Quarterly Investor Review and Insights

Posted on October 20, 2011 | Leave a comment

It sure would be pleasant to start writing uplifting market reviews.  Alas, the 3rd quarter of 2011 maintained its headline driven downhill momentum.   The attached newsletter includes quarterly returns of major indices, a brief look at the European Union’s rapid-response challenge, an article that describes correlation, and a possible explanation for the origination of the terms Bull and Bear.  To read click on Q3 2011 Newsletter

Thanks for stopping by.  Your comments and questions are always welcome.

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Passive Investing: The Choice of More Investors

Posted on November 5, 2009 | Leave a comment

Passive generally refers to investing in index mutual funds or exchange traded funds rather than active managed mutual funds.  The rivalry between the approaches has raged for years, but evidence is mounting for passive funds.  And investors are listening.

In 1999, $12 billion of exchange traded funds (ETFs) were issued.  Net issuance of ETF shares rose to $177 billion in 2008.  From year end 1998 through 2008 ETFs issued $661 billion in new shares.   The rise in demand came from both institutional and individual investors, according to the Investment Company Fact Book. (www.ici.org) 

Why the passive approach?

Passive investment vehicles include index mutual funds and exchange traded funds (ETFs).  Both track the performance of a basket of securities included in an index.

For instance, the Russell 3000 Index measures the performance of the broad U.S. equity market.  The Ishares Russell 3000 Fund (IWV) is an exchange traded fund that holds a representative sampling of the securities in the Russell 3000 index.  The sample has an investment profile similar to the index, and may or may not include all of the securities that are included in the index.

As of 10/31/2009 the Russell 3000 index included 2,968 securities.  The Russell 3000 Fund (IWV) held 2,964 of the securities included in the Russell 3000 index. (source:Morningstar)

An index does not invest in the securities, it simply tracks their performance.  Therefore there are no fees included in the index returns. 

Funds, however, invest in the securities and the performance is reduced by transaction costs and other ongoing costs, such as management fees and other fund expenses. The net annual expenses, ongoing costs, for the Russell 3000 Fund are .20% (1/5 of 1%), according to the 2009 annual report.

A fundamental reason investors choose a passive approach is because they are aware that the majority of actively managed mutual funds are not able to out perform their benchmark index over an extended period of time.  The high expenses associated with active management such as transaction and ongoing costs,  reduces the fund’s performance by an average of about 1.5% per year, according to http://www.icifactbook.org/fb_sec5.html

That means if the index posts an 8% return, the average active managed fund would have to achieve a 9.5% return in order to net 8% after costs. If the fund’s returns are less than 9.5%,  it under performs the index. 

Relatively efficient pricing of stocks and bonds along with costs associated with active management makes beating the index a daunting task.  According to a Standard and Poors study, Indices Versus Active Funds Scorecard, Year End 2008, less than 50% of active managers beat their indices over a 5-year period.

An analysis of two – five-year periods of performance; 2004 to 2008 and 1999 to 2003 revealed the following for…

…Large-Cap Active Managed Funds: 72% under performed their S&P 500 index in 2003 to 2008 period, 53 % under performed in 1999 to 2003. 

…Mid-Cap Active Managed Funds: 79% under performed the S&P MidCap 400 benchmark in 2004 to 2008 period, and 91% under performed in 1999 to 2003.

…Small-Cap Active Managed Funds: 86% under performed the S&P SmallCap 600 benchmark in the 2004 to 2008 period, 69% under performed in 1999 to 2003.

According to the study, one consistent investment myth has been that active managers have an advantage in bear markets due to the ability to move quickly into cash or defensive securities.  The study analyzed the performance of active managers during the past two bear markets, 2008 and 2000-2002.   The report illustrated over 50% of the active Large-Cap funds under performed their benchmark, over 70% of the Mid-Cap and Small-Cap funds under performed their respective indices. 

The under performance of active managed international equities and bond funds were similar to U.S.  stock funds. 

To view this study you may have to copy and paste this url  http://www2.standardandpoors.com/spf/pdf/index/SPIVA_Rerpot_Year-End_2008 

In conclusion

Exchange Traded Funds and Index Funds offer low cost ownership of both stocks and bonds.  The high cost of active management is one stumbling block that is difficult to overcome for most active managed funds.  Even in bear markets, the majority of active managers fail to beat their benchmark index.

Golden Hills Financial Group is an independent investment advisory firm utilizing exchange traded funds and index funds in portfolio construction.

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Posted in asset allocation, fees, investment fees, investments

How to Hang Tough in a Tough Market

Posted on October 9, 2008 | 4 Comments

These are tough times to be an investor. The stock market’s long-term return of 11-13% fades in relevance as the value of your portfolio declines. Investors begin to doubt their decision to invest in this wild, volatile, crazy, anxiety-creating market. I’m not writing this article to say you shouldn’t feel that way. I’m writing to suggest you grasp the lessons an ugly market teaches us, and evaluate whether you have the correct plan for your portfolio.

Striking the Right Balance

The most important decision an investor makes is the allocation of their money between stocks, bonds, and cash. Some research has shown that 90% of your long-term return comes from this asset allocation decision. Many, maybe most, people jump right into buying stocks and mutual funds before they have crafted their stock/bond/cash strategy. They end up with too much in the stock market, making them susceptible to larger losses than they can tolerate.

The stock market over the long term has provided higher returns than bonds because investors demand a premium for accepting the higher risk in stocks.  Why do stocks pose more risk to investors? The brief answer is when you buy shares of a company, you become part-owner in the firm. There are no guarantees of dividends or that you will ever get your money back. If you buy a bond issued by the government or a corporation, you become a creditor. You have lent them money. They in turn will pay you interest over the life of the bond. Upon maturity you get your principal back. Regular payments and your money back. Not much risk in that. Oh, if a company you lent money to goes broke, you get paid before stockholders get a dime. Common stockholders get paid if there’s any money left after bond holders and preferred stock holders are satisfied.  It’s not unusual in bankruptcy cases for common stockholders to receive $0.   

Points to consider.

There are three major considerations when deciding on how much to invest in stocks. How comfortable you are with market ups and downs, called risk tolerance, how long your money needs to last, called time horizon, and the size of your financial base relative to your financial needs.

Risk tolerance. Investors familiar with the stock market have a better idea of how they’ll react if the market drops. If you have been in the market the past few weeks, you may have decided you want less risk than you have. This market is putting every investor through a risk tolerance test. But if you aren’t sure how much risk you will be comfortable with, you can take a smaller bite of the stock market than would be recommended based on your time horizon. You can always add to that position as you learn through experience.

Time horizon. Too often individuals consider the years up to retirement as their time horizon. Not so. You could be in retirement for 15-30 years. Let’s say you are 45 years old with plans to retire at age 65. You are healthy and expect to live to be 90. Your time horizon is 45 years. The goal is to accumulate enough funds by retirement, the pre-retirement years, that will last throughout retirement, the retirement years. Generally, it is recommended that about five years before retirement the investment in stocks is reduced and bonds and cash are increased. But your money needs to last a long time, and it’s the stock portion of the portfolio that provides growth.

Financial base. The larger the difference between your portfolio size now and where you want it to be at retirement, the larger the allocation to stocks. Stocks are the growth engine of a portfolio. Bonds and cash protect the downside risk and provide income.

Let’s say Madeline wants to have $750,000 in her 401k when she retires in 20 years. She has $50,000 today with plans to add $6,000 per year. To achieve her goal, Madeline needs to earn 11% annually. Stock market returns over the long term have averaged 12%. Therefore, Madeline would need to have a 90 – 100% allocation to stocks to achieve a 11% return.

If Madeline had $100,000 in her 401k, instead of $50,000, she could reduce her allocation to stocks because she only needs an 8% annual return to achieve her goal of $750,000.

Sample Portfolios

Here are some examples of portfolio allocations during different stages of life according to Richard A. Ferri, author of the book All About Asset Allocation.

Mid-life Allocation Range

  Aggressive Moderate Conservative
Equity + REIT  70% 55% 40%
Fixed Income 30% 45% 60%
Cash    0% 0% 0%

 Pre-retiree and Active Retiree Allocation Range

  Aggressive Moderate Conservative
Equity + REIT  60% 50% 35%
Fixed Income 38% 48% 63%
Cash    2% 2% 2%

REIT = Real Estate Investment Trust
Fixed Income = Bonds

Each investor has an allocation that is unique to his or her situation.  The above examples may or may not be appropriate for you. 

A risk of NOT investing a portion of your portfolio in the stock market is that you will outlive your money.

A risk of investing TOO MUCH in the stock market is you will not have time to recover large losses. In addition, fear may cause you to sell in a panic when stocks are at their lowest prices.

Now is the time for rational decisions. “This time is different” is the phrase that pops up each time the stock market takes a precipitous fall. It may or may not be true this time. What we do know is what has occurred in the past. History demonstrates that markets recover and eventually move up.

An exodus to cash will leave you with the daunting decision of when to re-enter the market.  Investors who run to the side-lines often wait too long to buy back in, missing some of the best days’ in the stock market. This is one of the reasons the average investor significantly underperforms the S&P 500. The other reason is that investors chase performance, buying last years’ winners. For most people the best action is no action for now.  You may want to consider making adjustments to your portfolio later, after the market had recovered.

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Posted in asset allocation, investments, life changing events, retirement, risk tolerance

Three Reasons to Include Bonds In Your Retirement Portfolio

Posted on June 30, 2008 | Leave a comment

1) Bonds reduce portfolio risk by reducing volatility.

Creating a portfolio is like putting the pieces of a puzzle together.  Portfolios are built by assembling pieces of stocks, bonds, and cash, with possible additions of real estate, commodities, & alternative investments.  Modern portfolio theory taught us that by combining securities that don’t follow each other, when one leans left the other right, we are likely to achieve a more stable return.  Bonds tend not to move in tandem with stocks.  In finance terms, they have a low correlation to stocks.  So if stocks drop 15%, bonds may decline but less than 15% or they may even rise.  Bonds are the pieces that reduce short-term, gut wrenching swings in the portfolio’s value. 

A recent example.  From October, 2007 to March, 2008, the S&P 500 had lost around 16%.  The Lehman Aggregate Bond Fund, used to represent the broad U.S. bond market, was up about 4%. A portfolio split 50/50 between the S&P 500 & the Lehman Bond Fund, would have returned -6%.  

2) Bonds protect the downside.

While similar to #1, protecting the portfolio’s value is of special importance to retirees who are withdrawing funds regularly to supplement their income.  When cash is withdrawn from a 100% stock portfolio during down markets, the distribution takes a larger piece of the portfolio than if the markets were up, and that piece is gone so it can’t come back when the markets climb.  

For simplicity let’s consider a portfolio made up 2,000 shares of an exchange traded fund, IWV, that represents the U.S. stock market.  The price per share has plummeted to $78.  Each month the retiree withdraws $1,000 for living expenses.  13 shares are sold at $78 to provide this month’s withdrawal.  Next month IWV has risen to $95 per share.  Only 11 shares have to be liquidated in order to withdraw $1,000.  The two additional shares that had to be sold at $78 are no longer in the portfolio and able to come back with the market.

In a declining stock market, cash and bonds can provide the income needed.  When the stock market comes back, (yes it will rise again) the stock portfolio will not have been depleted so will take full advantage of the rising prices.

3) Bonds provide income.

Bonds pay interest, which makes up most of their return.  The other portion of the return comes from the change in the price.  Individual bonds typically make interest payments every 6 months.  Bond funds generally distribute interest monthly.  The interest payments provide stability to a portfolio, and dependable cash distributions to investors.  When the markets are performing poorly, during a bear market, interest payments are a stable source of income.

If you rely on distributions from your investments to supplement income.  If you do not have other income streams to use when the stock market is declining.  If your financial position is such that you are concerned you may outlive your money.  Then investing a portion of your portfolio in bonds is wise.

The portion you allocate to bonds could vary from 15% for the aggressive investor with a time horizon over 20 years, to 85% for an investor more concerned with preserving their portfolio and has a life expectancy less than 5 years.

 

 

 

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3 Tips to Keep From Running Out of Money In Retirement.

Posted on June 6, 2008 | Leave a comment

Your vision is of a white sand beach, you’re in a lounge chair sipping an exotic drink, watching the waves slowly roll in as swimmers frolic in the aqua clear waters. Then you wake up.  You immediately remember you fell asleep struggling with feelings of euphoria and panic as you begin the next phase of your life called RETIREMENT. 

We all want to enjoy our retirement years with as much vigor and as little stress as we can muster. While I can’t help much with the vigor, a few financial tips on how to live in retirement may help to reduce the stress.

Tip #1: Invest wisely.   Allocate your investment portfolio across stocks, bonds, cash in proportions that reflect both your tolerance for risk and your financial position. For instance, you may have a very low tolerance for taking risk with your money. Based on that alone, you might be comfortable with a very small or no portion of your retirement money in the stock market. Now review your financial position. Based on your current spending habits, you plan to spend, or are currently spending, 8% of your portfolio annually. That mean in order to maintain the principle balance your portfolio needs to earn 8% + some inflation factor of let’s say 3% per year, or 11% annual rate of return. That won’t happen invested in cash and bonds.  Over the long term cash has returned about 3%, bonds 5%, and stocks 10%. In the short term, returns vary dramatically from year-to-year, putting stress on you and your finances during retirement. So what do you do? You might start by reducing your spending habits. But that’s not my point in Tip #1. Find the right balance in allocating your money between stocks, bonds, and cash so the volatility in your stock investments will be offset by the more conservative and stable investments in bonds and cash. Stocks add a long-term growth element to the portfolio which is needed to increase the probability your money will live has long as you do. The following are some sample retiree portfolio allocations to consider:

Preservation Portfolio: This is probably best for retirees who stay awake at night worrying about losing money. It’s more appropriate for people with a shorter time horizons–say less than 10 years. By “time horizon” I mean life expectancy.
15% Stock
60% Bond
25% Cash

Conservative Portfolio: If you expect to live at least 10 years and you don’t like taking a lot of risk.
30% Stock
55% Bond
15% Cash

Moderate Portfolio: Retirees who expect to live more than 10 years and have an appetite for some risk, may want to consider a larger allocation to stocks.

60% Stock
35% Bond
5% Cash

Aggressive Portfolio: Do you expect to live 20 years or more? Is your spending flexible enough that you could reduce expenses during down markets? Do you have another source of income, such as a pension, that you can rely upon if the markets are negative for two or more years? If so, you may be a candidate for the Aggressive Portfolio.
75% Stock
20% Bond
5% Cash

Even the most aggressive portfolio does not have 100% stock. Some retirees may have a level of wealth that no matter how they invest they will never run out of money, think Bill Gates. Most retirees should not be risking their entire nest egg in the stock market. You will also notice that the portfolio with the least risk includes some stock. That is to maintain some potential for growth. There is uncertainty in knowing how long we will live. Even a preservation portfolio may need to last longer than we initially thought. You want living longer to be considered a good thing.

Tip #2: Minimize your fixed costs.
Flexible spending during your retirement years will put you in control. If you have the control to reduce expenses and draw less from your portfolio when the stock market is doing poorly, then your dollars will last longer. Wait until the markets have plumped up your funds with good returns before buying those cruise tickets. For many, the mortgage is their largest monthly fixed cost. Focus on paying it off.  Or downsize to a smaller, less expensive house.  If there’s equity left over, invest it.  Pay off your credit card debt.   

Tip #3: Don’t retire….. recreate your life.
For many retirees working after retirement will not be a choice.  It will be necessary.  Living in retirement for maybe 20-40 years is a very long time.   If there’s a pretty good possibility you may outlive your finances, take a year or so to live the retirees dream, then create your next life phase.  This could be your opportunity to do something you are good at but couldn’t make enough money from it to support yourself and your family.  Now the financial need isn’t as great, so go for it.  Take Dick and Nancy.  Dick taught painting before he retired and Nancy worked in art museums.  In their 70s now, they live 6 months in Italy where Dick paints the landscape and sells his art work to tourists.  Nancy authors books on artists and writes travel guides of Italy that include Dick’s art work.  How about Steve, a man who can fix anything.  He has fun socializing a few hours each week at a hardware store where he helps make home and landscape projects less daunting for those with lesser experience.  The extra cash, social enjoyment, and mental activity keep him young so he can continue to enjoy four days a week at a lake home with family and friends.

Recreate a life that makes you happy! 

 

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Posted in investments, life changing events, retirement

Markets Come Back in April: How Did You Do?

Posted on May 7, 2008 | Leave a comment

The April comeback after a 1st quarter retreat brought some relief to investors.  Let’s take a look at index returns in the month of April and where the returns are year-to-date as of April 30, 2008.  Remember, Index returns are for illustrative purposes only. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. We rely on index returns as a benchmark to compare our portfolio’s returns. However, even if you bought each security in the index, reinvested all the dividends, and held them the exact length of time as the index return period, you would not be able to achieve those returns because you have to pay transaction costs each time you buy and sell a security.  The index reflects only the dividends and price changes of the securities it holds.

                                                              April 2008                YTD 4/30/2008

U.S. large stocks                                       5.1%                             -4.9% 

U.S. small & mid-sized stocks                 4.2%                              -6.1%

Foreign developed country stocks           5.4%                              -4.0%

Foreign emerging country stocks             8.1%                             -3.8%

U.S. broad bonds                                      -.2%                               2.0%

U.S. municipal bonds                                1.5%                                .3%

We’ll look at the broad equity (stock) and fixed income (bond) markets. 

The U.S. Stock Market:  The Russell 3000 Index represents approximately 99% of the U.S. stock market.  The largest 1,000 stocks make up the Russell 1000 Index.  The next 2,000 stocks make up the Russell 2000 Index.

The Russell 1000 Index, large U.S. companies, achieved a positive total return (dividends plus price change) of 5.1% in April.  That wasn’t enough to erase the losses in the 1st quarter.  Year-to-date April 30 returns still posted a negative 4.9%.     

The Russell 2000 Index, small & mid-sized U.S. companies, posted a return of 4.2% in April with a negative 6.1% return year-to-date.

Foreign stock markets did better than their U.S. counterparts.  The MSCI EAFE Index, representing developed countries, returned 5.4% in April with a negative YTD return of 4.0%.  Countries characterized as emerging economies posted 8.1% return in April but still lost 3.8% YTD.

If you had an allocation to bonds in your portfolio they helped buffer the losses experienced in the U.S. and Foreign stock markets in the 1st quarter.  

Bonds

The Lehman Aggregate Bond Index represents the U.S. investment grade bond market.  It includes U.S. government bonds, corporate bonds, mortgage pass-through securities, and asset-backed securities.  Returns for April were -.2%, achieving a 1.95% return YTD. 

For investors in a higher tax bracket who may have municipal bonds in their portfolio the S&P National Municipal Bond Index posted April returns of 1.5% and YTD returns of .3%. 

2008 has been a challenge to investors.  For those with an allocation between stocks, bonds, and cash that is suited to their risk tolerance and goals, it has been less stressful.  If you have found yourself waking up during the night with your heart palpitating wishing it was morning so you could see how the markets are doing, I suggest you revisit your asset allocation because you could be too heavily invested in stocks. 

If you want me to talk about how to determine an asset allocation that is right for you in a future blog, let me know.  Or, if there is another topic of interest, send a comment to me.

Good investing!

 

 

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Selling Your Business – Getting the Best Price for Your Largest Investment

Posted on April 22, 2008 | 2 Comments

When should you think about selling your business?  The best answer is, when you become the owner.  At the earliest stage, consider an exit strategy.  Selling is one way to exit your business.  Other exit strategies can be to take the business public in an initial public offering (IPO) or pass it on to family members with a succession plan. 

If you plan to sell your business, then understanding what creates value will help you focus on value-creating aspects of the company.   Buyers look at the history of a business as support for today’s value.  Wouldn’t you rather buy a business with revenue and profits trending upward?  That means timing of the sale will be important to you.  If your interest is waning, the industry is stagnating, competitors are multiplying, your health is declining, you may find sooner rather than later will bring in the best offer.  Managing the business with an eye to its sale, will allow you to pick the best time to sell.   

An experienced, serious buyer will spend considerable time on due-diligence.  That is the process of scrutinizing your markets & marketing strategy, financial operations, property & equipment, and business operations & personnel.  Your preparation will reduce a buyer’s concerns and increase their willingness to make an offer. 

Manage the following aspects for creating value.

Maintain excellent records.  Lowering the buyer’s risk will increase what they are willing to pay.  Help the buyer feel confident that what they see is what they’ll get.  Keep good documentation for inventory control, payroll, financial statements and other key business processes. 

Buyer’s thinking:  A buyer has to continue to run the business when you are gone.  Having up-to-date written processes means the transition will go smooth even if some employees leave after the sale. 

Have a clean balance sheet.  Write-off or negotiate payment of old accounts receivable items.   Take care of the accounts payable items that have been on the books because of disagreements.  Focus on paying down debt, cleaning up the inventory, and minimizing liabilities. 

Buyer’s thinking:  Old receivables show an unwillingness for customers to pay.  A buyer will think there are unsatisfied customers.  Then the question is raised as to the quality of the product and service, the level of customer service provided,  and the overall customer experience and attitude. 

Focus on profit.  The concept is simple… increase revenue, reduce expenses, increase profits.  At least it’s simply stated.  To get the highest dollar for your business will require you to manage the income statement.   Are there opportunities to increase sales that have been overlooked or put on hold because you’ve concentrated on serving the current customers?   Have you reviewed contracts on real estate, property insurance, employee benefits, and so on to see if you can get the same or better service for a lower price.  Does the company lease vehicles?  Can you cut your lease expense?  If your income statement reflects accelerated depreciation, which is used to reduce profits and lower the tax liability, a different method for income statement purposes may reduce this expense, increasing the bottom line.  These are some general ideas for you to consider.  

Buyer’s thinking:  A  trend of increasing revenue and profitability shows that current management and processes are performing well.  The buyer can focus on growth with the expectation the current profits will be maintained after the purchase.   

Be sure the facilities, machinery & equipment are in good general condition.  Curb appeal is important.  Present a clean, organized facility.  Have the furniture & fixtures, vehicles, machinery & equipment in good condition.  

Buyer’s thinking:  If the seller maintains the property and equipment, then there is reason to think other parts of the business are well managed.  The buyer may be using these assets to collateralize the loan to finance the purchase.  The better the condition of the assets the more value the banker will assign to them resulting in a larger loan.

Have the right personnel.  A good management team and employees with the right skills need to be in place. 

Buyer’s thinking:  Adequate personnel keeps business disruption to a minimum during and following the transition.  A buyer can be more confident that sales will be maintained and impact on cash flow will be minimal.

Get a valuation analysis: It’s difficult to value your own business.   The personal attachment after years of hard work and personal sacrifice tend to inflate the value to a seller.  An ouside expert can give you a range of value developed from sound valuation practice and experience.  

Getting the highest price for your business may take 3 to 7 years of preparation.   The payback comes when you get the best price possible for the firm.  And, knowing the business you have worked so hard to create will continue into the future serving your customers and providing jobs for your employees. 

 

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