Sign up with your email address to be the first to know about new products, VIP offers, blog features & more.

A Different Market Perspective

In light of the market correction that is occurring, I have pulled together some interesting and compelling quotes that help to put it into perspective:

“Yesterday was the third worst point decline for the Dow since 1915. But it was only the 284th worst day [as a percentage].” – Michael Batnick

“On days like today it’s easy to tell the Good Guys from the Bad Guys. The Good Guys are saying reasonable things, reassuring those who look to them for insight. The Bad Guys are squirting lighter fluid on the media bonfire, reveling in the fear of others, mocking the masses.” – Josh Brown

“Worst day in eight months. Eight. Whole. Months. An eternity.” – Blair H duQuesnay

“If you have a solid global asset allocation you could expect similar returns as the S&P 500 but with lower volatility and drawdowns. You can also expect to underperform about half of all years, by a mile (>10%) every 5 years, and easily underperform many, many years in a row.” – Meb Faber

“S&P 500: this is the 23rd correction >5% since the March 2009 low. They all seemed like the end of the world at the time.” – Charlie Bilello

“Minus 4% Dow Jones days are more common than you think. We’ve had on every 82 days on average since 1900.” Michael Batnick

“Since 1928 the S&P 500 has seen 325 days w/losses of 3% or worse. That means it happens roughly 3.5x a year on average.” – Ben Carlson

Bonds: The Long and Short of It

Bond funds are often lumped together as one.  However, they are actually a range of very different investments.  This post will address only investment-grade bond funds which have a low probability of default as these are bonds that are issued by large and established corporations and the U.S. government.

It is important to know how changing interest rates affect short-term and long-term bond funds differently.  Short-term bond funds hold individual bonds that mature and ‘roll’ quickly into new bonds with current interest rates. This means short-term bond funds adjust relatively quickly to changing interest rates, so the principal risk is relatively low.   Short-term interest rates are set by our Central Bank as policy.  Long-term rates, however, are set by market forces and investor expectations.  Our Central bank influences, but does not control long-term interest rates. The interest rates on long-term bonds do not change for the length of their maturity.  What must adjust to changes in interest rates is the current price of the bond.  Higher interest rates mean lower current bond prices and vice versa (refer to my posts on duration).

What is important to know for today’s investors is that the Federal Reserve has raised short-term interest rates meaningfully off of zero over the last year or so and plans on continuing this trend.  As a result, some short-term investment grade bond funds are now offering SEC yields of around 2.5%.  However, long-term interest rates have only risen somewhat and, as a result, long-term investment grade bonds are offering an SEC yield of only 3 to 4%.  It was expected that long-term interest rates would rise accordingly with short-term rates, but thus far they have not.  Should this change, there is a real potential that longer-term interest rates will rise and the price of long-term investment grade bonds funds would be negatively impacted.

Investing in short-term investment grade bonds may currently have a lower dividend, but offer less principal risk.

Financial Advice for Young People Just Starting Out

Congratulations – You graduated from college and landed your first job. Unfortunately, the party ends shortly after that. According to Zillow, 22.5% of millennials ages 24-36 live at home (roughly 12 million). And of those “Boomeranger”, only 12.5% are unemployed, indicating that the majority choose to stay home for one reason or another. The cause of this could be a number of reasons such as rising costs or low wages. Not to mention crushing debt from student loans and credit cards.

For people just getting out of school and starting to establish themselves, here are six important concepts to keep in mind:

1. Automate your savings: Set realistic goals. Starting small with automated savings is a good place to start, in that case, you won’t feel strapped for cash and it’s much less painful. For example $5 a week. Once you get more comfortable with saving money increase it in smaller increments. Use any number of tools that will do it automatically for you. So you can “save-and-forget”. Over time, you can slowly raise the amount. Starting early and being consistent can have huge implications later in life.

2. Design a budget: Learn from your college years. When it came down to entertainment purchases or gas for your car, it was an easy choice. But now, life is more complicated. You have to save for big expenses (like replacing a car in a few years), paying down debts, and saving for retirement (which seems absurdly far away for a recent grad to consider). The solution is a budget. Start by paying yourself first. By that, I mean save for your future (retirement and major expenses). Then, budget out your most essential day-to-day expenses. Whatever is left can be spent on discretionary expenses (eating out, having fun, etc).

3. Search for less expensive alternatives: Building on the budget concept, there are simple ways to cut costs. Maybe there is a gym in the area $10 less per month, those savings can add up quickly. Review your subscriptions, search for alternatives and calculate the potential savings. Subscriptions have grown in popularity over the last ten years. You’d be surprised how much you can save by eliminating a few subscriptions or finding a cheaper option.

4. Beware of ‘Advertiming’: You’ve just reached a major milestone in your life, and brands also realize that. In fact, they’ve gotten pretty smart. Advertiming is a strategy used in advertising to run adverts to a specific audience at a specific time, (i.e Dunkin Donuts ads during the morning rush hour, AARP magazine in the mail when you turn 50). Audi offers a “College Graduate Offer” for recent grads, they’re trying to hook you early.

5. Don’t buy a brand new car after landing your first job: JD Power discovered that 29% of new vehicles are bought by Millennials. Recent grads might be experiencing the income effect. Imagine going from a college student budget and meal plans to a salary, you feel a whole new level of freedom. It’s important to recognize that the income effect is just an emotional reaction to a major increase in cash flow. You’re not used to it yet.

Kelley Blue Book’s most recent figure for the average price of a new car is $35,285. If the average depreciation of a car is 20% after the first year you should rethink your options. The need for a reliable car could be validated, but that could also be $7,057 towards paying off lingering debt. Instead look for a New-Used car.

6. Ease off the social media: Recent data from Forbes suggests 72% of Millennials have made fashion and beauty purchases influenced from Instagram posts alone. Could the social influence be thinning their wallets? At the very least, it’s important to keep in mind how deeply the consumer culture has worked its way into apps we use every day (like Facebook and Instagram)

Like generations before them, millennials attempt to leave the nest while burdened with rising costs of living, peer pressures and debt. Brands are getting smarter with targeting them at a time when they’re not financially secure to pursue their expensive tastes. Needs for short-term appear more important than the long-term. In essence, it comes down to needs vs. wants. The ability to distinguish between the two is a simple, timeless concept, yet so often overlooked.

Budget, plan, ignore the noise and most importantly, prioritize.

Special thanks to Dan Varghese, our current intern for researching this post.

How Hindsight Bias Impacts Investment Decisions

Picture this. It’s an average summer morning, except it looks a little cloudy outside. You decide to shut off the AC, open a few windows and get the fans going before you head out. On your way home from work it starts to pour. Heavily. You think….I knew it might rain, I should’ve closed the windows! Truthfully, at the time you never really knew it was going to rain, did you? Not to mention, neither did the weatherman.

This is what we call hindsight bias. We believe after a specific event occurred that we had enough knowledge to predict the event.

Investors develop hindsight bias by becoming reactive to any new information they receive. There is a famous story of Sir Isaac Newton who was a victim of hindsight bias. He sold out of an investment thinking he got out at the top. While all of his friends stayed invested, he watched as they double and tripled their original investment. All the while, he was kicking himself for selling out early (Hindsight bias at work). And then he famously bought back into this investment at the very top. It quickly plummeted and left him almost broke. But he didn’t learn his lesson. He went on to make a number of other poor investment decisions that left him penniless.

Why are we so susceptible to hindsight bias? Psychology tells us that humans have a need to create order. So in a way we are attempting to learn from our mistakes by oversimplifying the causes of a certain outcome. In the real world, there are too many variables to account for. Usually, we pretend like we had the knowledge to make the correct decision at the time when we really did not. This type of bias makes it difficult to learn from our past mistakes, we don’t stop and review what really occurred and why. By believing one’s ability to predict future events, an investor can develop ‘overconfidence’ while attempting to predict future events in the market. Consequences can arise when investors attempt to make informed decisions with an unrealistic view of risk leading to mediocre returns, or worse, losses.

It is important for investors to recognize this bias so they can prevent it from spoiling their judgments while making important investment decisions.

This post was written by our intern, Dan Varghese.

Buybacks Drive Stocks Higher

The tax cuts that went into effect this year lowered the corporate tax rate from 35% to 21%. Of course, most corporations were not paying that, the effective rate that was actually paid was much lower. However, the new lower 21% official rate allowed corporations to lower their effective rate even further and boost earnings. Also of great importance, it allowed for bringing overseas earnings back home for a limited time at a substantially reduced tax rate. While the goal of this ‘bring the money home’ legislation was to increase investments in plants, equipment, and jobs (which is happening) much of the cash is going to stock buybacks.

Stock buybacks are driving the stock market higher. Corporations are buying shares in the open market creating demand and driving prices higher. Additionally, when corporations buy their own shares they ‘retire’ these shares leaving fewer shares outstanding. Each remaining outstanding share then represents a larger piece of the corporation. Therefore, when total earnings are reported, a smaller number of shares are divided into them. This increases earnings per share and further boosts share price.

Unlike paying out dividends to shareholders, buybacks do not involve immediate taxation. Dividends are taxed up to 20% while buybacks can result in meaningful capital gains in share price which will only be taxed when they are eventually sold. Buybacks can be a very positive way to reward shareholders with earnings in excess of what the underlying corporation needs to finance ongoing business plans.

So far this year, buybacks are running at a record pace.

Furthermore, and not quite as positive, several years of ultra-low interest rates have encouraged corporations to borrow money to buy back shares. This has resulted in record levels of debt carried by U.S. corporations. While stock buybacks help boost share price in the short run, this incurred debt may be problematic over the long run as more and more money is going towards interest payments. This leaves less for ongoing business needs, especially in recessionary times.

While there is no equation to forecast the effect of buy backs on future share prices, it continues to be a very strong positive in the short run.

Keeping Tariffs in Perspective

Recently, I was asked about my thoughts on the tariffs and the impact it may have on a portfolio.  What follows is my response:

“I see this as a giant game of chicken between China and the US.  I see this causing a lot of anxiety and volatility in the market, but I’d imagine that someone is going to “blink”, a deal will be struck and no tariffs will be enacted.    There will always be some issue that is of concern that gets blown out of proportion which leads to an overreaction among investors (thanks to the 24/7 media coverage). It could be the possible government shutdown, conflicts in Ukraine, North Korea, Brexit, elections, or rate hikes.  All of these received the same kind of media attention over the last 3-4 years.

It’s hard to separate ourselves from these kinds of issues because we are so close to them. It’s currently happening around us.  It’s on the news. It’s being discussed around the water cooler.  We are seeing it translate to the performance of our accounts.  And that can be scary.

Ultimately, in working with clients, I take a longer-term view on the markets. How will we look back in five years on the impact of these tariffs if enacted?  I can’t help but believe that it would be a foggy memory for most investors, just like Brexit, the taper tantrum, and the government shutdown.  And you take it out to an extreme example, some investors are starting to forget their fears they had during the last recession because they are seeing their account values grow significantly above the pre-recession values.

So in the grand scheme of things, I don’t see the tariffs as having a material impact on your situation in the long term. “

The Psychology of the Tax Refund

The average tax refund is about $3,000. And people do one of two things with it. They either spend it or set it aside for a specific purpose. What’s the distinction between these two groups of people? It all comes down to their expectation.

If the refund was unexpected, chances are it will be spent. This group of people is subject to the Windfall Syndrome in which “found” money is spent more freely than money earned.

If the refund was expected, chances are it will be saved. I’ve heard many people refer to their tax refund as “the money they will use for vacation” or “the money used to pay off last year’s Christmas bills”. This group of people abides by a behavioral finance concept known as Mental Accounting.

The key to all of this is the expectation. It is the single most important factor in determining if the refund will be spent or saved. It just goes to show how powerful a little bit of planning can have.

The Most Unusual Tax Deduction I’ve Ever Heard

What do you do with a house you no longer want? What if it’s a house in bad shape but you love the land?

Up until recently, I would have offered two options: renovate it or knock it down and rebuild.

Turns out there is a very creative strategy. You donate the house to the local fire department, who in turn burn it down for training purposes. You, in turn, receive a sizeable charitable contribution.

It’s common enough of a strategy that the Journal of Accountancy wrote a summary piece on what to be aware of (it’s written for CPAs, so it’s really technical, but the conclusion confirms it).

Analysis of the Tax Cuts

Recently some clients attend a talk on the recent tax law changes by Eliot Bassin of Bregman & Company. I thought it was interesting enough to send the slides out to readers of the blog and newsletter as there were several important take-aways that were new to me.

See the Slides: Analysis of the Tax Cuts Jobs Act

Here are a few slides that jumped out to me:

Slide 10: A comparison of tax brackets and who pays more (Red) and who pays less (green)

Slide 24: A simple impact analysis based on different hypothetical situations

Slides 33-40: a summary of tax changes affecting CT residents