Tara Unverzagt July 18, 2016 No Comments

Index funds are safe, right?

My last article showed how you could work towards a carefree retirement like my grandfather had by looking at your spending and saving choices today. Your spending and saving decisions are the number one behavior that affects your financial life. Once you have that under control, you hopefully have money to invest. What do you do now?

What Now?

Let’s look back to what happened before 1980. That’s more realistic going forward than to expect a return of the high flying 1980s. For those who survived the 1980-2010 roller coaster with savings intact, interest rates could go up long term, but “normal” pre-1980 interest rates were just a few percentage higher than current interest rates and the stock market is a bit high, but about where it should be.

Buying low and selling high is still the way to make your money work for you. Unfortunately, the way we’re wired, we love to buy high, when investments are exciting. Then we want to throw in the towel when prices are low. This is a formula for failure.

Stocks are often the investment to emphasize but sometimes more in bonds are called for. Sometimes cash is king, when interest rates are super low and the stock market is valued high (sound familiar?) Most people think this ratio depends on your age, but that’s not the only parameter to look at when deciding your “asset allocation,” or how much you invest in bonds vs stocks vs cash vs any other investment choice.

A huge portion of money today is being invested in basic, low fee investments, like index funds and ETFs (Exchange-Traded Funds). You won’t “beat the market” but you’ll do as well as the market, right? Maybe, maybe not. Not all index funds and ETFs are created equally. You still need to do your homework on the fees and what they invest in. And know that when you buy an index fund to “match the market”, you’re choosing to buy the big losers as well as the high flyers.

Sears was in the Dow until 1999 when it went from a high of over $60 in 1998 and tanked to below $40 in in 1999. If you were invested in the “index” you would have held Sears to the bottom before being rid of it. Individual stock holders could sell long before it hit bottom. Sears wasn’t removed from the S&P 500 until 2012 when its value was below the required threshold to be in the S&P 500.

The index funds have helped investors that buy individual stocks because the index funds have distorted the price of some stocks and created market inefficiencies. When a bunch of money goes into an index fund raising a particular stock price higher than it should be, it’s a great time for someone who owns that stock to sell and take a profit. The person with the index fund will just hold on to it while the price peaks and then sinks. On the other hand, if a stock is undervalued, the index doesn’t take advantage of the bargain and buy more shares. And, as in the case of Sears, the index may hold on to a tanking stock that should be sold.

In addition, asset allocation at any given point has been shown to be far more important to wealth accumulation than what particular stock or bond you buy. If you always keep the same asset allocation, you will sometimes be over invested in stocks and under invested in bonds (see below for a time when investing heavily in bonds made sense) or vice versa. While no one has a crystal ball telling them the highs and lows of a market, there are usually pretty good signs that an asset class is in the range of the bottom or the range of the top. Right now both stocks and bonds, overall, are overvalued. What will you do?

The answer to that question is not simple or straightforward. It depends on your individual situation. The internet will give you great generic advice, but I’ve never met a generic person. Talking to a professional can help you sort through your priorities and risk tolerances. For example, someone that has a million dollar income will deal with risk tolerances differently than someone who is living pay check to pay check. If you are planning for just retirement, you will plan differently than if you have to pay for your kids’ college before retirement.

What Happened?

Investing was far easier for my grandfather then for you or me. Interest rates were pretty steady, between 2% and 5% most of his life. In retirement, interest rates went soaring to a peak of 15% in 1980, the highest interest rates of all time. Having reliable, steady, high interest rates in retirement is so sweet!

The stock market was a roller coaster during his lifetime, as it has always been and always will be. The Dow Jones Index went from around 1350 to as high as 7000 before returning to below 3000 before he died in the early 1980s. If you were invested in stocks back then, utilities were where you found the best growth. The Dow Jones Utility Index went from just over 10 in the early 1940s to as high as 160 by the 1980s, or about a 7% annual return.

Life changed in the 1970s when I was a kid and my parents were saving for the future. Interest rates went crazy, as did inflation. From the “bumping along” 2%-5% rates, interest rates shot up in the late 1970s to early 1980s. This turned all investing heavy into bonds and the stock market was flat 1965 to 1972. Life was uncertain and scary for most of us. Buying a house with a mortgage interest rate as high as 20% was daunting to many, prohibitive to most. Grandpa’s generation was happily retired invested in bonds at those high rates with a steady retirement income as a result.

Investing has always been complicated, but probably more so today than ever before. We think 1980-2010 was “normal”, but it’s no longer relevant. Our journey through our working and retirement life is nothing like Grandpa’s journey. So while he taught me a lot, I have to figure out this one myself.

The information given here is general in nature. If you would like to know how it pertains to your particular situation click “contact” above. If you found this or any of the other articles interesting, please subscribe at the bottom of this page.

photo by https://www.flickr.com/photos/ecotravols/

 

Tara Unverzagt June 30, 2016 No Comments

Transparency

Transparency is all the rage these days. People want complete information, no secrets held back. This is true in the finance industry as much as anywhere. The SEC is requiring the finance industry to be more transparent, such as recent changes to advisors who help manage your retirement plans. In the past, it wasn’t unusual for advisors/brokers to find creative ways to get paid without you knowing. ETFs are thought of as low cost, but know that some have fees higher than some mutual funds.

Originally there were upfront fees on mutual funds. Once people started saying “Hey, how come I’m paying so much just to give you money?” The front end fees started going down.

Then the “maintenance” fees paid every year were used to pay the money managers. You can now find out where the manager of your retirement account, mutual funds, or ETFs are getting paid. Beware “free” investments. Know that the advisor is getting paid somehow. No one, especially in the finance business, works for free. Often the more “free” someone is, the more they are actually getting paid, somewhere.

Do your homework. Ask your advisor all the ways they get paid: fees, commissions, incentives, bonuses, etc. If you’re investing in a mutual fund or ETF, read the material they provide. Everything now has to be disclosed, but it’s up to you to read it.

If you’d like help reviewing your investments, knowing what to ask or what to look for in a fund’s material, contact me at tara@southbayfinancialpartners.com

 

photo by https://www.flickr.com/photos/fdecomite/

Tara Unverzagt June 22, 2016 No Comments

What About RoboAdvisors?

RoboAdvisors have become popular recently. They provide a way for you to input what your goals are and the RoboAdvisor will come up with a plan just for you (and a million other people just like you). They are popular because they’re pretty easy to get started and their fees are very cheap, far cheaper than personal advisor. And they do a good job for what they do. I had a conversation with my hair stylist yesterday about why you might want a “person” to be your advisor.

In the middle of the conversation, another stylist came over to get advice on what color to use on her client. She said her client wanted highlights, but thought her ends (her last highlight color) were too light, she wanted darker highlights this time. The stylist was confused because the ends were the color that she would have picked for the client also.

My stylist said that perhaps the ends were the right color, but there was too much of that color. He pointed out that sometimes when clients say a color is too light, it’s really just that they want less of that color, not a darker color. My stylist pointed out a way to help the client get more information so she could make the right decision. The other stylist walked away to review the choices with her client.

After the other stylist left, I said “And THAT is why a RoboAdvisor isn’t the best solution for everyone. Sometimes, a client misunderstands what the issues are. A robot can’t have that discussion with you.”

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Tara Unverzagt March 22, 2016 No Comments

Why Are Interest Rates So Low?

Bond prices go up when interest goes down. If you read the Wall Street Journal, they mention this fact a lot, especially these days, but what does it mean? It takes just a moment to understand this, but longer to have it become ingrained.

Let’s start with an example:

If a bond has 3% interest (that is, you receive $3 for every $100 you invest in that bond every year), the bond starts out costing $1 for every $1 of bond. Therefore, a $10,000 bond would cost $10,000 and you receive $300 every year for holding the bond.

If interest rates went up to 3.5%, who would pay $10,000 for a 3% bond when you could invest $10,000 in a 3.5% bond now? You might be willing to buy that 3% bond for less. How much less? It would have to be enough less so that you get 3.5% for your investment.

The math requires algebra. Remember that class that you probably hated and wondered “when will I EVER use this?!” Well, here’s your opportunity. The math comes down to: if you can pay $1 for a bond with a 3.5% coupon, you would need to pay 3%/3.5% or .85 (i.e. 85 cents) to have a bond with a 3% coupon to be equivalent to a 3.5% payout.

What happened in the US from 2008 until recently? Interest rates came down so prices went up.

What’s happening now? The Federal Reserve has been trying to raise rates, but the demand for US bonds has also gone up. And the old rule “when demand goes up, prices go up” trumps the interest rule “when interest rates go up, price comes down.” The demand forces the price up which actually causes the interest rate to go down, despite the Fed’s desires.

We are living in interesting times.

 

Check out other articles on bonds and interest rates

 

Tara Unverzagt February 21, 2016 No Comments

The Bond Case

I recently had a conversation about buying individual bonds versus a bond mutual fund. I’m always amazed that investment advisors believe that buying individual bonds is a bad idea. The most cited reason for not holding individual bonds is that you get a terrible price compared to the “Big Boys” at a mutual fund. But the difference in price is less than the 1% that the Big Boys are charging you annually to manage your bond fund (and some funds have much higher annual management fees).

Another argument is that the Big Boys get a much better price when selling. I argue that the Big Boys are probably selling far too often. I’m a big believer in buy and hold, especially with bonds. Get a bond ladder in place and hold the bonds until maturity. You don’t have a selling commission and you get full face value for the bond. Why sell and potentially lose money?

Some say that “you never know when you’re going to need the money NOW!” My first response to that is, “If you have a plan in place with a proper Emergency and Set Aside Fund, you won’t need to liquidate your bonds NOW.” And my second response is, “Does that mean you’re not going to invest in stocks? Because being forced to sell at a bad price is far more likely with equities than bonds.”

I’ve also heard it said that you can’t diversify and will have larger holdings in each bond. This argument implies that if a company defaults on a bond you own, you’ll be out a lot of money. I only recommend buying investment grade bonds which are highly unlikely to default. That’s not to say that investment grade bonds never default, investing your money always carries risk, but an investment grade bond defaulting is not as likely as stock prices falling.

Some will argue that your principal in the bond isn’t protected against inflation. Is any investment “protected” against inflation? Inflation exists and we are always trying to beat inflation. The cash you put in any investment is going to devalue at the same rate, you aim to have the return (growth and income) outpace that devaluation. Money used to buy bonds in a bond fund will be affected by inflation the same as money used to buy an individual bond.

Another concern with bond funds is that it’s not always obvious what you are buying. The Big Boys might appear to “beat the market”, but this is achieved by taking on increased risk with lower grade bonds (which have high yields due to high risk) or by using derivatives (futures and options) that can definitely raise yields in good times, but can also go very badly in bad times.

It seems to me that the Big Boys have done a wonderful job marketing and selling to the masses that you can only invest in bonds if you go through them. I argue, individuals can do just as well or better at a given risk level by investing in individual bonds.

All information provided is general in nature and not meant to be advice for you in particular. I can’t predict the future, the discussion above is my best guess given the current data that’s available to me. If you’d like to know more about how this topic relates to your situation or are looking for a financial planner, contact me.