Research Director’s Monthly Comment: February 2017

Surprises In Retirement

 I recently read an interesting article in the Wall Street Journal about things people did not anticipate in retirement.  As financial planners, retirement and retirement planning comes up lot in our work with clients.  In reading the article, a couple of things stood out about what folks saw as the biggest surprises in retirement: 1) what happens when you take risks; and 2) retirement nest eggs are working as planned.

 By “taking risks”, the interviewees were talking about trying something that was out of their comfort zones usually in a way that improved their lives or tapped a long-desired but postponed endeavor, like painting or music. The arts are one of the best ways to plumb the human soul, a soul that can get squelched over 30-40 years of corporate life. The “risk” for people doing this in retirement was the deep fear of being no good at it, or feeling they would never be able to learn something like art or music. It is a good thing that at this point in their lives, these folks feel they can take the risk and get closer to their own souls.

The other interesting surprise was that, at least for these interviewees, their retirement nest eggs were working out as planned. Granted, most of these folks were retired corporate or professional types. As a group, I would believe these types of folks were/are more inclined to be more disciplined about retirement savings. They were lucky, but they also had discipline around retirement savings and investment. The point of this is virtually all of us can significantly improve our odds of a happier retirement through disciplined savings and investing.

 

Another interesting surprise that many of these people found out was the realization that you will spend 100% of your pre-retirement income in retirement. We always assume in our retirement expense assumptions that people will spend at a level at least equal to that of their working years particularly in the first 10-15 years of retirement. We also include an expense projection for medical costs. A number of the interviewees mentioned that medical insurance premiums were growing at a rate higher than they anticipated and this was a concern for many of them. We believe incorporating medical cost projections into a retirement capital projection is imperative.

 

One parting thought on achieving a happier retirement: one needs to act proactively to prepare as best they can financially. This preparation takes discipline: discipline in savings, investing, and spending. A sound financial plan that includes a retirement capital analysis can also help in achieving this important goal (financial preparedness) and in achieving peace of mind that one has done all one can to prepare for it.

 

Bob Toomey, CFA®/CFP®

Vice President, Research

Research Director Monthly comment: January 2017

Fearless Forecasts and Financial Planning

 

This time of year in our industry, we get all the pundits out with their fearless forecasts for the financial markets for the coming year. After reading these for the past 30 years, I have come to learn that these forecasts have to be taken with a grain of salt. Why? Because statistics show that the pundits are correct about half the time, the statistical equivalent of a coin toss.

An interesting irony this year, and one thing that has been quite confounding to the pundit crowd of late, has been the recent Presidential election. Most pundits had assumed if Trump won, the stock market would tank. As the market usually does a good job confounding the consensus, it is up about 9% since the election and has been recently achieving new record highs.

What is behind the gain in the market that has confounded the experts? Primarily the belief the new administration will actually succeed in implementing several things that are favorable to business. This includes a reduction in corporate tax rates, potential for increased infrastructure spending, and potential for reduction in business regulations. All of this has positive implications for corporate profits, which is the primary driver of stock prices. And with a Republican majority in Congress, a lot of this may actually get done. Some people say it’s crazy, it’s not real. But the market is simply reacting logically to what it perceives may happen.

A corollary to this is while many pundits have been forecasting tepid gains for the stock market in 2017 (consensus is 5-7% total return), there is reasonable potential for the market to return more than this, perhaps significantly more, if these changes and legislation come to fruition. They would have a powerful effect on corporate profits, which may not be fully discounted yet by the market.

So what does all this have to do with financial planning? To be truthful, not much. We don’t put a lot of “stock” in the forecasts of the great “punditry”.  Similarly, when we put together a financial plan and set an investment policy, we don’t try to guess what the market is going to do (i.e., time the market); rather we look at long-term trends in returns in asset classes which we believe provide a better guide for estimating long-term growth in client assets. By diversifying portfolios across multiple asset classes, we capture growth in those asset classes while reducing portfolio volatility and delivering a more stable long-term return. True, while an all-stock portfolio may outperform a diversified portfolio in a strong equity market, an all-stock portfolio will most likely have materially greater downside than a diversified portfolio in a severe stock market decline. This is borne out in the long-term record of diversified portfolios, which have delivered superior risk-adjusted returns than an all-stock portfolio primarily because they are less volatile. We believe risk-adjusted return is arguably the most important measure of performance in wealth management.

 

1Q-17 Investment Committee Meeting Summary

We held our 1Q-17 investment strategy meeting on December 21, 2016. It was an interesting and fairly momentous meeting given the recent Presidential election. The outcome of the election adds an element of uncertainty that makes forecasting a bit more difficult currently. While there has been a lot of media coverage about what Trump’s strategies may be in areas such as foreign and domestic policy, defense policy, taxation, healthcare, and fiscal policy, it is still uncertain how all this will play out.

Based on what we have seen so far, it would appear that a Trump administration could be reasonably pro-business. Trump himself comes from the business sector and appears to be bringing into his cabinet a number of people with high profile business backgrounds. If the new administration is going to take more of a “pro-business” approach, on the surface it would appear to have positive implications for the economy and hence, the stock market. But again, at this point, “visibility” into the new administration and its policies is limited.

As of now, there does appear to be better visibility for some of the key factors that drive the stock market, the two most important being valuation and corporate profits. After 4-5 quarters of declines, corporate profits are now expected to grow 8-10% in 2017, which is a positive. Stock valuation is not exceedingly high. We estimate the forward P/E on S&P500 is now about 17x. This is above the long-term average of about 15x but not in a range that would be a material impediment, in our opinion, and certainly not excessive when compared to bond yields. The outlook for the U.S. economy remains stable. We continue to expect more of the “2+2” economy: 2% GDP growth and 2% inflation. And while we believe the Fed will raise rates again in 2017, we expect it will remain cautious and deliberate in its moves, which should not be overly disruptive to the stock market. These factors support a continued constructive outlook for U.S. equities. China and its economy, in our view, continues to be the greatest risk for global financial markets and is one reason why we decided at our meeting to eliminate a position in emerging markets.

With respect to changes in your portfolios following the meeting, overall equity exposure was reduced very slightly, about 2%, while fixed income exposure remained essentially unchanged. The slightly lower equity exposure should help to buffer against what could be increased market volatility in the new year. Within sectors, we slightly reduced our exposure to mature equity and increased exposure to small cap stocks. We think smaller cap stocks could stand to benefit more from the potential for lower business taxes currently being discussed by the incoming administration. Within the international sector, we eliminated exposure to emerging markets and added a position in large-cap European stocks. The investment in European stocks is based primarily on valuation which remains very attractive. We reduced our exposure to REITs by about 8% as we believe returns in the sector could be more muted in a rising interest rate environment. Within commodities/natural resources, we eliminated positions in gold and energy and replaced these with the Flexshares Global Upstream Natural Resources ETF (GUNR). We like this ETF because it has nicely balanced exposure across five important areas: energy, metals, agriculture, timber and water. Within the fixed income area, there were no significant changes and we continue to maintain a shorter duration by overweighting shorter-term bonds and underweighting long-term bonds.

All of us at S.R. Schill & Associates wish you and your family a very happy holiday season and a happy New Year !

Bob Toomey, CFA®, CFP®
Vice President, Research

Research Director’s Monthly Commentary: December 2016

Biggest Money Mistakes

 Recently, a major Wall Street newspaper ran an article entitled “Biggest Money Mistakes By Decade” which caught my interest. We see big money mistakes quite often in our practice as financial planners. Money mistakes can come in many forms: poor estate planning; speculating with retirement money (e.g., day trading); taking on too much personal debt; emotionally-driven purchases, such as a big boat or second home, that are outside of one’s financial capacity; poor savings discipline; etc…the list goes on and on.

 
The article highlighted several “mistakes” that that I thought were noteable. One was the somewhat paradoxical mistake of “playing it safe”. One would think “playing it safe” in investing is a good thing, but from a long-term planning perspective, it can have serious negative consequences. This appears to be a problem for the younger set, millenials and GenXers. This group, which saw their parents’ portfolios crushed in the 2001 and 2008 bear markets, appear to be avoiding stocks and favoring guaranteed income. Two big problems with this strategy: 1) rates of return on guaranteed income products are now quite low implying locking in low returns; and 2) by avoiding stocks they are not capturing enough growth in their portfolios to build adequate retirement resources. The long-term rate of return on large cap stocks is about 10% per year. This is where, for most people, the bulk of their asset growth comes from. Not capturing this growth can seriously impair one’s ability to reach their retirement goal.

 The article talked about the “nightmare scenario” of having to “catch up” later in one’s life (50s and 60s)  because of a lack of retirement savings. This happens to be huge problem for my generation, the baby boomers, who adopted a “live for today” mentality. Well, the chickens have come home to roost and that mentality has led to, for many boomers, a not so happy retirement outlook and potentially a struggle in the retirement years; and social security won’t be nearly enough to offset their lifetime savings deficit. This gets back to the point of how important disciplined savings is: it pays off in the long run. For example, using current IRA contribution limits of $5500 per year up to age 49 and $6500 per year over age 50, if we assume a person averages an IRA contribution of $5500 per year for 40 years (age 25-65) growing in a diversified portfolio returning about 7% per year, this savings at age 65 amounts to $1.17 million. Not bad for $5500 per year. To avoid some form of disciplined savings is a huge money mistake.

One other mistake the article points out that can be significant for many people is the mistake of not delegating financial responsibility, particularly as one gets older, like 70s and 80s, where cognitive impairment can be a problem. I would also add to this situations where one is smart enough to know they need help…..at any age. For many people, to try to “wing it” on their own can lead to big financial mistakes in the areas of spending, savings, estate planning, and investments. This is where sound financial planning and working with a planner you trust can offer significant benefits. What are some of these benefits? A financial plan provides a “roadmap” that imparts discipline around the key areas of spending and savings that are critical to achieving retirement goals. A good financial plan also includes a customized investment strategy that enables the client to meet their financial objectives (retirement, estate, education, philanthropy, etc) with lower risk. Additionally, studies have shown that working with a financial planner may result in higher retirement income and a larger estate*.  Another important benefit of working with a financial planner is the peace of mind knowing you have a plan (“roadmap”) and are taking rational concrete action to improve your odds of achieving your financial goals, whatever those may be.

 

As we move rapidly towards year end, you may want to reflect back on 2016 and what might be your biggest money mistakes right now…..and what steps can you take now to address them.  

 
I wish you and yours a very happy holiday season and a happy, successful 2017 !

 

* “Working With An Advisor Important To Retirement Savings”, Financial Advisor Magazine, April 25, 2013

 

Research Director's Monthly Commentary - November 2016

Fall Foliage: Variations on a Theme

Having grown up on the northeast, the autumn season always had a special significance, not just for the pretty foliage but also as a harbinger of change. But what change you ask? Lots: the advent of snow and ski season, "fun" winter driving conditions, the end of mosquito season (!!) to name but a few.

 

So what does this have to do with financial planning? A lot actually. Like the changing leaves in the fall, our lives and life circumstances are constantly changing. From a financial planning perspective, changing life circumstances can (and usually do) result in changing financial prospects that in turn, raise questions about our financial goals (such as retirement, estate planning, or kids’ education goals). A change in job status or health can also result in a change in financial prospects, which can call into question one’s ability to meet financial goals.

The good news is most if not all of the financial planning issues raised by changing life circumstances can be captured in a financial plan. Our work with clients presents myriad differing life circumstances and goals. The tools we use for developing a financial plan (primarily comprehensive planning software) enables us to model a wide range of financial circumstances and goals and probability of achieving these goals. The other bit of good news about the planning process is it goes a long way to putting clients’ fears and anxieties at ease and enables them to move forward more confidently knowing a) they have a financial plan and b) doing something to take charge of their financial prospects through the discipline that a financial plan offers.

Changing prospects for the financial markets are also part of the theme of “change”. We cannot predict the short-term course of the financial markets but we know assumptions about the outlook for financial markets will change. This invariably results in market volatility, which by the way, is one constant for the markets: while we don’t know what the financial markets will do in the short term, we know there will always be volatility in the markets (and sometimes it can get severe, as in a bear market).

 Right now, based on economic fundamentals (i.e. corporate profits, inflation, etc), we think the prospects for the stock market remain favorable. One “little” issue going on now for the markets, is the upcoming presidential election. While we don’t anticipate extreme volatility regardless of who wins, there could certainly be some increased volatility associated with the outcome. We handle portfolio volatility through a) due diligence in research and securities selection in client portfolios and b) employing a diversified investment strategy. This means holding multiple asset classes (e.g. stocks, bonds, international, real estate, natural resources, etc.). Because these asset classes have varying correlations to each other, this helps to dampen portfolio volatility. So while the market may “change” through increased volatility, long-term risk-adjusted return (IMO the most important measure of performance in wealth management) should benefit through the lower volatility of an appropriately diversified portfolio.

 

Bob Toomey, CFA, CFP

Research Director

S.R. Schill & Associates

November 4, 2016

Research Director’s Monthly Commentary, September 2016

Q4 Investment Strategy Meeting Summary

We held our Q4 investment strategy meeting on September 28, 2016. With respect to macro fundamentals, we do not see much change from last quarter’s meeting. We view the U.S. economy  currently mired in a “2% world”, meaning 2% GDP growth and 2% inflation. The U.S. economy is actually growing less than 2% so far this year, but we expect some acceleration in second half GDP growth. There are signs that U.S. inflation may be accelerating somewhat as a result of moderate upward pressure on wage growth; however, at this point, we continue to expect overall inflation to remain moderate. In terms of the global outlook, it appears that China’s economy has stabilized as a result of government measures to prop up growth; however, the estimated long-term growth rate for China’s economy is coming down. While the stabilization in China’s economy is positive for global growth, the slower expected growth in China could act as an additional factor keeping global growth relatively subdued.

We continue to view Federal Reserve policy as accommodative to the financial markets. It is clear from last week’s FOMC meeting that the Fed continues a relatively light hand with respect to interest rates. While we expect a fed funds rate hike in December, the latest FOMC meeting shows that the Fed has backed off its expected number of rate increases for 2017 and 2018 with the majority of FOMC now expecting only two rate hikes in each year, down from the previous four in each year. This is significant and indicates the Fed expects to remain gradualistic in its approach to monetary policy. The implication of this for the financial markets is positive, particularly for equities. This plus an improving outlook for corporate profit growth are reasons why we remain constructive towards stocks.

We made several tactical changes to your portfolios following the meeting. We increased exposure to equities slightly. Within the mature (large cap) equity area, we added a position in the biotechnology industry (IBB) as we believe health care remains an attractive secular growth story and biotech in particular appears undervalued. Within developing equity, we added a position in small cap value stocks (VBR), which we believe offer attractive value. We also continue to maintain a position in the homebuilding industry (ITB) which we view as one of the strongest sectors of the U.S. economy. Within the international sector, we added a small position in the emerging markets area (VWO) as we believe that sector will benefit from stabilization of the Chinese economy. Within natural resources, we added a position in energy (XLE) as we believe the outlook for oil prices should improve and valuation remains relatively attractive. Our overall exposure to fixed income remained unchanged. While we reduced exposure to long bonds, we increased exposure to short maturity bonds and increased portfolio yield through the addition of a shorter-term high yield bond ETF (SHYG).

In our objective to manage risk in your portfolios, we set a “trigger” at our meeting that would  cause us to reduce market exposure under certain conditions. The reason for this is our concern over the potential for increased market volatility around the upcoming presidential election. Historically, the presidential election can be a time of heightened stock market volatility and we believe it could be somewhat more acute this time. Our trigger is based on a combination of two factors: the combination of 1) a closing price on the VIX (forward implied CBOE volatility index) exceeding 20.0; and 2) a closing price on the S&P500 below 2000. We believe this combination would signal to us that market volatility may be increasing at a pace faster than we feel comfortable with and which would justify some action to reduce exposure.

Research Director’s Monthly Commentary August 2016

Being Prepared

 
As an avid hiker having spent many wonderful trips on the trails of our beautiful Cascade Mountains, one thing one learns is how important it is to be prepared out in wild. Prepared for what? A number of things: hiking mishaps, injuries, getting lost, blisters, water and food issues, to name a few. For example, on one trip into the Olympic Mountain National Forest, I had forgotten to pack a critical component of my camp stove. I did not find out about it until the first evening, eight miles from the trailhead (and another two-hour drive back to the nearest supply store!). I “prepared” for a mishap like this by remembering to pack matches to start a camp fire. In another “mishap” on a trip to the Enchantments, I slipped on loose gravel on a downslope and re-injured an earlier tear of my left quad tendon. I had nothing for an injury like this. Fortunately, one of my buddies had packed a self-adherent leg wrap that greatly helped me continue the journey; but we still had to cut the trip short because of the re-injury. I was NOT prepared for this. Not a good Boy Scout on that trip!

In hiking and mountain climbing, preparing for contingencies is critically important. This is no different with financial planning. There are many ways financial planning helps one to “be prepared” for the unforeseen.  What are these “unforeseen” events? Unexpected changes in your life or health, unexpected changes in the financial markets, or unexpected changes in your estate plan to name a few.

 

Financial planning is flexible. One thing that can be done to improve one’s preparedness for contingencies is running multiple planning scenarios. The process of iterative “scenario analysis” can provide great insight into how different life events or life changes can impact one’s financial future. From this analysis, we can adjust or fine tune spending, savings, and investment plans.

An integral part of our planning process is setting an investment strategy for each client in accordance with their financial plan. As part of preparing for the inevitable volatility of the financial markets, we embrace a diversified investment strategy. This entails investing client assets in multiple asset classes such as stocks, bonds, real estate, international, etc. Why? It has been shown that diversified portfolios exhibit lower volatility and higher risk-adjusted returns over time. We know the financial markets will be volatile and we can take proactive steps to prepare for and mitigate this factor in client portfolios.

 

Another way financial planning prepares one for uncertainty is the planning process itself. A disciplined review of one’s finances, spending, contingency planning, and an annual review all help to provide greater clarity, reduce financial risk, and improve confidence in one’s outlook for the future. It also places one in a stronger position to weather unforeseen changes or events by having a stronger financial position and discipline to stick with the plan for the long term. An insurance needs analysis can also be incorporated into a financial plan to provide not only financial risk assessment but also risk mitigation measures that can help one prepare for and protect against catastrophic and unforeseen financial mishaps.

 

Bob Toomey, CFA®/CFP®

Vice President, Research