to my parents who spent three weeks helping us with renovations. It has been live for one week now, and we have eight bookings in April and May. Let me know what you think about the listing!

We Went Into Debt

Prior to this purchase, we were debt free and we purchased our new property with a mortgage. I could have sold investments and paid cash for the house, but I think that would have been a bad idea. Taking a mortgage is the better choice.

Leverage can be a tremendous tool, when used properly. Taking on debt to buy appreciating assets and cash flowing investments can have a multiplier effect. This is “good” debt. Bad debt would be spending on depreciating assets like cars, or using credit card debt to fund a lifestyle. I eventually realized that being debt-free would actually slow down our growth versus taking on some smart debt.

For Airbnb investors, a property evaluation is often based on the “Cash on Cash” return. What does that mean? Let’s consider a $200,000 house which produces a hypothetical $14,000 a year in profit. If you purchase the property with $200,000 cash, your Cash on Cash return is 7%. But if you put only 20% down ($40,000) and make $8,000 (net of the monthly mortgage), your cash on cash return is 20%. In other words, it can be a fairly attractive investment because of the leverage. Without the debt, the returns are not that compelling compared to stocks, for example. And if you use mortgages, you can buy $1 million of properties with $200,000 down. That could grow your wealth much faster than just buying one property for $200,000.

Debt, Inflation, and Government Spending

Beyond the numbers for this particular house, I think the world is now favoring debtors. Our government spending has been growing for years. And then when the pandemic hit, spending shot up dramatically and shows little sign of returning to its previous trajectory.

Our government, and many others, are running massive deficits and have no intention or ability to reduce spending. They will simply never pay off this debt. It will only grow. (See: the US Debt Clock.) We now have inflation of over 7%. I don’t think inflation will stay this high, but I also don’t think it will go back to 2%. Governments will have to inflate their way out of debt. There is an excellent video from billionaire hedge fund manager Ray Dalio: the Changing World Order. He documents historical civilizations who expanded debt and saw resultant inflation. It is a brilliant piece if you want to understand today’s economy.

Inflation favors debtors and penalizes holders of cash and bonds. 7 percent inflation over 5 years will reduce the purchasing power of $1000 to $600. The holder of a bond will see a 40% depreciation of the real value of their bond. And the debtor, such as the US government or a mortgage holder, will benefit on the other side.

I reached the conclusion that I should be a debtor like our government. Staying in cash and a lot of bonds, would be a poor choice long term. I didn’t sell any stocks to buy our investment property, but I did reduce cash and bonds. Today, we can borrow at 3-5% while inflation is at 7%. And if interest rates do come back down to 2%, I can always refinance the mortgage.

Thoughts on Real Estate Investing

Real Estate is a business, not a passive investment. Managing an Airbnb is time consuming and can have headaches of dealing with people and problems. We have spent a huge amount of time (and about $14,000) improving our property and furnishing it for Airbnb. Buying an Index Fund does not carry as much risk or time commitment!
It is the leverage which makes real estate attractive. Without the mortgage, not so much. (Imagine if we could buy $100,000 of an S&P 500 Index fund with only 20% down. That would be incredible over the long term.)
Higher inflation can help real estate prices and rent prices, while our mortgage stays fixed. Besides the cash flow, we also benefit from: 1. Paying down the mortgage and building equity. 2. Increasing home value over time. 3. Some tax benefits such as depreciation.
Your personal residence is still an expense, not an investment. More pre-retirees should be looking into House Hacking. This will enable many to retire years earlier.
I like the returns on short-term rentals. With elevated prices today, many long term rentals have mediocre cash flow potential. Especially if we have some repair expenses and vacancy.

So far, we are happy to have bought an Airbnb. It fits well with our willingness to take risks, start a business, and do repairs ourselves. We are looking to buy another. But we know it’s not for everyone. If this is something which interests you, I am happy to discuss it with you and share what I know.

Investment Themes for 2022

Posted On December 5, 2021 By Admin In Financial Planning /

Let’s look ahead to 2022 and consider what investment themes we believe should be incorporated into our portfolio models. This process is not meant to be a prediction of whether markets will be up or down. I don’t think anyone can time the market successfully. (Here is my letter to clients from March 21, 2020 for reference.) Rather, my goal is to add value to our investment process in three ways.

One, we want to tilt towards areas of relative value. That means when one category is cheap and another is expensive, we want to have more of the cheap stocks and less of the expensive stocks. This sounds obvious, but many investors chase performance without regard to valuation. Inadvertently, they load up on expensive stocks. Tilting towards cheaper categories is inherently contrarian as we are often buying what has recently lagged.

Two, we aim to identify Satellite categories which are attractive under the current market environment. Unlike our Core positions, Satellite positions are temporary and may be removed in future years. Satellite investments are stocks or bonds in a smaller, more focused niche than our core funds. For example, a Floating Rate Bond fund would be a satellite fund, whereas an Investment Grade Bond Index fund would be a core position. We select satellite funds with the goal of enhancing returns.

Three, to diversify our portfolios better, we include Alternative investments. We are looking for investments outside of the usual stock and bond categories which might offer an acceptable return, but with low correlation to the risks of stock markets or interest rates. This could include Real Estate, Hedge Fund Strategies, Preferred Stocks, Convertible Bonds, Commodities, Managed Futures, etc. Typically, these provide some ballast when stocks have a Bear Market, so their primary purpose is to reduce risk, rather than to increase return.

Stocks in 2022

Today, we are looking at our investment themes for stocks for 2022; next week we will cover bonds and alternative investments. Needless to say, there is a lot of uncertainty about the stock market going into 2022. As investors, we have to come to terms with the fact that markets do not always provide us with a clear and obvious direction. Uncertainty is the normal state.

No one knows what will happen with the virus or with the Federal Reserve trying to slow inflation without hurting the economy. Those are the two big questions facing stock investors at the end of 2021. However, those are known unknowns. Often, markets are surprised more by the unknown unknowns – the risks we aren’t even considering right now.

Over the past 50 years, the S&P 500 Index was down 12 years, up 37 years, and exactly at 0% in 2011. The 10-year return of the S&P 500 is 16% a year. Being negative on stocks has proven to be a losing bet over time. Yes, you can lose money on stocks and past performance is no guarantee of future results. With that disclaimer, I see no reason to attempt to try to time the market today and withdraw from stocks.

Tilts: Value, International, Small

Here is what I am doing for 2022: weighing relative valuations between stock categories. There are stocks which have gone way up and are probably overvalued. But there are also stocks which have lagged and are relatively cheap. We can break this down three ways: Growth versus Value stocks, US versus International Stocks, and Large versus Small companies.

Growth has lead the markets for more than a decade. As a result, the spread between value and growth categories has widened to historic levels. In fact, the difference today between Value and Growth is equal to what it was during the Tech bubble in 1999. For 2022, we are increasing our tilt towards Value. While we have little in pure Growth funds, we will be reducing our cap weighted index funds, which have become concentrated in Growth names.

US Stocks have led international for a long-time and there is now a wide gap in valuations. US stocks, especially Growth, are expensive. Most US investors have a significant home bias. For 2022, we will shift a small percentage from US to International. We are already overweight in Emerging Markets, and are not adding to our positions in EM.

Small versus Large has been very interesting in 2021. In the US, Small Value has had a great year and looks promising for 2022. US Small Growth, however, lagged Large Growth by more than 20%. In other developed markets, small cap lagged large cap by a small amount. In Emerging Markets, small cap outperformed large cap by more than 20% year to date. There is not a uniform trend here, except that Small Value has done better than Small Growth. In terms of diversifying and looking for cheap stocks, our small cap selection will lean towards value rather than core or growth.

Taxes Matter

We will be making trades to our portfolios for 2022. Even after these trades, a 60/40 portfolio is still going to have about 60% in stocks and 40% in bonds. But the weightings of the positions will change slightly and some of the funds used may change. Our goal is to reduce risk and stay broadly diversified, while using low-cost investments that are transparent and have a good track record.

Throughout the process, we aim for tax efficiency. Changes are easy to incorporate in IRAs and that is always our first choice. In taxable accounts, we harvested losses in March of 2020, which carried forward to 2021. That can also allow us to make some changes without creating additional taxes for the year. And while I could automate the trading process, I am looking at this one client at a time, to do what is best for you, not easiest for me.

Next week, we will discuss our investment themes for 2022 for bonds and alternatives. Then we will be placing trades at the end of December and into January for most clients. I should note that even without making any changes to the portfolio models, we would still be looking to rebalance here at the end of the year. We will do both steps at the same time – rebalancing and any changes to the model – to avoid any unnecessary trades.

I examine investments all year round, but try to limit changes to once a year to avoid short-term trading. Each year, in the fourth quarter, I go through a process of reviewing all our holdings and our allocations. Here is what I wrote last year, looking ahead to 2021: Investment Themes for 2021

Have concerns about your investment portfolio or specific investments? Will your portfolio be sufficient to achieve your goals? How will you transition your accumulation portfolio to spending it down? These are uniquely individual questions and where our conversations can be the most valuable.

Year End Tax Planning 2021

Posted On November 21, 2021 By Scott Stratton, CFP(R), CFA In Financial Planning /

Let’s discuss some of the key year end tax planning strategies for 2021. It has been a remarkable year with markets soaring, inflation picking up, and the economy booming as we recover from the Pandemic crash last year. A year and a half ago, there were losses everywhere. Now, investors in stocks, real estate, cryptocurrency, and other assets are facing significant gains. Taxes are a major concern.

Here are 10 tax steps to consider before December 31.

Capital Gains Considerations

1. Beware of active mutual funds distributing large capital gains in December. If you have active funds in a taxable account, then make sure you are NOT reinvesting dividends. Better to take that cash and invest in a more efficient ETF or to rebalance.

2. Harvest losses, if you have any for 2021. We harvested losses via tax swaps last year and carried forward tremendous tax benefits into 2021 for our clients. This will help us as we look to rebalance portfolios at year-end.

3. If you are in the 12% tax bracket, your long-term capital gains rate is zero. You can harvest long-term gains and pay no tax. Rather than harvesting losses, you should harvest gains! Then, you can immediately buy back your ETF or fund and reset your cost basis higher. This will help protect you against future taxes. Don’t hold on to gains until future years.

Who is in the 12% bracket? For 2021, this includes single filers with taxable income under $40,525 and married filers under $81,050. Taxable income is after you subtract your standard deduction. So, add back the standard deduction of $12,550 for single or $25,100 married, and you could have gross income of up to $53,075 (single) or $106,150 (married).

4. If you anticipate you will itemize for 2021, bunch deductions as possible before the end of the year.

IRAs and Retirement Contributions

5. If you are able, increase your automatic contributions for 2022. While IRA contributions remain at $6,000 for 2022 ($7,000 if 50+), 401(k) contributions are increased to $20,500 or $27,000 if 50+. Health Savings Accounts are bumped up to $3,600 or $7,200 for a family.

6. Washington wants to eliminate the Backdoor Roth IRA. If you are eligible for 2021, I would do it right away. It may be gone in 2022!

7. Alternatively, if you are in a low tax bracket, consider making Roth Conversions before the end of the year to convert within your low bracket. The key to making this work is making small conversions over many years. Not sure how much to convert? Then let’s talk.

Giving Strategies

8. Even if you do not itemize, you can take an above-the-line deduction for a cash charitable donation of up to $300. For couples, this is doubled to $600. This is only for 2021. In 2022, you will have to itemize to deduct any charitable donation. Above this amount, we suggest donating appreciated securities from a taxable account rather than cash.

9. Consider using your annual gift tax exclusion of $15,000 for personal gifts or for funding a 529 Plan for 2021.

10. If you are 72 or older, don’t forget to complete your Required Minimum Distributions for 2022! Congress waived RMDs for 2020 but they are back this year. If you are over 70 1/2, you can make Qualified Charitable Distributions from your IRA which will count towards your RMD. Be sure to complete any QCDs by December 31.

These are 10 of our top ideas for year end tax planning 2021. I am constantly searching for ways to improve client’s tax situation and add value to their financial planning. I have been getting many new clients this year who are facing large tax bills in the years ahead! Many people aren’t thinking about the eventual taxes as they are building a portfolio or growing a 401(k). And then one day, they realize they have need some help in managing their life in a more tax-wise manner. If that’s you, we can help!

House Hacking

Posted On October 22, 2021 By Scott Stratton, CFP(R), CFA In Financial Planning /

If you are looking to buy a home and want to really grow your wealth, consider house hacking. Our ability to save, invest, and grow real wealth begins with a very simple premise. You have to spend less than you make. It couldn’t be more simple, but that doesn’t make it easy.

For most people, your three biggest expenses are housing, taxes, and cars. If we manage those three expenses well, you may be able to save a significant amount of your income. The more you save, the faster you grow, and the sooner you might reach your goals. Read more: Five Wealth Building Habits

The problem is that most Americans are doing the opposite and creating a lifestyle which consumes 100% of their income. And then there is nothing, zero, left to invest.

House Hacking gives you an incredible opportunity to reduce your biggest expense, in some cases, down to zero. Here’s how. Instead of buying a single family home, you buy a duplex, triplex, or four-plex. You live in one unit and rent out the rest. Your tenants will cover much or even all of your mortgage. You can live there with little or no monthly expenses.

With a house hack, you are freeing up your income so you can save and invest. You can pay off your credit cards. Maximize your 401(k) and Roth IRAs. Start saving for college in a 529. And it’s all because you were willing to live in a multi-family home rather than spending thousands every month on a single family home.

The Details

Sure, house hacking isn’t going to be for everyone. But maybe you want to ask how this might work, if you were to consider it. Although you are buying a multi-family building, you are going to use the house as your primary residence and live there. That means you can still use an FHA mortgage and not have to get a more expensive mortgage for a rental or investment property. With an FHA mortgage, you can put as little as 3.5% down with a FICO score of just 580.

Of course, if you have 20% to put down, you could also do a conventional mortgage as a primary residence. Or, if you’re a veteran, you might be eligible for a VA loan with zero down.

Once you have the property, you can split costs between the area where you live and the area which you rent. This means you can also enjoy some of the tax benefits of being a landlord. Let’s say for example, that your building is 3,000 square feet and you live in 1,200 feet and rent out the rest. You occupy 40% and have 60% as a rental.

Then you can look at your costs, such as insurance, utilities, repairs, taxes, etc. For your bills on the whole house, you can allocate 60% of those costs against your rental income on Schedule E. For the 40% where you live, you can also qualify for the Section 121 capital gains exclusion, when you sell.

Living with other people in the same building might not be your dream situation, but if you can make it work, there could be great benefits for you financially. When you manage your biggest expenses, it becomes easy to have money left over to save and invest. Put your savings on autopilot. Maximize your 401(k). Put $500 month into your Roth IRA to get to the $6,000 annual limit.

Who Can Do a House Hack

House hacking certainly makes sense for a first time home buyer, a single person, or a young couple. That’s probably the typical situation. But it could also work well for older investors who want to turbo charge their savings while they are still working. And if you could reduce your monthly housing cost from $2,000 to $200 or $0 a month, would that change when you will be able to retire? Probably. A house hack might enable you to retire at 55 versus 65. Under the 4% rule, reducing your expenses by $2,000 a month means you now need $600,000 less in your nest egg to retire.

Most of us will resist making a sacrifice to be able to save. Still, if you have an open mind, a house hack might be a brilliant way to save and invest. While your friends and colleagues are barely saving anything, you might be able to put away 50% of your income while your tenants are paying down your mortgage. If you can invest $2,000 a month for 10 years, at a 7% return, you could have $344,000. That might be worth a small sacrifice.

Housing is an expense. Your house should go up in value over time, but the expenses of interest, taxes, insurance, and upkeep are not building your wealth. What if you get someone else to pay for your house? When you reduce those expenses, you are giving yourself a tremendous opportunity to save and invest in appreciating assets. If that is important to you, look for creative ways to cut your biggest expenses!

Have you done a house hack? I’d love to hear from you about your experiences. Send me a note!

Inflation Investments

Posted On September 10, 2021 By Scott Stratton, CFP(R), CFA In Financial Planning, Portfolio Management /

With the cost of living on the rise in 2021, many investors are asking about inflation investments. What is a good way to position your portfolio to grow and maintain its purchasing power? Where should we be positioned for 2022 if higher inflation is going to stick around?

Inflation was 5.4% for the 12 months ending in July. I share these concerns and we are going to discuss several inflation investments below. Before we do, I have to begin with a caveat. We should be cautious about placing a lot of weight in forecasts. Whether we look at predictions of stock market returns, interest rates, or inflation, these are often quite inaccurate. Market timing decisions based on these forecasts seldom add any value in hindsight.

What we do know for sure is that cash will lose its purchasing power. With interest rates near zero on most money market funds and bank accounts, it is a frustrating time to be a conservative investor. We like to consider the Real Yield – the yield minus inflation. It would be good if bonds were giving us a positive Real Yield. Today, however, the Real Yield on a 10-year Treasury bond is negative 4%. This may be the most unattractive Real Yield we have ever seen in US fixed income.

Let’s look at inflation’s impact on stocks and bonds and then discuss three alternatives: TIPs, Commodities, and Real Estate.

Inflation and Stocks

You may hear that inflation is bad for stocks. That is partially true. Rising inflation hurts companies’ profitability and consumers’ wallets. In the short-term, unexpected spikes in inflation seem correlated to below average performance in stocks.

However, when we look longer, stocks have done the better job of staying ahead of inflation than other assets. Over five or ten years, stocks have generally outpaced inflation by a wide margin. That’s true even in periods of higher inflation. There are always some down periods for stocks, but as an asset class, stocks typically have the best chance of beating inflation over a 20-30 year horizon as an investor or as a retiree.

We can’t discuss stocks and inflation without considering two important points.

First, if there is high inflation in the US, we expect that the Dollar will decline in value as a currency. If the Dollar weakens, this would be positive for foreign stocks or emerging market stocks. Because foreign stocks trade in other currencies, a falling dollar would boost their values for US investors. Our international holdings provide a hedge against a falling dollar.

Second, the Federal Reserve may act soon to slow inflation by raising interest rates. This would help slow the economy. However, if the Fed presses too hard on the brake pedal, they could crash the economy, the stock market, and send bond prices falling, too. In this scenario, cash at 0% could still outperform stocks and bonds for a year or longer! That’s why Wall Street has long said “Don’t fight the Fed.” The Fed’s mandate is to manage inflation and they are now having to figure out how to keep the economy growing. But not growing too much to cause inflation! This will prove more difficult as government spending and debt grows to walk this tightrope.

Inflation and Bonds

With Real Yields negative today, it may seem an unappealing time to own bonds, especially high quality bonds. Earning one percent while inflation is 5% is frustrating. The challenge is to maintain an appropriate risk tolerance across the whole portfolio.

If you have a 60/40 portfolio with 60% in stocks and 40% in bonds, should you sell your bonds? The stock market is at an all-time high right now and US growth stocks could be overvalued. So it is not a great buying opportunity to replace all your bonds with stocks today. Instead, consider your reason for owning bonds. We own bonds to offset the risk of stocks. This gives us an opportunity to have some stability and survive the next bear market. Bonds give us a chance to rebalance. So, I doubt that anyone who is 60/40 or 70/30 will want to go to 100% stocks in this environment today.

Still, I think we can add some value to fixed income holdings. Here are a couple of ways we have been addressing fixed income holdings for our clients:

Ladder 5-year Fixed Annuities. Today’s rate is 2.75%, which is below inflation, but more than double what we can find in Treasury bonds, Municipal bonds, or CDs.
Emerging Market Bonds. As a long-term investment, we see attractive relative yields and improving fundamentals.
Preferred Stocks, offering an attractive yield.

TIPS

Treasury Inflation Protected Securities are US government bonds which adjust to the CPI. These should be the perfect inflation investment. TIPS were designed to offer a return of inflation plus some small amount. In the past, these may have offered CPI plus say one percent. Then if CPI is 5.4%, you would earn 6.4% for the year.

Unfortunately, in today’s low yield environment, TIPS sell at a negative yield. For example, the yield on the Vanguard short-term TIPS ETF (VTIP) is presently negative 2.24%. That means you will earn inflation minus 2.24%. Today, TIPS are guaranteed to not keep up with inflation! I suppose if you think inflation is staying higher than 5%, TIPS could still be attractive relative to owning regular short-term Treasury Bonds. But TIPS today will not actually keep up with inflation.

Instead of TIPS, individual investors should look at I-Bonds. I-Bonds are a cousin of the old-school EE US Savings Bonds. The I-series savings bonds, however, are inflation linked. I-bonds bought today will pay CPI plus 0%. Then your investment is guaranteed to keep up with inflation, unlike TIPS. A couple of things to know about I-bonds:

You can only buy I-bonds directly from the US Treasury. We cannot hold I-Bonds in a brokerage account. There is no secondary market for I-bonds, you can only redeem at a bank or electronically.
I-Bond purchases are limited to a maximum of $10,000 a year in electronic form and $5,000 a year as paper bonds, per person. You can buy I-bonds as a gift for minors, and the annual limits are based on the recipient, not the purchaser.
I-bonds pay interest for 30 years. You can redeem an I-bond after 12 months. If you sell between 1 and 5 years, you lose the last three months of interest.

Commodities

Because inflation means that the cost of materials is rising, owning commodities as part of a portfolio may offer a hedge on inflation. Long-term, commodities have not performed as well as stocks, but they do have periods when they do well. While bonds are relatively stable and consistent, commodities can have a lot of volatility and risk. So, I don’t like commodities as a permanent holding in a portfolio.

The Bloomberg Commodities Index was up 22% this year through August 31. Having already had a strong performance, I don’t think that anyone buying commodities today is early to the party. That is a risk – even if we are correct about above average inflation, that does not mean we are guaranteed success by buying commodities.

Consider Gold. Gold is often thought of as a great inflation hedge and a store of value. Unfortunately, Gold has not performed well in 2021. Gold is down 4.7% year to date, even as inflation has spiked. It has underperformed broad commodities by 27%! It’s difficult to try to pick individual commodities with consistent accuracy. They are highly speculative. That’s why if you are going to invest in commodities, I would suggest a broad index fund rather than betting on a single commodity.

Real Estate

With home prices up 20% in many markets, Real Estate is certainly a popular inflation investment. And with mortgage rates at all-time lows, borrowers tend to do well when inflation ticks up. Home values grow and could even outstrip the interest rate on your mortgage, potentially. I’ve written at length about real estate and want to share a couple of my best pieces:

While I like real estate as an inflation hedge, I’d like to remind investors that the home price changes reported by the Case-Schiller Home Price Index do not reflect the return to investors. Read: Inflation and Real Estate.

Thinking about buying a rental property? Read: Should You Invest In Real Estate?

With cash at zero percent, should you pay off your mortgage? Read: Your Home Is Like A Bond

Looking at commercial Real Estate Investment Trusts, US REITs have had a strong year. The iShares US REIT ETF (IYR) is up 27% year to date, beating even the S&P 500 Index. I am concerned about the present valuations and low yields in the space. Additionally, retail, office, apartments, and senior living all face extreme challenges from the Pandemic. Many are seeing vacancies, bankrupt tenants, and people relocating away from urban development. Many businesses are rethinking their office needs as work-from-home seems here to stay. Even if we do see higher inflation moving forward, I’m not sure I want to chase REITs at these elevated levels.

Inflation Portfolio

Even with the possibility of higher inflation, I would caution investors against making radical changes to their portfolio. Stocks will continue to be the inflation investment that should offer the best chance at crushing inflation over the long-term. Include foreign stocks to add a hedge because US inflation suggests the Dollar will fall over time. Bonds are primarily to offset the risk of stocks and provide portfolio defense. We will make a few tweaks to try to reduce the impact of inflation on fixed income, but I would remind investors to avoid chasing high yield.

As satellite positions to core stock and bond holdings, we’ve looked at TIPS, Commodities, and Real Estate. Each has Pros and Cons as inflation investments. At this point, the simple fear of inflation has caused some of these investments to already have significant moves. We will continue to evaluate the inflation situation and analyze how we position our investment holdings. Our focus remains fixed on helping clients achieve their goals through prudent investment strategies and smart financial planning.