portfolio management

Dealing with Financial Emergencies, Three Things

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The dramatic and unexpected events of 2020 have tested our adaptability and resourcefulness like no other. There are patterns in those who are navigating these times successfully.

1. Realize there are usually lessons in history to guide us; maintain perspective.
2. Avoid hasty decisions that could have negative long term consequences.
3. Look for the opportunity in the challenge, not vice versa.

By taking time to think about the context, understand our own situation, and get accurate information about whatever the new reality is, we usually can make better decisions.

In personal finance, tapping high interest credit cards to maintain spending in the face of income reductions may be necessary for some items. But any outlays that can be avoided, or are discretionary, should be deferred, not financed. The average credit card interest rate remains in double-digit territory, a huge drain.

In your investments, long term holdings should not be disrupted by short term considerations. When the situation changes in ways that everyone knows, the new circumstances are likely to be priced into the market already. So there may not be an edge in taking action. If you do not need the funds in hand for pressing purposes, you might leave them be.

The stress of the situation may be alleviated by working on things within your control. Practicing healthier habits with regard to exercise, nutrition, sleep, and alcohol can also reduce stress, while giving you a sense of conrol.

Finally, contact with other people is a necessity for social beings such as humans. It may be especially useful as you talk things out or need someone to bounce ideas off of. We would be happy to visit with you by phone or email, Zoom video or in person – about whatever is on your mind. Email us or call.

Stagnation

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The word stagnant is an adjective used to describe things that are motionless, lifeless, lethargic, slow-moving, inactive or static, like water with no flow to it.

If these kinds of words also describe financial accounts you own, this may be a good time to get things moving. A dormant old 401(k) or too much cash parked in the bank could be in that category. Investments or advisors you don’t understand might be another sign.

A wise person once said that every past market crash looks like an opportunity. We do not have to wait until after the inevitable rebound to treat the current turmoil as an opportunity. It could be a great time to do something about the stagnant pieces of your financial puzzle. Or not. No guarantees.

(We address our communications to clients, but know that we have many eavesdroppers. To them we say, our approach is not for everyone. You can learn a lot about it here at 228Main.com, or in our Twitter or LinkedIn feeds.)

You may need to clean house in your finances or review your plans and planning in light of new information. If we might be able to help, put us to work. It’s what we do.

Clients, if you would like to talk about this or anything else, please email us or call.

Footwork is Key

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A long time ago, a coach told us 80% of success was in the footwork. I can’t remember if it was in reference to playing linebacker, or fielding a baseball, or defending the basket. Certainly, in all those endeavors, one’s position is important.

Add this to the list: how your investments are positioned. Many people have a number of different kinds of accounts, from traditional retirement accounts to Roth IRA’s to regular taxable accounts. Where you own what may make a big difference.

For example, because the gains in Roth IRA accounts will never be taxed even when withdrawn, if the rules are followed, it makes sense to hold the most dynamic investment opportunities inside Roth IRA’s. (Of course, no guarantees – we can’t know the future.) There is little sense in having your most boring investments in your Roth account.

Conversely, investments you might own forever, blue chip stocks for example, might best be owned in taxable accounts. If you don’t sell in your lifetime, you will not owe tax on gains. And heirs get a stepped-up cost basis, a big tax break if there are large unrealized gains.

The key to this idea is managing your investments on a household basis. If you are thinking about the big picture, you do not need to have each individual account be balanced and diversified, nor do you need to make sure you are making transactions in each individual account every year. It could benefit you to have just a few high-potential holdings inside your Roth, and ‘buy and hold’ stocks in your taxable account, as part of a coherent household strategy.

Later in 2020, LPL Financial will start performing investment advisory account supervision on a household basis, rather than an account by account basis. This will make it easier for us to maintain the positioning strategy, with fewer conversations behind the scenes to be sure we can do our best work for you.

Clients, if you would like to talk about this or anything else, please email us or call.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

A Structural Reminder

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The ability to adapt to changing conditions is what sets those who thrive apart from those who merely survive.

Our portfolio theory evolves over time as economic and market conditions unfold. The problem with the textbook approach in a changing world is that a textbook, once printed, never changes. Looking at the world as it is and doing our own thinking, we see things in a new way.

Some time ago, we concluded that counterproductive monetary policies have distorted pricing for bonds and other income-producing investments. By crushing interest rates and yields to very low levels, the old investment textbook had been made obsolete.

Therefore the classic advice about the proper balance between stocks and bonds brings new and perhaps unrecognized risks, with corresponding pockets of opportunity elsewhere. Yet the classic advice met a need which still exists: how to accommodate varying needs for liquidity and tolerance of volatility.

Our adaptation to this new world is the portfolio structure you see above. Our classic research-driven portfolio methods live in the Long Term Core. We believe our fundamental principles are timeless, and make sense in all conditions.

But people need the use of their money to live their lives and do what they need to do. So a cash layer may be needed, tailored to individual circumstances.

The layer between is ballast. This refers to holdings that might be expected to fall and rise more slowly than the overall stock market. Ballast serves two purposes. It dampens volatility of the overall portfolio, thereby making it easier to live with. Ballast may serve as a source of funds for buying when the market seems to be low.

The client with higher cash needs or who desires lower volatility may use the same long term core as the one who wants maximum potential returns. One may want a ‘cash-ballast-long term core’ allocation of 10%-25%-65% and the next one 4%-0%-96%. It’s a free country, you can have it your way.

It may be time to review the structure of your portfolio. Clients, if you would like to talk about this or anything else, please email us or call us.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

All or Nothing

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We keep hearing reasons why financial advisors should have 100% of every client’s invested assets, instead of some fraction. This theory is popular with… financial advisors.

You might guess we have a contrarian opinion on this subject, like most subjects. Our theory is that we end up with all the business we deserve. Since you who own the money are the judge of that, we are relieved of the burden of worrying about it. We don’t want any money in our shop that doesn’t want to be here, after all.

There are sound reasons to consolidate assets in one place – including lower costs through volume discounts. But some may prefer not to do that, for whatever reason.

Our investment approach is different than most. Rather than use the standard pie chart approach of owning a little bit of everything, or outsourcing investment management to some third party somewhere, we do hands-on research and our own thinking, using individual securities as appropriate. So our work is a useful diversification, something different, from run-of-the-mill conventional portfolio management using investment products instead of stocks and bonds.

When somebody wants to allocate a fraction of their wealth to our care, it is fine by us. We already know how much business we will ultimately end up with: all that we deserve.

It turns out that remembering whose money it is not only respects the people who engage with us, but also reduces our stress.

Clients, if you would like to talk about this or anything else, please email us or call.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Where Did All The Risks Go?

© Can Stock Photo / Hmelevskih

In what seems like the good old days, we thought about many kinds of risk. Now, to many, risk only means one thing. All the other kinds of risk seem to have disappeared. Here are some of the classic risks as we learned them long ago, and still understand today:

Market Risk. Changes in equity prices or interest rates or currency exchange rates that hurt the investment value.

Liquidity Risk. Being unable to sell an investment without a discount for lack of buyers.

Concentration Risk. Having all your eggs in one basket, when the basket gets upset.

Credit Risk. A bond issuer might not be able to pay you back because of adverse conditions.

Inflation Risk. A loss of purchasing power over time because investments fail to keep up with a rising cost of living.

This old-fashioned approach to risk focused on possibilities for what might happen in the future. This makes sense to us, since the future is where we will get all of our coming investment results, good and bad. The past is past.

But perhaps the most popular approach to risk today is based totally on the past, not the future. Past volatility is supposedly the measure of risk in any investment and every portfolio. Modern Portfolio Theory (MPT) implicitly assumes that past volatility is the sole measure of risk. Yet volatility is inherent in any form of long-term investing, and has little to do with many of the classic forms of risk.

Investment firms and advisors promoting ‘risk analytics’ and many measures of ‘risk tolerance’ are using this backward-looking theory of risk. It has nothing to do with the classic definitions of risk, outlined above. In our opinion, some of the latest and greatest risk management technology is not focused on actual risk at all, and could discourage people from enduring the volatility required to achieve long term results.

Meanwhile, the classic understanding of risk has us thinking about its many dimensions as we choose securities and build portfolios. One drawback of our approach? It takes more work to do things the old-fashioned way. But we think it is the right way to go. No guarantees, of course.

Clients, if you would like to talk about this or anything else, please email us or call.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

Letters to Our Children #7: Know Your Assets

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Our previous letters have talked about the three buckets you have for your money: short term, long term, and in-between. Each one serves different purposes. Today we will dive into the details of the different assets you can put into those buckets.

The simplest and most familiar asset class is cash. It has a fixed value and is completely liquid, available to spend any time you want. While the change jar on your counter is not exactly an investment, you can put it in a savings account and generate a little bit of interest. Short term certificates of deposit and Treasury bonds can also be considered cash equivalents as long as the maturity is within a few months. They can not be spent without notice, but could be turned into cash quickly for major expenses.

Longer duration CDs and bonds fall into another asset class: fixed income. You can expect higher interest by accepting longer maturities and shakier credit ratings, so fixed income will generate more income than cash. There is a reason for this: your risk exposure also increases. Buying bonds with poorer credit quality increases the risk that the borrower will go broke and default. And if you lock in your money long term at a fixed interest rate, you will be in for pain if inflation and interest rates rise. This can make fixed income investing difficult in a low interest rate environment.

The third main asset class are equities, or stocks. These are what you are thinking of when you talk about the stock market. Stocks represent partial ownership in a given company. Exchange-listed stocks are liquid, and owning a share of a rapidly growing company offers the potential for higher returns. But again, these returns come at a trade-off of volatility and risk. There is no fixed face value or interest rate on equities, and the market price can change rapidly.

There are also alternative investments outside of these three main asset classes. Most alternative investments are tangible assets such as real estate or physical commodities. These assets are largely speculative: they do not grow on their own and do not pay out interest. As such, we do not generally recommend them.

Different assets are useful for each bucket. Your short-term bucket needs both liquidity and stability, so it should be mostly or entirely in cash. Your long-term bucket can tolerate more volatility and will probably want to seek higher returns, so equity investments may be more appropriate. The intermediate-term bucket can hold a range of investments, although you will probably want a healthy proportion of cash and short-term investments.

Your financial situation is unique, and there is no one-size-fits all approach. Clients, if you want to discuss what is in your buckets, please call or email us.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.

CDs are FDIC Insured to specific limits and offer a fixed rate of return if held to maturity.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

Stock investing involves risk including loss of principal.

Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the investor’s portfolio. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

The Hidden Trade-off: “Risk-adjusted Returns”

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You surely have noticed this by now: we disagree with conventional ways of doing many things. Modern Portfolio Theory (MPT) forms the theoretical underpinnings of a lot of investment practice today, without adequate understanding of its deep flaws.

MPT defines volatility as risk. We believe, as Warren Buffett does, that volatility is just volatility – the normal ups and downs – for long term investors. So one common practice is to promote the advantages of getting 80% of the market returns with only 50% of the risk (for example). This supposedly is a superior “risk-adjusted return.”

But you could use the same statistical methodology to show that it may cost you about one third of your potential wealth in 25 years to have a 50% smoother ride on the way. For an investor with $100,000 in long term funds, this might be a $250,000 future shortfall. The question might be, “What fraction of your future wealth would you sacrifice in order to have less volatility on the way?”

The idea of sacrificing future wealth is a lot different than the idea of reducing risk. But they are two sides of the same coin. This is the hidden trade-off in superior risk-adjusted returns.

Our experience is that people can learn to understand and live with volatility. We believe investors get paid to endure volatility.

Of course, our philosophy is not right for everyone. Volatility is easier to tolerate for investors with a longer time horizon. But we believe everyone should see both sides of the coin before making a decision to forego significant potential future wealth for a smoother ride, less volatility, along the way.

Clients, if you would like to talk about this or anything else, please email us or call.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss.

This Will Pay Dividends

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One of the joys of thinking is that every once in a while, you might come up with a good idea. We are hoping we just did exactly that.

Our buy list, the securities we believe have favorable prospects for the years ahead, provides the building blocks for your portfolios. We rank them in order of timeliness, together with a weighting or percentage each should have. When funds are available in a portfolio, we start at the top of this cascade and fill up each holding to the desired weighting.

In our research and portfolio management, our object has long been to maximize total returns.

The bright idea? We re-ranked the Buy List based on dividend yield, and changed the weightings to reflect an income emphasis. By taking the top twenty dividend payers on the list and putting more weight on the better payers, we come up with a healthy dividend yield in a portfolio that has the potential to grow, too. Income and growth.

Dividend payments could be used to reinvest and compound your income or taken as a monthly payment, your choice.

Is this right for you? Maybe, maybe not. Our traditional “total return” approach is more suitable for many. Both alternatives feature holdings that fluctuate in value. These “income emphasis” portfolios will be more concentrated, although having twenty holdings provides diversification.

If you would like to talk about this, or anything else, please email us or call.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

Writing the Book on Investing

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In the 21st century, it is possible to be more open about every aspect of business than ever before. Digital communications enable us to describe in real time what we are doing, why, how, and for whom with a level of detail that was not possible in the last century.

We have always had a well-defined investment process. We know what we want to own, and why. Since 2015 we have been able to share insights about our views, thinking, philosophies, strategies, and tactics here on the blog at 228Main.com. Those of you who are regular readers have perhaps gained a good sense of what we are about.

It is time to take it to the next level. We are working to comprehensively document our investment management process, from philosophy to research sources to investment selection methods to portfolio structure to tailoring client fit to trading protocols to client and account review process. We will be writing a book.

As great thinker Morgan Housel wrote, “writing crystallizes ideas in ways thinking by itself will never accomplish.” So we expect to come out of this exercise with a tighter, better-defined set of processes and protocols. No guarantees, of course.

This will take time and effort. What are the other advantages in doing it?

• To provide even greater clarity for you.
• To gain a comprehensive business operating manual.
• To help new associates understand what the enterprise is about.

Bottom line, this is a step toward greater sustainability, one of our major objectives for the years ahead. Clients, if you would like to talk about this or anything else, please email us or call.