Is What Warren Buffett And Charlie Munger Thought In 1996 Relevant Today?

I was looking at some past Chairman’s Letters from Berkshire Hathaway (penned by Buffett and Munger) and thought you might enjoy some insightful excerpts from the 1996 letter. What was relevant for intelligent investors eighteen years ago remains so today.

On Investment Fees

   “Seriously, costs matter.  For example, equity mutual funds incur corporate expenses - largely payments to the funds' managers - that average about 100 basis points, a levy likely to cut the returns their investors earn by 10% or more over time.  Charlie and I make no promises about Berkshire's results.  We do promise you, however, that virtually all of the gains Berkshire makes will end up with shareholders.  We are here to make money with you, not off you.”

(They are talking about actively managed mutual funds and the current average expense ratio for actively managed funds is about 1.3 percent or 130 basis points. Also worth noting, only 39 percent of active managers beat their benchmarks in 2012. So for the majority of investors in actively managed funds you not only made less than the average index fund investor you paid more for the privilege.)

On Taxes

   “In 1961, President Kennedy said that we should ask not what our country can do for us, but rather ask what we can do for our country.  Last year we decided to give his suggestion a try - and who says it never hurts to ask?  We were told to mail $860 million in income taxes to the U.S. Treasury.”

     “Here's a little perspective on that figure:  If an equal amount had been paid by only 2,000 other taxpayers, the government would have had a balanced budget in 1996 without needing a dime of taxes - income or Social Security or what have you - from any other American.  Berkshire

Shareholders can truly say, ‘I gave at the office.’”

     “Charlie and I believe that large tax payments by Berkshire are entirely fitting.  The contribution we thus make to society's well-being is at most only proportional to its contribution to ours.  Berkshire prospers in America as it would nowhere else.”

(This is not relevant to this blog post but with more U.S. companies changing domicile to foreign countries to avoid paying U.S. corporate taxes – which are the highest – I found Berkshire’s perspective interesting.)

On Common Stock Investments

    

“Our portfolio shows little change:  We continue to make more money when snoring than when active.”

     “Inactivity strikes us as intelligent behavior.  Neither we nor most business managers would dream of feverishly trading highly-profitable subsidiaries because a small move in the Federal Reserve's discount rate was predicted or because some Wall Street pundit had reversed his views on the market.  Why, then, should we behave differently with our minority positions in wonderful businesses?  The art of investing in public companies successfully is little different from the art of successfully acquiring subsidiaries.  In each case you simply want to acquire, at a

sensible price, a business with excellent economics and able, honest management.  Thereafter, you need only monitor whether these qualities are being preserved.”

“Let me add a few thoughts about your own investments.  Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”

     “Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering.  Intelligent investing is not complex, though that is far from saying that it is easy.  What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected":  You don't have to be an expert on every company, or even many.  You only have to be able to evaluate companies within your circle of competence.  The size of that circle is not very important; knowing its boundaries, however, is vital.”

     “To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets.  You may, in fact, be better off knowing nothing of these.  That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects.  In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices.”

     “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.  Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock.  You must also resist the temptation to stray from your guidelines:  If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes.  Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.”

(To summarize their thoughts on common stock investments: Buy and hold with a long-term time horizon and unless you really know how to value a business and understand market pricing, buy index funds. I might add that using the services of an accredited advisor to help you reach your future goals and manage expectations with regard to financial planning and portfolio construction may be the best idea of all.)

CBlakely, CFP®             06/2014

Source: BERKSHIRE HATHAWAY INC., Chairman's Letter, 1996

Should Individual Investors Buy an I.P.O.?

Twitter has an initial public offering (I.P.O.) for 70 million shares coming in a couple of days and has confidently upped the price range by about 30 percent in the last week. The new price range ($23-$25) will give Twitter around $1.7 billion to finance its growth.

These high profile I.P.O.’s beg the question: Should individual investors buy into an I.P.O.?

According to research from Fidelity Investments, the number of I.P.O.’s so far this year is up 40 percent from the same point last year, and the dollar values of those offerings has increased 10 percent. Sounds like a good deal for investors on the surface, but think back to the last high profile tech I.P.O., Facebook’s I.P.O. was a disastrous stock debut.

Twitter is the type of I.P.O. that creates all kinds of media attention which might entice people to try to buy the stock without doing enough (or any) research. The more of a household name a brand is the higher the probability it will attract a greater number of investors but excitement for a brand and financial success are uncorrelated.

I.P.O.’s don’t just rise in value as they did in the late 1990’s. There are many more flameouts than winners in this market, but most people don’t remember the losers, it’s not wired into our optimistic DNA. (Which is another reason to use a professional advisor, we are like Missourians in that we tend to say, “Show me.”)

For instance, information on the company ahead of an I.P.O. is limited (although there are exceptions). And larger offerings like Twitter’s, often mean more hype, which can cloud an individual investor’s judgment. Remember, as with any investment, it comes down to the fundamentals, current financials and long-term growth prospects. Not to mention, security fit in your overall investment strategy.

Buying with the intent to quickly flip the stock at a profit is a recipe for disaster. Even Wall Street insiders admit they can’t predict the future. A better approach may be to look at what a company does and ask if it is something that will be needed in the future. As always, take the long-view with stock investments. Is the company going to around for the next ten years, if you believe so, maybe the better strategy is to find several stock companies in that industry sector and buy a basket of stocks.

Conversely, not buying the I.P.O. does not mean you should forget about the company. If an investor bought Facebook shares at their low of $18 three months after the I.P.O they have a nice gain currently. Seventeen months after the I.P.O. the stock is trading around $52 a share.

Finally, if it’s something you know about and you have an insider’s perspective on it, an I.P.O.is a way to gamble on that perspective, with maybe better odds due to the depth of your knowledge. Put another way, if you have 20 years in tech and are determined that social media has continued upside for the foreseeable future, buy that I.P.O., but remember, it’s still a bet.

CBlakely CFP®, CTFA      11/2013

Source: New York Times - Business Day, Fidelity Investments

An Interesting Summer Indeed!

I took most of this summer off. Not because I'm too busy to write or not because there was nothing of interest to write about (on the contrary). Nope, it was because I spent most of the summer rehabbing from a very complex surgery.

The condition was described to me as an aortic dissection, which occurs when a tear in the inner wall of the aorta causes blood to flow between the layers of the wall of the aorta. Aortic dissection is a medical emergency and may lead to death rather quickly even with treatment, as a result of decreased blood supply to other organs (brain), cardiac failure, and sometimes, as in my case, rupture of the aorta. My aorta tore right as I was being hooked up to life support. Lucky timing, HooWah!

Why Am I telling you this? Two reasons, first, if you have high blood pressure make sure you treat it. It's easy and inexpensive to treat hypertension. There is a reason it's called the silent killer, cause you normally feel fine right up to when you don't, and by then it may be too late. 

Next, because of technology. Without the current technology available to the Doctors in the operating room, my chance of survival was exactly zero. There was no chance. But today, with mechanical valves, Dacron™ sleeves to replace arteries, new surgical techniques, patient monitoring systems and integrated big data (yep) this second chance becomes reality for me and tens of thousands of other patients every year.

Health care accounts for one in five dollars spent in the United States. It’s 17.9 percent of the gross domestic product, up from 4 percent in 1950. And technology has been the main driver of this spending: new drugs that cost more, new tests that find more diseases to treat, new surgical implants and techniques. Much of the spending has been worth it. While the U.S. spends the most of any country by far, health care is becoming a larger part of nearly every economy. That makes sense. Better medicine is buying longer lives. 

How does this segue into investing? Well, speaking of amazing new medical devices and technology, Vanguard has low cost Health Care ETF - (ticker symbol VHT) with a solid risk reward profile. The return since inception - after taxes on distributions - is 7.08 percent. The fund was started in 2004. The passively managed fund, which has an expense ratio of 14 basis points, tracks the performance of a benchmark index that measures the investment return of stocks in the health care sector, and holds names like Johnson & Johnson and Gilead Sciences - companies involved in providing medical or health care products, services, technology, or equipment.

Now factor in the Boomers whose first wave is already hitting the retirement years and have the money to afford procedures (elective and otherwise) and Medicare that spent $562B in 2012 and that's pretty good built in demand for medical technology and devices in my opinion.

Should everyone allocate assets to a sector fund? No, not all investors should allocate assets to this sector or any other sector for that matter. What I suggest is talking to your advisor to see if your risk profile permits any allocation and how it fits into your overall strategy. There is additional risk involved when investing in a narrow band of the stock spectrum and the potential for additional reward.

CBlakely, CFP®         09/2013

Keep Taxes Low to Maximize Returns - Here's How

Portfolio research has examined the long-term impact of expenses and taxes on investment returns and concluded that, while asset allocation remains the most important factor affecting variability of returns, keeping costs and taxes low is an important factor for investors who are trying to maximize return.

Because mutual funds may distribute capital gains throughout the year, mutual fund investors are often concerned about losing investment returns to taxes. But individual stock and bond investors are vulnerable to taxes as well, depending on how they manage their investments.

Return lost to taxes sucks, but the good news is you can exercise a good deal of control here. Think about this: diversification and asset allocation are great tools for helping to reduce portfolio volatility and variability, but we're still going to be subjected to the short-term moves of the market, no matter how diligent we might be in setting up our portfolio and selecting our investments. Where we have the greatest degree of control is the area of expenses and tax-efficient implementation. Doesn't it make sense that where we can exercise the most control, we should?

Below is a table that displays where investors who want to minimize taxes may want to place their investments.

Taxable accounts	Tax-deferred accounts such as traditional IRAs, 401(k)s and deferred annuities
Here, you'd ideally place...	Here, you'd ideally place...
Individual stocks you plan to hold more than one year	Individual stocks you plan to hold one year or less
Tax-managed stock funds, index funds, exchange-traded funds (ETFs), low-turnover stock funds	Actively managed funds that may generate significant short-term capital gains
Stocks or mutual funds that pay qualified dividends	Taxable bond funds, zero-coupon bonds, inflation-protected bonds or high-yield bond funds
Municipal bonds, I Bonds (savings bonds)	Real estate investment trusts (REITs) Private equity, partnerships (IRA only)

Also to keep fees as low as possible research index funds and index ETF's and use fee only advisors!

CBlakely CFP®, CTFA                      02/2013

Source: Schwab Insights

Gamma - The New Investment Concept!

When it comes to generating retirement income, investors arguably spend the most time and effort on selecting ‘good’ investment funds/managers—the so called alpha decision—as well as the asset allocation, or beta, decision. However, alpha and beta are just two elements of a myriad of important financial planning decisions, many of which can have a far more significant impact on retirement income. Morningstar introduced a new concept called “Gamma” designed to quantify the additional expected retirement income achieved by an individual investor from making more intelligent financial planning decisions. This is a must read for planners and for investors who want to optimize their retirement assets. This is the essence of Intelligent Investing!

Read all about it here!

CBlakely  CFP®, CTFA           01-2012

Wee Three Things

As we are in the middle of the Holiday Season I thought now a fine time to take respite from fun and family and talk about taxes and estate planning, which, in the end is good for your family.

First, with the buzz around the fiscal cliff and the Bush tax cuts that are set to expire in 2013, what is getting overlooked is a tax that will definitely take effect in the 2013: the 3.8% tax on investment income.

Congress passed the 3.8% tax in 2010 to help fund President Obama’s Affordable Care Act and Medicare overhaul, and the new tax is scheduled to go into effect on Jan. 1, 2013.

As a result, you should meet with your advisor before year-end to decide whether to sell any assets before the end of the year. One simple idea is to rebalance your portfolio this December, instead of January, that way any gains would not be subject to the new tax. A good news note, about half of all accounts that hold dividend paying stocks are in tax-advantaged vehicles, so they remain indifferent to this new tax policy.

According to the congressional Health Care Caucus’ information site, the new tax will be imposed on unearned net investment income, including capital gains from stock sales, dividend income, bonds, mutual funds, annuities, loans and home sales. People subject to the tax are individual filers who earn adjustable gross income of more than $200,000 and married couples filing jointly with AGI of more than $250,000.

Next, if you're planning to make a charitable donation, do it before December 31 and you may be able to write it off on your 2012 taxes. A donor-advised fund can give you even more benefits. Remember you can receive an immediate tax deduction for contributions to offset taxable income, also, you can avoid capital gains taxes on the contribution of appreciated assets held for more than one year and it removes contributed assets from your taxable estate.

Finally, I found an interesting exhibit in one of my estate planning books. It compares Chief Justice Warren Burger and Elvis Presley’s wills. Elvis Presley’s will contains many important clauses that are necessary in a well constructed will. Warren Burger’s will is literally three sentences long. Elvis passed on 27 percent of his estate to heirs, while Warren Burger passed on 75 percent of his assets. The length and number of clauses mean very little to estate planning if proper planning is not completed.

Meet with your CFP® advisor or estate planning attorney, if you don’t have one start interviewing candidates.

CBlakely CFP®, CTFA      12/2012

Sources: http://health.burgess.house.gov/ Bloomberg LP, Estate Planning, by Michael Dalton

Stocks are Dead; Long live Stocks!

The S&P 500 is setting multiyear highs right now. It’s the economy right? Not really, the U.S. economy grew 1.7 percent in the second quarter, creating about 140,000 jobs a month on average this year. That is less than half of the monthly hires needed to bring the unemployment rate back to pre-crisis levels by 2015. Well then, it’s due to our government averting the so-called fiscal cliff—the spending cuts and tax hikes that could stall the economy next year. Not so fasr, our government has not addressed that issue yet – hey, they still have 100 days. Europe’s financial crisis is resolved! That’s not it, Europe’s problems, while getting better, remain unresolved.

So how is it that the Standard & Poor’s 500-stock index is up 25 percent over the past 12 months? Stocks have reached levels not seen since Lehman Brothers and Bear Stearns existed.

Over the long term, through all the noise, stock prices actually move relative to corporate earnings. S&P 500 profits estimates (Bloomberg) suggest earnings growth of 11 percent next year, and 12 percent in 2014; this may send the S&P 500 to record levels if earnings come in at or near expected.
Corporate America is lean and mean - think of great comapnies like Apple and Wells Fargo. We are also counting on help from the Federal Reserve, which is widely expected to start a third round of bond purchases to boost the economy.

With that said, the threats to the market remain (actually they never quite go away). Chief among them is the fiscal cliff. Under a law passed last year the failure of lawmakers to agree on some combination of spending cuts and tax increases would result in $1.2 trillion of automatic cuts and accompanying tax hikes in January 2013. That combination could shave 2.9 percent off economic activity in the first half of 2013, according to the Congressional Budget Office. While many economists believe the impact to be good for the economy long-term, in the short-term the market would likely hiccup, frankly creating a chance to buy on the dips.

Europe also remains a potent threat, Greece has yet to ratify the spending cuts necessary to receive life saving bailout funds and there is no guarantee that Spain, which is suffering through an economic depression, will agree to more austerity in exchange for the European Central Bank’s financial aid.

Individual investors could also decide to get with the program. While prudent managers have been suggesting to add equities to portfolios where appropriate, do it yourself investors have pulled money from U.S. equity mutual funds for a fifth straight year in 2011, moving $75 billion out of stocks this year alone. If these dollars come back to stocks it could raise stock prices even further – as individual investors usually buy high.

As always, talk things over with an accreditied investment manager or financial planner to see what proportion of high-quality equities make sense for you.

CBlakely CFP®, CTFA     Sept. 2012

Sources: Bloomberg LP.

The Financial Problem of Living Too Long - Solved!

If you are one of the 10,000 baby boomers retiring today (or in the next several years) then this post may be of some interest to you because for many, traditional asset allocation is inadequate at confronting retirement risk. Let me explain.

Trying to rebuild a retirement portfolio in a low return investment landscape has many challenges. Importantly there are two risks that really have taken center stage, investment-performance risk and longevity risk. Equity market returns have been lousy for about a decade, prompting new phrases into our vernacular such as, “the new normal” and “stocks suck.” Over the last generation life spans have increased to the point that the fastest growing segment of Americans is the over 100 age group – aka the Willard Scott gang. The odds of at least one spouse reaching the age of 86 is 25 percent.

Since the great recession of 2008 income losses for those nearing retirement, specifically households led by people between the ages of 55 and 64 have taken the biggest hit, a decline of 9.7 percent. During retirement, the income flowing from a portfolio made up of stocks and bonds is sensitive to market fluctuations.  This can significantly increase an investor’s longevity risk, or outliving one’s assets.

Creating a portfolio that confronts and diminishes these risks requires adding longevity insurance into the mix. Yep, you guessed it, I’m talking about annuities.  But wait, Ibbotson Associates research shows that investors can mitigate both longevity and investment performance risks with a carefully constructed combination of a guaranteed income stream and traditional assets such as mutual funds and ETF’s.

Annuities can be expensive (guarantees normally cost more) and hard to understand. Determining how and when to use them can be confusing too which is why few investments are as polarizing, but it is wise to set aside preconceived notions in response to this current challenging environment.  Many retirees should consider ways to turn a portion of their portfolio into pension- like income streams.

A fairly recent innovation in deferred variable annuity (VA) products is the guaranteed minimum withdrawal benefit (GMWB) rider. The GMWB rider for life gives you the ability to protect your retirement investments against downside market risk by allowing you the right to withdraw a fixed percentage of the benefit base each year until death. The benefit base can step up and resets to the high-water mark of the contract value on the rider anniversary date when the market has performed well. The remaining contract value at death will be paid to your beneficiaries, which removes concern about giving up liquidity to your heirs (i.e. if I die early, my family loses).

After deciding whether longevity insurance has a place in your retirement portfolio the next challenge is how much to allocate to this product versus traditional assets. The easiest way is for your advisor to follow up the strategic asset-allocation decision with a secondary “product-type” optimization.  Barring that, a recent Ibbotson study using  Monte Carlo simulation based optimization to find an optimal product-type mix of traditional products and a VA+GMWB by maximizing a utility function at the life expectancy  offers helpful guidelines to product allocation. See the major findings (below):

Ø  The higher the risk tolerance, the lower the VA+GMWB allocation;

Ø  The longer the life expectancy (subjective), the higher the VA+GMWB allocation;

Ø  The higher the age, the lower the VA+GMWB allocation;

Ø  The higher the ratio between wealth and income gap, the lower the VA+GMWB allocation; and

Ø  The preference for bequest has almost no impact on the VA+GMWB allocation.

By adding products that offer guaranteed income for life to your portfolio (if appropriate) you can avoid an extreme outcome (i.e. outliving your assets) and better enjoy your retirement. But, as case studies show investors and advisors must be careful when determining which products and allocation percentages.

CBlakely CFP®, CTFA          Auggie 2012

Sources: The New York Times; Allocation to Deferred Variable Annuities with GMWB for Life, Xiong, Idzorek, Chen (Ibbotson); The Impact of Skewness and Fat Tails on the Asset Allocation Decision, Xiong, Idzorek (Financial Analysts Journal, Vol. 67 #2)

Sizing Up The American Dream

Browse more Lifestyle infographics.

  

CBlakely  CFP, CTFA      07/2012

Source: visual.ly

Two Summer Tips to Save Your Life

So you think you want to look at alternative investments for individual investors and invest like many institutions do. Well look no further than DirexionShares mutual funds. This is a fine example of the proliferation of leveraged exchange traded funds (ETF’s) – these funds are supercharged in that they give you two (2X) and three times (3X) the return on an index. Take for example, the fund with the ticker symbol GASX - it's an ETF that is 3X short natural gas stocks. In other words if the index is down 10 percent the fund should be up about 30 percent. Our predilection for doubling up to catch up in this market is being exploited by many funds – but remember, slow and steady wins the race.

The benchmark index for this fund was down just over 22 percent for the last 12 months ended March 31, 2012. Therefore, the GASX fund should be up about 66 percent, which sure helps. But alas, the fund is up 10.6 percent over the same period. Up is good, but what happened to about 56 percentage points of return?

Fund Objective

“The Direxion Daily Natural Gas Related Bear 3X ETF seeks daily investment results, before fees and expenses, of 300% of the inverse (or opposite) of the performance of the ISE Revere Natural Gas Index ^TM. There is no guarantee the fund will meet its stated investment objective.”

The answer is underlined. The fund is not beholden to its own objective. From its inception nearly two years ago, GASX is down 38.5 percent. The benchmark index is up 17 percent for the same period. If you bet against natural gas companies two years ago, you would have been right, but this ETF would have lost you close to 40 percent.

What makes this even more interesting is that its mirror image, GASL, the 3X long natural gas index ETF is down about 57 percent for the year ended March 31, 2012 (only about 10 percent away from where it should be at 3X the index). And it’s down 48 percent for the period since inception about two years ago (where it should be up around 50 percent).

What gives? This is what's known as leveraged ETF slippage. The concept of “tracking error” or “slippage” is now front and center. ProShare Advisors, one of the top structured ETF firms just got hit with a lawsuit. From the Wall Street Journal:

A lawsuit seeking class-action status claims that ProShare Advisors and others violated a securities act by failing to disclose risks inherent in its ProShares UltraShort Real Estate fund, an inverse leveraged exchange-traded fund, including the risk of a "spectacular tracking error."

Now if you want to find alternative ways of losing money in alternative investments, try some of the other Direxion ETFs. Indian equities, long-term treasuries, semiconductors - whatever. Who said that derivatives and leverage was just for the big guys? With these sloppy funds over time you lose either way. And the higher the volatility the more you lose.

It is in fact remarkable that this is a retail product. But no worries, there is proper disclosure.

Fact sheet disclosure: - Investing in the funds may be more volatile than investing in broadly diversified funds. The use of leverage by a fund increases the risk to the fund. The Funds are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, consequences of seeking daily leveraged investment results and intend to actively monitor and manage their investment. The Funds are not designed to track the underlying index over a longer period of time.

Well, duh!

As always, consult an accredited financial advisor before diving in, there are sharks in the water. Also, wait at least one hour after eating before going swimming.

CBlakely CFP ®, CTFA     06/2012

Sources: Sober Look, WSJ, Bloomberg, LP.

The Retirement Savings Drain: Hidden & Excessive Costs of 401(k)s

I normally write something I feel can help most investors. Occasionally you run across something that just needs to be shared. This eye opening new report from the Demos Organization, authored by Robert Hiltonsmith, is compelling. Highlights below, link to the report at the end.

Though your retirement or bank accounts statements contain no evidence of it, everyone who has an IRA, 401k, or any other individual retirement savings account pays a variety of fees every year. But because these fees are taken “off the top” of investment returns or share prices accountholders generally have no idea how much all of this is costing them.
These fees can be substantial: over a lifetime, fees can cost a median-income two-earner family nearly $155,000 and consume nearly one-third of their investment returns. Worse, these fees are often excessive and financial services companies can get away with charging higher-than-necessary fees for a number of reasons, namely: the savers’ lack of information, the inefficiency of financial markets and individualized investing, and the substantial costs—both in money and time—associated with switching between investment brokers.
This brief sheds light on the hidden costs of 401(k)-type individual retirement plans, details the different types of fees paid by the consumers, and uses an example investment from Demos’ own 401(k) plan to illustrate these fees’ heavy burden on the average account-holder. Using industry data on fees, the brief estimates the high costs of 401(k) fees to a model family over a lifetime of saving for retirement. The brief also explains the causes of the nearly universal excessive fees that investment firms charge to savers, and argues for a wholesale reform of this country’s broken private retirement system.

KEY FACTS

LIFETIME FEES

• According to our fee model, a two-earner household, where each partner earns the median income for their gender each year over their working lifetime, will pay an average of $154,794 in 401(k) fees and lost returns.
• A higher-income dual-earner household, one where each partner earns an income greater than three-quarters of Americans each year can expect to pay an even steeper price: (as much as) $277,969.

OTHER FEE FACTS

• The median expense ratio of mutual funds in 401(k) plans was 1.27 percent in 2010.
• Trading costs vary from year to year, but have been estimated to average approximately 1.2 percent a year as well.
• In the long run, the average mutual fund earns a 7 percent return, before fees, matching the average return of the overall stock market. However, the post-fee returns average only 4.5 percent, meaning that, on average, fees eat up over a third of the total returns earned by mutual funds.
• Smaller 401(k) plans have higher average fees than larger ones. The median expense ratio for plans with less than 100 participants was 1.29 percent, while for plans with more than 10,000 participants, it was 0.43 percent.

TYPES OF 401(k) or IRA FEES

• Expense Ratio Fees: This ratio incorporates the administrative, investment management, and marketing fees charged to savers. Because these fees do not vary much from year to year, they are reported as a static expense ratio and listed both in a retirement plan’s summary documents and the individual prospectuses of each mutual fund in the plan.
• Trading Fees: The costs incurred by a mutual fund when buying and selling the securities (bonds, stocks, etc.) that comprise the fund’s underlying assets. Investment managers of mutual funds pay a fee each time they buy or sell one of the securities that comprise the underlying assets of the fund, and they pass these on to savers via the funds’ share prices. Trading fees vary from year to year depending on the frequency with which fund managers buy and sell the funds’ assets.

Download the report here!

As always, talk to your advisor to find out what you can do to minimize the impact of fees on your retirement nest-egg.

CBlakely CFP®, CTFA           05/2012

Emerging Markets Debt – Not as Risky as You Think

Over the next several years the challenges of collecting sufficient income, due to low current interest rates, may be somewhat lessened by taking a more tactical approach to fixed income investing. Current yield is a big component of investing for income investors and there are opportunities available for investors to achieve attractive current and total returns.

The perception for years has been that emerging markets debt as an asset class had been one of high volatility of returns. But look back to the crash of 2008 and remember that emerging markets experienced less of the effect of the crash and moved out of it faster than the U.S. did.

Looking back at 10-year annualized returns for major markets, the average annual total return for emerging markets debt was over 10 percent, while its standard deviation of returns was less than 10 percent. Contrast that with long-term U.S. Treasuries with had comparable returns but with a standard deviation of about 12 percent and Large Cap Domestic Equities with a 10-year average annual return of less than 5 percent  but a standard deviation of over 15 percent.*

Another factor is that valuations for this asset class remain attractive. A typical valuation metric for bonds is to look at the yield of the security compared to the yield of a U.S. Treasury security with a like maturity date – called the spread. The median spread of high-yield debt over the past 30 years has been about 500 basis points (five percent). Currently, that spread is around 600 basis points. If the economy recovers, during good economic times that spread generally narrows to 300-400 basis point range. This is positive for the price of the bonds.

Many emerging economies benefit from a younger demographic and a fast growing middle class. Also, many of these countries live within their means and have reached a point where they are self-funding.

 Talk to an advisor for detailed information and to see whether adding this asset class to your portfolio makes sense. There are real risks associated with emerging debt, this is not a “set it and forget” it strategy.



CBlakely CFP®, CTFA 05/2012





Source: Morningstar data as of 12/31/2011
Standard deviation is a statistical measure of historical volatility, the higher the standard deviation, the greater the volatility.

Finding Income Without Adding Significant Risk

The current priority at the Federal Reserve is to keep rates low to help the broad economy, especially housing and the money center banks, get healthy again. However, this has a deleterious effect over the long-term on savers and income investors. With short-term interest rates near zero and the Fed committed to keeping rates low for the next couple of years what is an income investor to do? Do you throw out your risk tolerance parameters and plow into stocks?


The short answer is no. You can maintain your risk profile while adapting to the current environment by embracing creative solutions in small percentages in your portfolio. Many solutions used in the past are probably not the solutions that will serve you best over the coming decade. Remember a successful portfolio funds an investor’s current and or future needs or liabilities, anything short of this is a failure.

For high net worth individuals the use of charitable trusts can create a satisfactory income stream. Tax breaks for some charitable trusts can help high net worth investors divest highly appreciated assets tax-free. The trust income goes to the investor and eventually the remainder goes to the charity. For the majority of investors this is not a prudent option.

There are several opportunities for investors not interested in trusts. First, mortgage backed securities funds are an option. These funds contain AAA/Aaa rated mortgage securities backed by the guarantee of Fannie Mae, Freddie Mac and Ginnie Mae. There are many low cost funds available that offer access to mortgage backed securities. The yields are in the 4.0 to 4.5 percent range.

Next, income investors might consider adding a small percentage of high dividend equities to the portfolio. One example might be adding a select dividend fund or a utility fund to your portfolio for the current income. Both types of funds offer a current dividend yield of 3.5 to 4.0 percent depending on the fund family and fund makeup.

Finally, the fundamentals within the high-yield bond market are strong. That is reflected in yields which are currently around 6.5 percent and approaching historical lows. The main risk to the health of corporate fundamentals would be a meaningful slowdown in the U.S. economy. Base case is that the economy does not come off the rails. The most probable economic outlook is for a slow-growth environment with reasonably steady interest rates. However, the economy is not robust enough, nor are yields high enough, to protect high-yield investors against certain macroeconomic shocks. Macroeconomic driven events - such as, the European debt situation, China's slowing economy, and geopolitical events in other parts of the world - will cause short-term gyrations in the funds value.


If your portfolio is predominately fixed income, adding a small percentage in each of the three types of income investments to your portfolio may actually decrease the overall risk profile through diversification. Minor adjustments can add value to your portfolio.

As always, to see the impact this strategy would have on your investments and cash flow discuss this with your (accredited) financial advisor.

CBlakely CFP®, CTFA, CMFC     05/2012

Sources: Morningstar, iShares

401(k) Reform?

Defined contribution [DC] plans - 401(k)s, 403(b)s, 457s, much as they have grown to be dominant, have for many, been a failure. Recent statistics indicate 97 percent of Baby Boomers have not saved enough for retirement. Many, though not all people like the illusion of control, and seeing their balances — it makes the DC plan tangible, even if you don’t get what is really needed at retirement. Our cultural obsession with consumerism may keep us well dressed and living in nicely furnished homes, but it is quietly killing our financial future.



Retirement plan reform has to face three realities. First, people don’t know how much to put away for retirement. The general answer is, for almost all people, put away 15 percent of your gross pay. Next, most people don’t know how to invest, so should be handed off to advisors who will do it for you, being very mindful of costs. Finally, given that many people are poor investors or not interested in investing, offering a low cost annuity option at retirement makes sense as an option. Managing a lump sum on your own as you retire is not advisable for many. Annuitization currently is an option only for defined benefit [DB] plans.


Given the above changes and assuming heavy doses of mandatory participant education yield increased savings rates, this likely leads to much better results for plan participants. This is the sort of plan that would yield better results for most, given that DB plans are out of favor, and participant-directed DC plans lead to high expense/poor results. It may be time to consider a hybrid plan: A trustee-directed DC plan for accumulation and a DB plan for distribution.


In the meantime do yourself a favor and pay off credit cards every month. Put away 15 percent of every paycheck and take advantage of employer 401(k) matching plans. If you can, retain and use the services of an accredited financial planner to help you navigate the retirement investment landscape.


Christopher P. Blakely, CFP®, CTFA, CMFC 03/2012

Diversify Your Holdings (or not - That's Cool Too)

 Should you put all of your money in one stock or should you spread your bets across many investments? If it is the latter, how many investments should you have in your portfolio? The debate is a good one at one end is the advice that you get from the efficient markets camp: maximum diversification across asset classes, and within each asset class, across as many assets you can hold: the proverbial “market portfolio” held in proportion to its market value. At the other is the “all in” investor, who believes that if you find a significantly undervalued company, you should put all or most of your money in that company, rather than dilute your upside potential by spreading your bets.


Which Gospel? Mark or John
These arguments got media attention recently, because two high-profile investors took opposite positions. The first salvo was fired by Mark Cuban, who made his substantial fortune (estimated at $2.5 billion), as an entrepreneur. Cuban's profile has increased since, largely from his ownership of the Dallas Mavericks, last year's winners of the NBA championship. With typical understatement, Cuban claimed that diversification is for idiots and that investors, unless they have access to information or deals, should hold cash, since hedge funds have such a tremendous advantage over them. In response, John Bogle, the founder of Vanguard, countered that "the math (for diversification) has been proved over and over again. It's not just the first thing an investor should think about, but the second, the third and probably the fourth and the fifth thing investors should think about."

So, should you diversify? And if so, how much should you diversify? The answers to these questions depend upon two factors: First, how certain your assessment of value and second, how certain you are about the market price adjusting to that value within your specified time horizon.

At one limit, if you are absolutely certain about your assessment of value for an asset and that the market price will adjust to that value within your time horizon, you should put all of your money in that investment. Though this may seem like the impossible dream, there are two possible scenarios where it may play out:

1. Finite life securities (Options, Futures and Bonds): If you find an option trading for less than its exercise value: you should invest all of your money in buying as many options as you can and exercise those options to make a sure profit. In general, this is what falls under the umbrella of pure arbitrage and it is feasible only with finite lived assets (such as options, futures and fixed income securities), where the maturity date provides a endpoint by which time the price adjustment has to occur.
2. A perfect tip: On a more cynical note, you can make guaranteed profits if you are the recipient of inside information about an upcoming news releases, but only if there is no doubt about the price impact of the release (at least in terms of direction) and the timing of the news release. The problem, of course, is that you would be guilty of insider trading and may end up in jail.

At the other limit, if you have no idea what assets are cheap and which ones are expensive (which is the efficient market hypothesis), you should be as diversified as you can get.

Most active investors tend to fall between these two extremes. If you invest in equities, at least, it is inevitable that you have to diversify, for two reasons. The first is that you can never value an equity investment with certainty; the expected cash flows are estimates and risk adjustment is not always precise. The second is that even if your valuation is precise, there is no explicit date by which market prices have to adjust; there is no equivalent to a maturity date or an option expiration date for equities. A stock that is under or over priced can stay under or over pced for a long time.

How Diversified?
Building on the theme that diversification should be attuned to the precision of your valuations and the speed of market adjustment, the degree to which you should diversify will depend upon how your investment strategy is structured, with an emphasis on the following dimensions:

A. Uncertainty about investment value: If your investment strategy requires you to buy mature companies that trade at low price earnings ratios, you may need to hold fewer stocks , than if it requires you to buy young, growth companies (where you are more uncertain about value). In fact, as a general rule, your response to more uncertainty should be more diversification.


B. Time horizon: To the extent that the price adjustment has to happen over your time horizon, having a longer time horizon should allow you to have a less diversified portfolio. As your liquidity needs rise, thus shortening your time horizon, you will have to become more diversified in your holdings.


In summary, then, there is nothing crazy about holding just a few stocks in your portfolio, if they are mature companies and you have built in a healthy margin of safety, and/or you have the power to move markets. By the same token, it makes complete sense for other investors to spread their bets widely, if they are investing in young, growth companies, and are unclear about how and when the market price will adjust to value.


Bottom Line
Most investors are better off diversifying as much as they can, investing in mutual funds and exchange traded funds, rather than individual stocks. Many investors who choose not to diversify do so for the wrong reasons (ignorance, over confidence, inertia) and end up paying dearly for that mistake. Some investors with superior value assessment skills, disciplined investment practices and long time horizons can generate superior profits from holding smaller, relatively undiversified portfolios. Even if you believe that you are in that elite group, be careful to not fall prey to hubris, where you become over confident in your stock picking and market assessments and cut back on diversification too much.

CBlakely CFP®, CTFA 02/2012

Source: New York University Stern/Damodaran

Viewer Discretion is Advised!

2012 seems like it could be the year prognosticators of doom and end of days theorists will be in the spotlight. Full disclosure: – I have a 2012 Mayan calendar and the kitten pictures are just too cute. But seriously, there is one prognosticator in particular that actually does scare me. Not because I think it is true, nope, that’s not even a consideration. It’s that it is loaded with exaggeration using scaremonger tactics to frighten investors into actually buying into this baloney.

Dis-infomercial

I was watching TV and saw an ad for an online video with the following warning label: “The following presentation is controversial and may be offensive to some audiences. Viewer discretion is advised.” “OK,” I said “you got my attention.” The production values are pretty high and I thought it made sense to at least skim the thing before passing judgment. So I watched this video proclaim the end of America and the dollar as we know it. Interestingly, it carried the requisite language ‘may’ and ‘likely’ added to avoid absolutes. This keeps the investment regulators at bay but makes for strange narration with phrases like – “there is absolutely no doubt that this may happen.”

What the video contains is about 45 minutes of hyperbole followed by thirty minutes of a really cheesy sales pitch for investor newsletters authored by the team at Stansberry Investment Research. Really?

Back in 2007 this group was substantially fined by the SEC for securities fraud. Now they make an end of the America as we know it pitch using scare tactics and specious charts and graphs (why are they not properly sourced or labeled?) to goad people into buying their newsletter.

While we are all entitled to our opinion a person who acts in a fiduciary capacity is held to a higher standard. Fiduciary law, putting others interests in front of your own, may be the highest law in the land. And to treat it lightly is to breach that duty. While I have read forecasts that are indeed dire, none of the pieces close by trying to sell you a way to actually make money, while the economy and the dollar and our standard of living collapse around us.

To give one example, at one point during the video Mr. Stansberry talks about something called the 100% Strategy. He claims you can make money without ever having to own a stock. OK, sure, that’s true. Then he makes the statement that you might be forced to buy a stock at less than its current value if something goes wrong with the 100% Strategy. These two positions are so obviously at odds with one another. This is one of myriad examples of how crafty yet misleading this report is.

Fool me once…….

Successful investing is difficult enough with an advisor that is working with you in your best interests, it is nearly impossible otherwise. My advice is to avoid this wolf in wolf’s clothing.

Chris Blakely, CFP® 01/2012

Jobs and Asian Investing

The current economic downturn has been called a housing crisis, a financial crisis and a debt crisis, but now, according to nearly everyone running for office, we are in a jobs crisis. Politicians currently talk of vague jobs plans, filled with serious-sounding phrases and little real meaning.

Think about it, when has a corporate CEO ever been rewarded for hiring people who aren’t absolutely required. Most companies hire only when its workforce can no longer keep up with the demand for its products.

The government’s ability to create jobs is pretty disappointing and that’s ok. The most popular types of jobs programs involve state tax breaks or subsidies that seek to move a company from one state to another. These policies don’t add to overall employment so much as they just shuffle jobs around.

John Maynard Keynes’s view is that government can create jobs by spending a lot of money. The stimulus, however, has to be borrowed, and it has to be huge — probably something close to $2 trillion — to fill the gap between where the economy is and where it would be if everyone was spending at pre-recession levels.

Many Republicans follow the more fiscally conservative University of Chicago School, which argues that Keynesian stimulus can’t heal a sick economy — only time can. Chicagoans believe that economies can only truly recover on their own and that policy interventions only slow the recovery.

Of course, Republicans can’t say, “wait this thing out while we cut taxes and regulation.” These policies may make the economy healthier in 5 to 10 years, but the immediate impact would require firing a large number government workers.

The U.K., as part of its austerity measures, is in the process of firing about 500,000 government workers under the notion that the private sector would expand (lower taxes and regulation) and employ all those laid-off. But this isn’t happening. The British economy continues to grow slowly, if at all and few government workers have found new jobs in the private sector.
The second area of agreement is the most important: an economy is truly healthy only when its people know how to make and do things that others will pay them a decent amount for. Jobs are not the cause of a healthy economy, they’re the product.

The economy that emerges from this recession is going to be different. Without the distortion of a credit bubble, it is clear that far too many Americans don’t know how to do anything that the world is willing to pay them a living wage for (Kardashians excepted).For confirmation, look to the aptly named rustbelt and also look at the negative correlation between education and unemployment.

An economic downturn is the time to learn new skills – move forward and learn about something that can help produce a paycheck. Those who can’t find a job where they live should consider moving to places where there are more jobs than applicants.

With Europe plugging the nearly insolvent country dyke that seems to spring a new leak every six months and until the U.S. economy, somewhat mired in mud, gets unstuck, emerging economies will be a beacon to investors.

Take for instance, The Matthews Asian Growth and Income Fund, the Fund invests in dividend-paying common stock, preferred stock and other equity and convertible securities of companies located in Asia – it’s paying a 3.4 percent current dividend. Investors are becoming increasingly aware of the attractive demographics and strong economic growth that exist in the region.

Over the last 15 years the Fund has delivered risk adjusted performance (alpha) of 7.24 percent ABOVE the index. And during this period of economic volatility, the Fund was able to accomplish one of its main aims—to offer a degree of downside protection—and cushion shareholders from the worst of the sell-off.

To index is smart when the market is terribly efficient. Managers cannot consistently outperform in highly efficient markets as prices instantly change to reflect new public information. This is true of the Treasury market and may be true of the domestic large cap stock market. In inefficient markets a good manager can exploit this to the shareholders advantage. Small cap stocks and emerging markets currently fall into this category. Indexing in these markets may not be as profitable over the long-term.

 CBlakely CFP®. CTFA 11/2011

Sources: PlanetMoney – Adam Davidson, Bill Gross-PIMCO, Matthews Asia