As Inflation Fears Fade, Deflation Moves Front and Center

December 31, 2014 — Sam H. Fawaz

As the Federal Reserve winds down its massive bond-buying program, the widely predicted after effects — rising interest rates and inflation — have thus far failed to materialize. The yield on the bond market’s bellwether 10-year Treasury note, which started 2014 at 3.03%, had fallen to 2.33% as of October 29.1 Similarly, inflation, as measured by the U.S. Bureau of Labor Statistics key benchmark, the Consumer Price Index, has risen just 1.7% in the past year and has averaged 1.6% since the Fed first initiated its bond-buying program four years ago.2

Currently, concerns over inflation have been replaced by an opposite economic condition: deflation, defined as two quarters of falling prices within a 12-month period.3

Deflation, a Good News/Bad News Story

The paradox of deflation is that it can create good as well as bad conditions. When prices on essential goods and services drop, consumers are left with more disposable income to spend on nonessential items. Case in point: Plunging oil prices have spelled relief at the pumps, as the average national price for gas has now dropped below $3.00 a gallon for the first time since 2010.4

But when prices tend to fall across the board, the effect can turn negative for the economy, companies, and governments alike. Consumers put off making major purchases in the hope that prices will fall even further. That purchasing stalemate can be disastrous for a consumer-driven economy like the United States’, which garners about 70% of its GDP from consumer spending.

When spending stalls, companies’ revenues suffer and pressure mounts to cut costs by laying off workers, freezing or reducing wages, or raising the price of the goods they produce — all of which can further stymie consumer spending and deepen the deflationary cycle.

Debt is the other major problem associated with deflation. On the consumer side, when wages are stagnant or declining, consumer spending power declines, and it becomes more difficult to pay off debts — even fixed-rate debt such as home mortgages — because the value of that debt relative to income increases.

The same scenario plays out for corporations and governments, causing cash-flow shortages, tax revenue shortfalls, liquidity problems, and even bankruptcy.5 Deflation fears are particularly pronounced in Europe, where sluggish economic growth has much of the continent teetering on the brink of recession. To a lesser extent Japan and China are facing similar woes.

On the Right Side of the Problem

The good news/bad news nature of deflation has everything to do with what is driving the drop in prices of goods and services. For instance, if it is a lack of demand — as many economists say is currently the case in the Eurozone — deflation could be damaging. If, however, it is due to a boost in supply — such as the oil and gas boom in the United States — it can prove beneficial to economic growth.6

Either way, analysts say that U.S. investors should benefit from current conditions for the time being. The S&P 500 Index has gained 6.3% thus far this year (as of October 26), while the Stoxx Europe 600 Index has fallen 0.3%. Meanwhile, virtually all major currencies are devaluing against the dollar in an attempt to export deflation to the United States.6

If you would like to discuss your current portfolio asset allocation or any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

I wish you great health and prosperity in 2015!

 

Sources:

1USA Today, “First Take: Beginning of the end of easy money,” October 29, 2014.

2U.S. Bureau of Labor Statistics, Consumer Price Index, September 2014.

3The Economist, “The dangers of deflation: The pendulum swings to the pit,” October 25, 2014.

4AAA’s Fuel Gauge Report, November 3, 2014.

5Yahoo Finance, “Why deflation is so scary,” November 3, 2014.

6Bloomberg, “U.S. Gains From Good Deflation as Europe Faces the Bad Kind,” October 26, 2014.

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Sam Fawaz Guest Speaker-Tune into SiriusXM CH 111 on Tue Dec 30th at 5.30pm EST!

December 28, 2014 — Sam H. Fawaz

On Tuesday, December 30th, I will be the guest Financial Planner on SiriusXM’s Business Radio show “Your Money“, hosted by Kent Smetters. The show airs on Wharton Business Radio, Channel 111 and will begin at 5 PM EST / 4 PM CST. Make sure to tune in!

I am honored to have been invited to be the guest Financial Planner on Your Money and it would be even more of an honor if you were to tune in and provide me with your questions and/or feedback.

The show runs from 5:00 to 7:00PM EST (4-6 PM CST) and I will be on between 5:30 and 6:15PM EST (4:30 and 5:15PM CST).  We will be talking about and answering questions on New Year’s resolutions and financial plans for 2015.

I hope you can join me then!

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Is Your Portfolio “In Style” or Making a Bad Fashion Statement?

December 24, 2014 — Sam H. Fawaz

It is fairly common knowledge that a retirement portfolio’s carefully constructed asset allocation can become unbalanced in two cases: When you alter your investment strategy and when market performance causes the value of some funds in your portfolio to rise or fall more dramatically than others. But did you know there is also a third scenario? Your portfolio can become unbalanced due to unexpected changes in the funds’ holdings.

Getting the Drift

The phenomenon known as “style drift” generally occurs when a fund’s manager or management team strays beyond the parameters of the fund’s stated objective in pursuit of better returns. For example, this may occur when a growth fund begins investing significantly in value stocks or when a large-company fund begins investing in the stocks of small and midsized companies. As a result, the fund’s name may not accurately reflect its strategy.

If style drift occurs within the funds held in your portfolio, it could alter your overall risk and return potential, which may influence your ability to effectively pursue your financial goals.

Feeling the Effects

While some fund managers embrace a strategy that provides significant flexibility to help boost returns, and indeed such flexibility often proves quite successful, investors need to remember that too much flexibility can also present a threat to their own portfolio’s level of diversification. Investors need to consider their ability to tolerate unexpected changes in pursuit of higher returns.

For example, let us assume an investor allocates her equity investments equally between growth funds and value funds with the hope of managing risk and increasing exposure to different types of opportunities. If the manager of the growth fund begins to invest heavily in value stocks, the investor could end up owning two funds with very similar characteristics and a much greater level of risk than she intended.

Truth in Labeling?

Although most investment companies, including those represented in your retirement plan, adhere to stringent fund management standards, you may not want to simply judge a book by its cover, so to speak. An occasional portfolio review can help ensure that you remain comfortable with each fund’s management strategy.

For a comprehensive look at each fund and to evaluate its potential role in your portfolio, take the time to study its prospectus and annual report to determine how much flexibility the fund manager has in security selection. Also, look carefully at the fund’s holdings to see if they are in line with the stated objective. If you discover something that appears amiss, it may be appropriate to rebalance your portfolio accordingly.

If you would like to discuss your current portfolio asset allocation or any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Have a Merry Christmas!

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How Do the Markets Really Work?

December 21, 2014 — Sam H. Fawaz

We all do it.  But what do we really know about investing?  A recent post about investing wisdom features a lot of interesting (and often overlooked) facts and figures, plus some insights from Warren Buffett, Jeremy Siegel, William Bernstein, Nobel laureate Daniel Kahneman and a few economists you may have heard of.

Regarding market predictions, the post had this to say: The phrase “double-dip recession” was mentioned 10.8 million times in 2010 and 2011, according to Google. It never came. There were virtually no mentions of “financial collapse” in 2006 and 2007. It did come. A similar story can be told virtually every year.

According to Bloomberg, the 50 stocks in the S&P 500 that Wall Street rated the lowest at the end of 2011 outperformed the overall index by 7 percentage points over the following year.

Many of the items offered insight into how our investment markets actually work.  For instance:

  • Since 1871, the market has spent 40% of all years either rising or falling more than 20%. Roaring booms and crushing busts are perfectly normal.
  • Apple increased more than 6,000% from 2002 to 2012, but declined on 48% of all trading days during that time period. (Investing is never a straight path up.)
  • Polls show Americans for the last 25 years have said the economy is in a state of decline. Pessimism in the face of advancement is the norm.
  • A broad index of U.S. stocks increased 2,000-fold between 1928 and 2013, but lost at least 20% of its value 20 times during that period. People would be less scared of volatility if they knew how common it was.
  • There were 272 automobile companies in 1909. Through consolidation and failure, three emerged on top, two of which went bankrupt. Spotting a promising trend and identifying a winning investment are two different things.
  • According to economist Tim Duy, “As long as people have babies, as long as capital depreciates, technology evolves, and tastes and preferences change, there is a powerful underlying impetus for growth that is almost certain to reveal itself in any reasonably well-managed economy.”

The post had a few zingers about some of the best-paid executives in the financial and investment community:

  • Twenty-five hedge fund managers took home $21.2 billion in 2013 for delivering an average performance of 9.1%, versus the 32.4% you could have made in an index fund. Hedge funds are a great business to work in — not so much to invest in.
  • In 1989, the CEOs of the seven largest U.S. banks earned an average of 100 times what a typical household made. By 2007, that had risen to more than 500 times. By 2008, several of those banks no longer existed.

And finally, if you want to understand the difference between daily fluctuation and the underlying growth of value in the markets, consider this:

Investor Ralph Wagoner once explained how markets work, recalled by Bill Bernstein: “He likens the market to an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch. But in the long run, you know he’s heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the market players, big and small, seem to have their eye on the dog, and not the owner.”

If you would like to discuss your current portfolio or any financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Source:

http://www.businessinsider.com/things-everyone-should-know-about-investing-and-the-economy-2014-12

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Should We Fear—Or Cheer—Plunging Oil Prices?

December 18, 2014 — Sam H. Fawaz

Chances are, you’re celebrating today’s lower gas prices.  AAA reports that the national average price of gas is $2.48 today, the lowest since December 2009.  The result: an estimated $70 billion in direct savings for U.S. consumers over the next 12 months.  At previous prices, the average American was spending about $2,600 a year on gasoline, so the 20% price decline would result in $520 more to save or spend.

It gets better.  Even though gas prices (and, therefore, the cost of driving) have plummeted, the Internal Revenue Service is raising the standard mileage rates that people can deduct on their tax return for business travel, from 56 cents in 2014 to 57.5 cents per business mile driven next year.

Only the investment markets seem to think that cycling an extra $70 billion into the U.S. economy is a bad thing.  This past week, large cap stocks, represented by the S&P 500 index, saw their prices fall by 3.5%—their biggest drop since May 2012. Why?  The only possible explanation is that rapid Wall Street traders believe that lower oil prices will harm the economies of America’s trading partners, and therefore impact the U.S. economy indirectly.

So let’s take a closer look.  While U.S. consumers are cheering the decline in oil prices, and non-energy producing nations like Japan and countries in the Eurozone are seeing a boost in their economies, who’s NOT celebrating?

As it turns out, some of the biggest losers are American domestic shale oil producers, who basically break even when oil prices are at their current $50-$60 a barrel levels.  Any further drop in prices would slow down domestic energy production, and probably create a floor that would keep prices from falling much further.

Another big loser is the socialist government in Venezuela (remember Hugo Chavez?), which needs oil prices above $162 a barrel to pay for all of its social programs.  You can also sympathize with Iran, which reportedly needs oil prices to move up to $135 barrel to stay in the black, due to continuing sanctions from the world community over its nuclear program, and the high cost of supporting Hezbollah and its own military ventures in the Middle East.

The biggest loser is probably Russia, which requires oil prices of at least $100 a barrel for its budget to withstand international sanctions and finance its own military adventures against neighboring nations.  Economists are projecting that Russia will fall into a steep recession next year, when GDP could decline as much as 6%.  The nation is experiencing what economists call “capital outflows” of $125 billion a year—a fancy way of saying that wealthy Russians are taking money out of Russian banks and either investing abroad or putting their rubles in banks located in more stable foreign jurisdictions.  And in the process, they are exchanging their rubles for local currency, as a way to protect against the recent free-fall in Russia’s currency.  Bloomberg News recently published the below graphic which many Americans will find entertaining, but which is probably not happy news for Russian President Vladimir Putin.

Fear or Cheer Plunging Oil Prices

It’s interesting that the markets seem to be worrying about low oil prices when the economies with the most to lose are not only less than minor trading partners, but actual political enemies of U.S. interests. Cheaper oil will eventually be regarded as a plus for our economic—and political—interests, but the downturn suggests that Wall Street traders are hair-trigger ready to be spooked by anything they regard as unusual.

If you would like to discuss your current portfolio or any financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://www.marketwatch.com/story/5-countries-that-will-be-the-biggest-losers-from-oils-slide-2014-11-20?page=2

http://blogs.piie.com/realtime/?p=4644

http://www.accountingtoday.com/news/irs-watch/irs-raises-standard-mileage-rate-for-businesses-72990-1.html?ET=webcpa:e3476082:a:&st=email&utm_content=buffer4179f&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer

http://www.forbes.com/sites/northwesternmutual/2014/11/27/lower-oil-prices-give-a-gift-to-consumers/

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No Shutdown, No Problem

December 15, 2014 — Sam H. Fawaz

The good news from Congress this week is that it looks like the U.S. government isn’t going to have to shut down again due to partisan political bickering.  Last week, literally at the last minute, on the day that current funding provisions would have expired, the U.S. House of Representatives created a new government funding bill that will keep the lights on until September of 2015.  The narrow 219-206 vote also gave the Senate a grace period until Monday to approve the legislation dubbed “CRomnibus” before everybody goes home for the holidays.  The Senate followed suit and sent the bill to the President for signature on Monday.

In all, the spending legislation comes to 1,603 pages, and both Democrats and Republicans seem to be unhappy about it—for, of course, very different reasons.  But when you get past the immigration and health care reform debate on the right, and the rollback of Dodd-Frank provisions that would have barred Wall Street firms from using taxpayer-backed funds to engage in risky derivative trading that angered politicians on the left, the bill really doesn’t have much of an effect on most of us.  It keeps domestic spending essentially flat at $1.013 trillion, while providing additional funds to fight Islamic state militants in the Middle East and the Ebola outbreak in West Africa.  There are no new taxes, and enforcement of the current taxes is likely to be less stringent after the Internal Revenue Service’s budget was cut by $345.6 million—roughly what it costs to hire 5,000 auditors.  Also defunded: the Environmental Protection Agency, whose budget has been rolled back to 1989 levels.  And a specific provision will prevent the Fish and Wildlife Service from adding a Western bird called the sage grouse to the protected species list.

Perhaps the most interesting provision in the House-passed bill, which is not mentioned in the press anywhere, can be found in Section 979, where our lawmakers set salaries and expenses of the House of Representatives at a highly budget-conscious $1.18 billion, with a “b”.

Now the House and Senate will spend a few days debating whether to pass extensions of 55 different tax credits, including tax deductions for research and development expenses by U.S. corporations, tax credits for renewable energy production plants, and a provision that would exempt forgiven mortgage debt from taxable income.

Sources:
http://www.vox.com/2014/12/11/7376585/cromnibus-2015-appropriations-details

http://news.yahoo.com/real-reason-obama-pushed-house-144001131.html

http://www.cnn.com/2014/12/10/politics/policy-riders-spending-bill/index.html

http://news.yahoo.com/u-senate-appears-set-pass-spending-bill-timing-153042041–sector.html

http://www.csmonitor.com/USA/DC-Decoder/2014/1210/From-marijuana-to-Islamic-State-five-things-addressed-in-new-budget-deal-video

http://www.scribd.com/doc/249716409/Congressional-spending-compromise

http://www.msn.com/en-us/news/politics/us-house-narrowly-passes-spending-bill-averts-government-shutdown/ar-BBgEXlY?ocid=ansnewsreu11

http://news.yahoo.com/tax-extenders-expected-win-u-senate-approval-within-152109690–business.html

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Investor Know Thyself

December 10, 2014 — Sam H. Fawaz

In an ideal world, emotions would play a very small role in the way people invest and manage their money. Everyone would thoroughly research their options, maintain realistic expectations, and keep counterproductive habits under control.

But in the real world, even well-informed investors sometimes make emotionally charged decisions that may threaten their ability to stay focused on important financial goals, such as accumulating enough money for retirement. In fact, such missteps are so common that many academics have done extensive research on “investor psychology” or “behavioral finance” to explain why some people tend to keep encountering the same obstacles in their financial lives.

Behavior Insights

As you might imagine, different financial attitudes can result in very different consequences. For example, the behavior known as “anchoring” is the tendency for investors to hold on to a belief based on their own limited experience, despite the availability of contradictory information.

For instance, someone who lived through the Great Depression might be more likely to be a conservative investor, while someone who did very well in the market during the 1990s might tend to be a more aggressive investor. Of course, history shows that that type of decline or growth experienced by such individuals, is more the exception than the norm. As such, one possible result of anchoring is making long-term investment decisions based on misguided performance expectations or incomplete facts.

Overconfidence in one’s own abilities is another mindset that could make it more difficult to achieve lasting financial security. Why? Because it may lead investors to ignore sound advice, misunderstand goals, and potentially implement inappropriate investment strategies. On the other hand, a lack of confidence may be to blame for the “fear of loss” (or “fear of regret”) that causes some nervous investors to adjust their portfolios too often — or not often enough.

You’ve Got Personality

It can also be insightful to think about what type of “financial personality” you have. “Impulsives,” for example, are prone to spending spontaneously and not saving enough. “Planners,” however, are in the habit of setting aside as much as possible and sticking to an appropriate investment strategy.

If you would like to discuss your financial personality or any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

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Providing for Pets

December 7, 2014 — Sam H. Fawaz

This past summer, the entertainment world lost one of its most prominent and popular figures: Joan Rivers. When her estate planning documents were unveiled, it became clear that she was a careful planner of her legacy–and also a devoted pet owner. One of the most interesting details of her estate plan was the careful provisions Rivers made for her pets.

Rivers left the bulk of her estate to her daughter Melissa and her grandson Cooper–an estimated $150 million in total value. The two rescue dogs who shared her New York residence, and two other dogs who lived at her home in California, were beneficiaries of pet trusts, which included an undisclosed amount of money set aside for their ongoing care, and carefully written provisions that described the standard of living that Rivers expected them to receive for the remainder of their lives.

Traditional pet trusts are honored in most U.S. states, as are statutory pet trusts, which are simpler. In a traditional trust, the owner lists the duties and responsibilities of the designated new owner of the pets, while the statutory trusts incorporate basic default provisions that give caregivers broad discretion to use their judgment to care for the animals. Typical provisions include the type of food the animal enjoys, taking the dog for daily walks, plus regular veterinary visits and care if the pet becomes ill or injured. The most important provision in your pet trust, according to the American Society for the Prevention of Cruelty to Animals, is to select a person who loves animals and, ideally, loves your pets.

The trust document will often name a trustee who will oversee the level of care, and a different person will be named as the actual caregiver. In all cases, the trusts terminate upon the death of the last surviving animal beneficiary, and the owner should choose who will receive those residual assets.

Some states have different laws that require different arrangements. Idaho allows for the creation of a purpose trust, and Wisconsin’s statute provides for an “honorary trust” arrangement. There are no pet trust provisions on the legal books in Kentucky, Louisiana, Minnesota and Mississippi, but pet owners living there can create a living trust for their pets or put a provision in their will which specifies the care for pets. A popular (and relatively simple) alternative is to set aside an amount of money in the will to go to the selected caregiver, with a request that the money be used on behalf of the pet’s ongoing care.

It should be noted that a pet trust is not designed to pass on great amounts of wealth into the total net worth of the animal kingdom. The poster child of an extravagant settlement is Leona Helmsley’s bequest of $12 million to her White Maltese, instantly putting the dog, named “trouble,” into the ranks of America’s one-percenters. Rather than confer a financial legacy on an animal, the goal should be to ease any financial burdens the successor owner might incur when caring properly for your loved animals for the remainder of their lives, including food and veterinary bills.

How long should you plan for the funding to last? Cats and dogs typically live 10-14 years, but some cats have lived to age 30, and some dogs can survive to see their 24th birthday. Interestingly, estate planners are starting to see some pet trusts extend out for rather lengthy periods of time, as owners buy pets that have longer lifespans. For example, if an elderly person has a Macaw parrot as a companion, the animal could easily outlive several successor owners, with a lifespan of 80-100 years. Horse owners should plan for a life expectancy of 25-30 years, and, since horses tend to be expensive to care for, the trust will almost certainly require greater levels of funding. On the extreme end, if you know anyone who happens to have a cuddly Galapagos giant tortoise contentedly roaming their backyard, let them know that their pet trust would need to be set up for an average 190-year lifespan.

If you would like to discuss your estate planning or any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:
http://www.dailyfinance.com/2014/09/11/what-joan-rivers-just-taught-pet-lovers-about-estate-planning/
http://www.dailyfinance.com/2014/08/14/robin-williams-estate-plan-spares-his-heirs-drama/
http://www.1800petmeds.com/education/life-expectancy-dog-cat-40.htm
http://abcnews.go.com/US/leona-helmsleys-dog-trouble-richest-world-dies-12/story?id=13810168
http://www.aspca.org/pet-care/planning-for-your-pets-future/pet-trust-primer

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Massive withdrawals from 401(k)s thwart Americans’ retirement planning efforts

December 3, 2014 — Sam H. Fawaz

As the IRS released the 401(k) contribution limits for 2015, attention turned, as it has in prior years, to the large number of plan participants who come nowhere close to contributing these amounts. In contrast, many individuals use their 401(k) accounts as a means to pay off loans and other current expenses.

The amounts withdrawn are not negligible. According to a recent study by Vanguard, the average withdrawal represents one-third of the participant’s account balance. Additionally, most withdrawals are not for hardship — non-hardship withdrawals outnumber hardship withdrawals 2-to-1, and the rate of new non-hardship withdrawals doubled between 2004 and 20131.

So, why are so many withdrawals occurring? One reason is to pay off debt, including student loans. Another may be to help make ends meet when people are between jobs. Fidelity reported earlier this year that 35% of participants took all or part of their 401(k) savings when leaving a job2.

No matter the reason, the long-term implications of early 401(k) withdrawals can be considerable. In withdrawing from the account, plan participants will miss out on tax-deferred compounding of that money, which can add up over time.

Alternatives to Raiding Your 401(k)

Withdrawing from a tax-deferred retirement plan to meet short-term needs should be a last resort. Before doing so, consider alternatives such as the following:

  • Savings accounts or other liquid investments, including money market accounts. With short-term investment rates at historically low levels, the opportunity cost for using these funds is relatively low.
  • Home equity loans or lines of credit. Not only do they offer comparatively low interest rates, but interest payments are generally tax deductible.
  • Roth IRA contributions. If there is no other choice but to withdraw a portion of retirement savings, consider starting with a Roth IRA. Amounts contributed to a Roth IRA can be withdrawn tax and penalty free if certain qualifications are met. See IRS Publication 590 for more information.

If withdrawing from a 401(k) is absolutely necessary, consider rolling it over to an IRA first and then withdrawing only what is needed. According to the Vanguard study, fewer than 10% of withdrawals were rolled into an IRA; more than 90% were taken in cash1, which typically generates withholding taxes and IRS penalties.

If you would like to discuss your retirement investments or any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:
1Vanguard Investment Group, How America Saves 2014, June 2014.
2The New York Times, “Combating a Flood of Early 401(k) Withdrawals,” October 24, 2014.

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