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!

Posted in Fee-only, Financial Planning, General, investing, markets, retirement planning. Tags: , , , , , , . 1 Comment »

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/

Posted in Consumers, energy stocks, Financial Planning, General, markets, retirement planning. Tags: , , , , , . Leave a Comment »

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.

Posted in Fee-only, Financial Planning, General, investing. Tags: , , . 1 Comment »

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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Relative Prosperity

November 30, 2014 — Sam H. Fawaz

You might have read that the U.S. investment markets are jittery on the news that Japan has experienced two consecutive quarters of economic decline—the official definition of a recession.  But if you turn the news around, it offers us a reminder that, however much we complain about slow-growth recovery from 2008, Americans are actually part of one of the most robust economies in the world.

The statistics tell an interesting story.  The U.S. economy is growing at a rate of about 2.95% for the year, which is (as the complainers correctly point out) slightly below its long-term pace.  But this doesn’t look so bad compared to the 2.16% growth average for the G7 nations in aggregate, and our growth numbers are well ahead of the European Union, whose economies are expanding at an anemic 1.28% rate this year.

Look deeper and our story looks even better.  The current recession is Japan’s fourth in six years, despite long-term stimulus efforts that make the Fed’s QE program look like a purchase at the candy store.  Europe is rumored to be teetering on the edge of recession, which would be its second since the 2008 meltdown.  The published GDP figures coming out of China (which are very unreliable due to heavy government editing) could drop to about half the long-term rate this year, and Brazil entered recession territory last summer.

But what about the 5.8% unemployment rate in the U.S.?  That’s better than the 10% rate at the end of 2008, but it’s not good—right?  Compared with the rest of the world, America’s jobs picture looks downright rosy.  The list, below, shows that only 13 countries have lower jobless rates than the American economy, and some of those (Malaysia, Russia, Saudi Arabia) may be giving out numbers that their leaders want to hear.  Yes, it would be nice if the long, sustained GDP growth we’ve enjoyed these last six years were faster, and we all hope that the unemployment rate continues dropping.  But compared with just about everywhere else, life in the U.S.—on the economic front, at least—is pretty good

Global unemployment rates

Malaysia (2.7%)
Switzerland (3.1%)
South Korea (3.5%)
Japan (3.6%)
Norway (3.7%)
Taiwan (3.9%)
Denmark (4.0%)
Brazil (4.9%)
Russia (4.9%)
Germany (5.0%)
Mexico (5.1%)
India (5.2%)
Saudi Arabia (5.5%)
UNITED STATES (5.8%)
Indonesia (5.9%)
Pakistan (6.0%)
United Kingdom (6.0%)
Australia (6.2%)
Israel (6.5%)
Canada (6.5%)
Chile (6.6%)
Philippines (6.7%)
Venezuela (7.0%)
Czech Republic (7.1%)
Argentina (7.5%)
Sweden (7.5%)
Netherlands (8.0%)
Austria (8.1%)
Colombia (8.4%)
Finland (8.5%)
Belgium (8.5%)
Iran (9.5%)
Turkey (10.1%)
France (10.2%)
Ireland (11.0%)
Poland (11.3%)
Egypt (12.3%)
Italy (12.6%)
Portugal (13.1%)
Iraq (15.1%)
Spain (23.7%)
Nigeria (23.9%)
South Africa (25.4%)
Greece (25.9%)

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.

Sources:
http://www.washingtonpost.com/business/economy/japan-recession-europe-stagnation-cast-pall-over-global-economic-outlook/2014/11/17/5cd81612-6e8f-11e4-ad12-3734c461eab6_story.html

http://www.washingtonpost.com/world/japans-economy-tips-back-into-recession-in-another-blow-for-abe/2014/11/16/9a8f2e94-8c9c-44cf-a5e8-b57a470fd61f_story.html

http://www.washingtonpost.com/world/japans-abe-says-tpp-trade-talks-with-us-are-near-the-final-stage/2014/11/07/24ba0b42-63a8-11e4-ab86-46000e1d0035_story.html

http://www.washingtonpost.com/world/british-prime-minister-david-cameron-says-red-warning-lights-flashing-on-global-economy/2014/11/17/acc29d06-c38f-49a1-b478-30d334fd3389_story.html

http://www.tradingeconomics.com/country-list/unemployment-rate

http://www.economywatch.com/economic-statistics/year/2014/

http://vicshowplanet.blogspot.com/2014/08/brazils-economy-falls-into-recession.html

https://uk.news.yahoo.com/ebrd-says-russia-certain-fall-economic-recession-122646029–business.html#PklpsIB

http://online.wsj.com/articles/chinas-slowdown-raises-pressure-on-beijing-to-spur-growth-1413893980

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When Diversification Fails

November 26, 2014 — Sam H. Fawaz

Correlation coefficients are one of the most complicated areas of the asset management world, but the idea behind them is pretty simple–or, at least, most of us thought it was until the 2008-2009 meltdown.  The basic idea is that you study the price movements of, say, the stocks of large companies (represented by the S&P 500), and then look at the price movements of, say, stocks in the NAREIT (real estate) index.  You find that, on average, they tend to march to different drummers; when one goes up, the other goes up less, or it may go down.  When the other goes down, the first asset may go up or stay the same.  They have, in the parlance of experts, a low correlation.

These correlations between various flavors of stocks and real estate, commodities, bonds and other assets are expressed mathematically, and are one of the factors that professional investment advisors take into account when they build portfolios.  Whenever one kind of asset is going down, ideally you want something else in the portfolio to be going up, responding to different influences.

But all of these carefully-crafted models and all the higher mathematics went seriously awry during the 2008-2009 downturn, when every risk asset–from commodities to real estate to stocks–went down in concert as if the correlation coefficients had suddenly decided to converge at exactly the wrong time.  How could this happen?

At a recent investment conference, the outlines of a possible explanation began to emerge.  It was noted that all of those risk assets had one thing in common: they were financed or owned by the same small number of investment banking and brokerage institutions.  When Lehman Brothers went bankrupt and Bear Stearns was essentially folded into J.P. Morgan, when Citigroup and Merrill Lynch and Goldman Sachs suddenly had to rebuild their balance sheets, they all needed to sell assets to raise money.  The result: the world’s largest owners of risk assets were all desperate sellers at the same time.  Suddenly, all those assets, no matter how different their underlying economics, were in the same boat: they had to be sold so that companies could meet their net capital requirements and stave off bankruptcy.

And, of course, this caused those assets to have something else in common: they were dropping in value so fast that the average investor was scared out of his wits.  Instead of a run on the banks, as we saw in the 1930s, there was a run on the markets, fueled by the same kind of panic: will I be able to get my money out before it disappears?

This explains how the normal historical correlations failed to protect even the best-diversified portfolios.  The discussion then turned to: is there anything we can do about this going forward?  The solutions under discussion ranged from buying expensive hedges (which, of course, become dramatically more expensive during a panic), to selling into the teeth of the storm (and locking in significant losses), and, in general, the answers weren’t very satisfying.  The consensus was twofold: first, these kinds of panics don’t happen very often.  Interestingly, the mathematics of modern portfolio theory suggest that a 2008-like downturn should happen every 65-80 years, and that happens to be just about how long it was between the Great Depression and the Great Recession.

Second: these panics seem, in retrospect, to be great times to buy risk-based securities.  When others are selling in a panic, you can almost name your price, and to the extent that you don’t believe that civilization is coming to an end, you trust that sooner or later the stocks you bought cheaply will, when the panic subsides, rediscover their true value.  The trouble, as one advisor put it, is: how are you going to tell your frightened clients, in the height of a storm, that this is a great time to put more money into the market?  Is anybody going to listen to that advice when the largest global investing organizations are trying to unload those same assets at any price they can get?

The bottom line here is that professional investors are finally getting a handle on why well-diversified portfolios didn’t protect against the 2008 downturn.  But the fact remains that the people who can control their panic seem to be the only ones who will be protected the next time there’s a panic run for the exits.  Until we invent a cure for the human tendency to flee with the herd, investment portfolios are likely to go down the next time we experience a serious market downturn.  Let’s hope we’ll have to wait 60-80 years.

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.

Posted in Fee-only, Financial Planning, investing, markets, retirement planning. Tags: , , , , , . Leave a Comment »

Cheap Oil Gets Cheaper

November 23, 2014 — Sam H. Fawaz

Dear Clients, Prospects & Friends:

The economic news that everybody is talking about lately is the sudden unexpected drop in oil prices.  One type of oil, West Texas Intermediate crude, has fallen from over $140 a barrel in the summer of 2008, and $115 a barrel as recently as June, down to $91, and there is no sign that the decline will stop there.

The price drop seems to be the result of a perfect storm of factors, both on the supply and demand side.  On the supply side, U.S. production has risen to the point where only Saudi Arabia extracts more oil from its soil.  In the recent past, America’s additional production was offset by sharp declines in production caused by the civil war in Libya, plus production declines in Iraq, Nigeria and the Sudan.  Those countries are now back in business, adding the production equivalent of 3 million barrels a day, a significant fraction of the 75 million barrels a day of global production.

On the demand side, meanwhile, China’s growth has fallen by half, European economies are weakening, and people everywhere are driving more fuel-efficient cars and living in more energy-efficient homes.

As always, a major shift in global economics is producing some winners and losers.  American consumers are among the most prominent winners, since they consume more oil and gas per capita than the citizens of any other country.  The stiff drop in oil prices this year has resulted in U.S. gasoline prices falling 26¢ to an average of $2.88 per gallon, down from $3.14 a month ago. That’s equivalent to a $40-billion tax cut that will benefit various the transportation sector, energy-dependent manufacturers and, of course, the handful of Americans who drive automobiles.

Lower energy prices are also a boon for countries that import a significant amount of crude, including India, which brings in roughly 85% of its oil, and Japan, which is importing oil again now that its nuclear reactor industry is on hiatus.

Losers?  You can expect the major oil companies to report lower profits in the months ahead, and the Russian economy which is heavily dependent on energy exports and already feeling the impact of an impending recession, is being crushed.  Surprisingly, some believe the biggest loser is Iran, whose social program spending and high costs of extraction imply a break-even well above today’s prices, estimated as high as $130 a barrel.

As mentioned earlier, oil prices could—and probably will—drop further.  But don’t believe the predictions that have popped up in the newspapers and on the financial TV stations of a new era of oil abundance.  Oil prices almost certainly won’t fall to pre-2007 prices, which can be seen on the accompanying chart.

Why?  According to the International Energy Agency, the capital cost of producing a unit of energy—that is, the cost of finding oil and gas, drilling for it (and hiring the people who will do these things, who are some of the best-paid workers in the world), moving it from the well to the refinery and refining it have doubled since 2000, and the rise in these costs increases yearly.  If oil prices drop much further, shale oil producers in North Dakota and Texas will find it unprofitable to keep drilling.

Another floor under prices is the OPEC cartel, which together supplies about 40 percent of the world’s oil.  A Bloomberg report noted that OPEC nations—particularly Saudi Arabia—have been surprisingly relaxed about the supply/demand shifts.  The cartel nations pumped 30.97 million barrels a day in October, exceeding their collective output target of 30 million barrels for a fifth straight month.  However, if oil prices were to dip closer to $80 a barrel, the cartel could well turn down the spigot and change the equation back in favor of higher prices. An OPEC meeting scheduled on Thanksgiving Day should have market moving implications for oil prices.

What should you do about all this?  Enjoy it!  When was the last time you saw prices fall dramatically on an item that you use every day, and that you could hardly function without?  Chances are you’ve been whacked by higher gas prices a few times in your life; this is your chance to enjoy a different dynamic—while it lasts.

Oh…  And don’t spend a lot of time worrying about the big oil companies.  Somehow they’ll manage to muddle through and stay profitable long enough to reap big gains the next time prices jump in the opposite direction.

If you would like to discuss 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.

Sources:
http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/increased-spending-required-to-meet-future-demand/article18953856/
http://oilprice.com/Energy/Gas-Prices/Why-Despite-the-Boom-in-Oil-Production-are-Gasoline-Prices-Still-High.html
http://oilprice.com/Energy/Oil-Prices/Why-Oil-Prices-Are-About-To-Settle.html
http://www.vox.com/2014/10/7/6934819/oil-prices-falling-russia-OPEC-shale-boom-gasoline-prices

Posted in energy stocks, Financial Planning, investing, markets, retirement planning. Tags: , , , , , , . Leave a Comment »
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