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If interest rates were to rise…

There has been a lot of talk these last few months about what will happen to portfolios when the Fed eventually raises interest rates.  The Fed will only make changes to its low-interest policy when the economy confirms it will continue to improve.  The earliest the Fed would make any changes would be in September, although some experts predict it won’t happen until 2014. Below are a few key points that can help put this into perspective and explain what this means for you:

If interest rates were to rise…

  • Changing trends could provide new investment opportunities.
  • We could see certain domestic bonds decrease in value. Not all bonds but certain types, such as long-term government backed bonds, may be more affected than others when rates do rise. We see opportunities in short duration funds or funds with global diversification or a variety of sub asset classes (such as corporate bonds, senior loans, convertible bonds).
  • It could strengthen the dollar thus making stocks more attractive (both small and large cap could be buying opportunities).
  • The financial sector (regional banks, insurance companies, etc.) could be an opportunity as they historically perform well during periods of rising interest rates.
  • Large Multinational companies based in the US could see their values go down as a result of the strengthened dollar, while multinationals based outside of the US could be a better investment.

Talk about the magic of compounding interest!

I just stumbled upon this interesting nugget.  All things being equal, a 19 year old who contributes $2,000 per year for JUST 7 years will have more money at age 65 than a 26 year old who made $2,000 contributions each year until age 65.

Talk about the magic of compounding interest.  Too bad, most 20-somethings won’t realize this until it’s too late.

For details, read: Investment Advice for Gen Y

New Report on Upward Mobility

NY Times just released the results of a fascinating study about upward mobility in the United States.

The results show that a child who grows up in Bridgeport, CT area with parents who earn in the 10th percentile ($16k), ends up, on average, in the 38th percentile.

These results are indicative of the whole northeast, too.  Unfortunately, the south isn’t so lucky.

Read In Climbing Income Ladder, Location Matters.

3 Negative Views… And How to Spot Them.

The talking heads and supposed experts have done a good job of scaring investors away from the markets.  Their job isn’t to help investors reach their financial goals, rather they are looking to shock investors and make them stay tuned to the channel to learn more (and of course watch their advertisements).

“A connoisseur of woe, needs fresh worries from time to time, or he will become complacent”

Peter Mayle, A Year in Provence

A recent post at dragonflycap.com, has done a pretty good job at classifying these fear mongering talking heads.  Greg Harmon, breaks them into three categories:

The Postponement: Their rhetoric sounds like this, “The big market decline we’ve been talking about is going to happen, just not as soon as I said”.  This camp believes something big is coming and that it’s always right around the corner.  Remember Y2K, the election, the fiscal cliff, and even the recent Fed announcement?

The Rationalization: After a pundit makes a prediction and it turns out to be wrong, his strategy may be to rationalize why some unforeseeable event prevented his prediction from coming true.  It’s easy to explain everything away after it’s already happened.

The Decay: These “experts” look for all the small disappoints and set backs and attribute it to an overall decay of the markets, the economy, the country, etc.  This camp will look into the lowering of the GDP and turn it into something much, much larger.

These mindsets can be debilitating to an investor if they only look for the negative stories.  It’s important to remember these are opinions of people paid to keep you watching the TV and reading their articles.

Four Strategies to Determine Your Asset Allocation.

Asset allocation is an important component to any portfolio.  It deals with the ratio between various asset classes such as stocks and bonds.  Many investors don’t know where to start or how to determine if their asset allocation is appropriate based on their objectives or risk tolerance. Below are four strategies to determine an appropriate asset allocation.  Each one with pros and cons.

  • Rule-of-thumb Formulas are useful for quick planning purposes.  For an investor, this should be a starting point to see if their current allocation is in the ballpark.
  • Risk Tolerance. Investors can complete questionnaires which can identify how comfortable they feel about volatility in their portfolio.  The questions identify how the investor would feel if they were to see their account value decline by X% over various time frames.  Based on their answers, a portfolio is designed around their risk profile.  This is an objective data-driven solution, which many find appealing. But an investor’s risk profile is not static. It changes day to day, depending on their experiences, the news, and a variety of other factors.  When the economy has a negative outlook, an investor’s appetite for risk is usually much lower than when the economy is bullish.
  • Stage of Life.  Age based asset allocations that adjust over time have grown in popularity.  The premise is simple: as an investor gets closer to retirement, his allocation shifts to more conservative asset classes.  This can help reduce the risk of extreme market volatility right before they enter retirement.  The downside, this approach does not factor in personal considerations such as risk tolerance, longevity or financial goals.
  • Goal based. At times, we have built portfolios around a client’s financial goal, such as having $500,000 in assets by the time they retire.  We can show the client the risk factors he/she would take on to try to reach that goal.  This often sparks a conversation with the client about other factors that should be explored, such as increasing the savings rate or adjusting the goal.

If you’re looking to get started, begin with this popular rule of thumb: subtract your age from 110 to determine your stock percentage, put 10% in cash, and the remainder in bonds. From there, you can edge the portfolio to be more aggressive by increasing your stock holdings or more conservative by increasing cash or bonds.

This is starting point, although you should seek professional guidance in determining an asset allocation that will meet your objectives.

Active Asset Allocation Trend Updates: June 2013

The Active Asset Allocation Portfolio utilizes a trend following strategy by buying and selling securities based on established price trends in each asset class. Below is a snapshot of the current trends we are following:

US Equities:

The trends in US Equities are currently in question. The markets have not responded positively to the news from the recent announcement from the Fed regarding the efforts to stimulate the economy. What does this mean? If recent history is an indication for what to expect, a market correction would occur but has not yet affected the overall positive trend. It could be a “speedbump”. When QE1 ended, the S&P 500 Index dropped by 15% but quickly rebounded leaving the overall trend positive. The same thing happened with QE2.

We continue to see some bright spots – technology, healthcare and financials seem to have avoided the same sort of decline as the S&P 500 experienced over the last few weeks. These groups might provide leadership in any “rebound”.

Foreign Equities:

The trends that exist in the U.S. equities are similar to the ones we’re seeing in the foreign markets.

Bonds:

During the month of June, we have lightened up on our bond holdings. Again, this can be traced back to the Fed. As the economy shows more signs of improving, the Fed will reduce its bond buying program and slowly raise interest rates. As interest rates rise, the value of existing bonds become less valuable since they pay a lower interest rate than newly issued bonds..

Real Estate:

Our longest held position is currently trying to find a trend. We have been pulling back on some positions and will continue to monitor it closely. The reasons for the trend reversal are similar to what was outlined above.

Commodities:

Our holdings at this time are minimal.

 

 

Keeping the Fed in Perspective

It’s been a big week! But don’t lose focus on the long term.

Too many people are making a big deal over the Fed’s announcement earlier this week, resulting in traders kicking up a lot of dust in the markets and the talking heads dissecting the meaning of the announcement.  Let’s keep a few things in perspective:

1) Nothing substantially new was stated except that the Fed’s bond buying may begin to taper off at the end of this year as opposed to early next year.

2) This was not unexpected news. This was already hinted at a few weeks prior. We already knew this.

3) The life support, QE3, or Fed’s efforts to help the economy must end someday.  Did everyone forget that it was bound to happen?

4) Bernanke even stated that any policy changes would be contingent upon the economy’s CONTINUED growth.  As the economy strengthens and can stand on its own, the Fed would reduce aid accordingly.  And at that time, shouldn’t it be celebrated rather than shunned?
There is some volatility in the markets as a result this announcement.  It may continue for a while. Is it a little speed bump or is it the sign of something more?  We will wait for the dust to settle to see where things stand. We may see opportunities as the market rebounds.

Bonds turning negative. Real Estate closely watched.

During our last trend update, we wrote about trends starting to change in bonds. While US bonds have not maintained a clear direction for the past few months, we were pleased with the performance of emerging market debt and many actively managed funds. In a rather sudden series of events, many of the trends changed direction and turned negative resulting in several funds being sold off early last week.

We attribute this turnaround to a few factors:

1) Rising US Treasury yields.

2) Speculation that the Fed will reduce bond purchases.

3) Fed indications that it will raise rates if the economy continues to improve.

Real Estate has experienced a strong pullback over the last few weeks. Looking over the course of the last 10 months, it is still a positive trend. But this trend could be changing soon, like bonds have.