What does it mean when your portfolio is up 10%?

By Bob Veres

You receive portfolio performance reports every three months—a form of transparency that financial planning professionals introduced at a time when the typical brokerage statement was impossible to decipher.  But it might surprise you to know that most professionals think there is actually little value to any quarterly performance information, other than to reassure you that you actually do own a diversified portfolio of investments.  It’s very difficult to know if you’re staying abreast of the market, and for most of us, that’s not really relevant anyway.

Why?

The only way to know if your investments are “beating the market” is to compare their performance to “the market,” which is not easy. You can compare your return to the Dow Jones Industrial Average, but that index represents only 30 stocks, all of them large companies.  Most peoples’ investment portfolios include a much larger variety of assets: U.S. stocks and bonds, foreign stocks and bonds, both including stocks of large companies (large cap), companies that are medium-sized (mid cap) and smaller firms (small cap).  There may be stocks from companies in emerging market countries like Sri Lanka and Mexico.  There may be real estate investments in the form of REITs and investment exposure to shifting commodities prices, like wheat, gold, oil and pork bellies.

In order to know for sure that your particular batch of investments outperformed or under performed “the market,” you would need to assemble a “benchmark” portfolio made up of index funds in each of these asset categories, in the exact mix that is in your own portfolio.  Even if you could do that precisely, daily, weekly and monthly market movements would distort the original portfolio mix by causing some of your investments to gain value (and become larger pieces of the overall mix) and others to lose value (and become smaller pieces), and those movements could be different from the movements inside the benchmark.  After a month, your portfolio would be less comparable to the benchmark you so painstakingly created.

Many professionals believe that there are several keys to evaluating portfolio performance in a meaningful way—and the result is very different from comparing your returns with the Dow’s.

1) Take a long view.  What your investments did last month or last quarter is purely the result of random movements in the market, what professionals call “white noise.”  But you might be surprised to know that even one-year returns fall into the “white noise” category.  It’s better to look at your performance over five years or more; better still to evaluate through a full market cycle, from, say, the start of a bull market to the start of a new bull market.  However, you should remember that there are no clear markers on the roadside that say: “This line marks the start of a new bull market.”

2) Compare your performance to your goals.  Your financial plan indicated that your investments needed to generate (let’s suppose) 5% returns above inflation in order for you to have a great chance of affording a long, comfortable retirement.  If that’s your goal, then chances are, your portfolio is not designed to beat the market; it represents a best guess as to what investments have the best chance of achieving that target return, through all the inevitable market ups and downs between now and your retirement date.  If your returns are negative over three to five years, that means you’re probably falling behind on your goals—and you might be taking too much risk in your portfolio.

3) Recognize that some of your investments will go down even in strong bull markets.  The concept of diversification means that some of your holdings will inevitably move in opposite directions, return-wise, from others.  Ideally, the overall trend will be upward—the investments are participating in the growth of the global economy, but not at the same rate and with a variety of setbacks along the way.  If you see some negative returns, understand that those are the investments you’re counting on to give you positive returns if/when other parts of your investment mix are suddenly, probably unexpectedly, turning downward.

That doesn’t mean you shouldn’t look at your portfolio statement when it comes out.  Make sure the investments listed are what you expected them to be, and let your eye drift toward the longer time periods.  Notice which investments rose the most and which were down and you’ll have an indication of the overall economic climate.  And if your overall portfolio beat the Dow this quarter, or over longer periods of time, well, that probably only represents white noise.

Not “If;” “When”

By Bob Veres

You’re starting to hear people talk about “if” there’s a bear market during the Trump Administration, when the real truth is they should be talking about “when.”  And it won’t necessarily be triggered by a poorly-worded tweet, a global-trade-stopping new tariff regime or tax and entitlement reform.  Every presidential cycle has its share of market draw downs, seemingly regardless of presidential policies.

You don’t believe it?  The accompanying chart shows the worst stock market draw downs for every president since Herbert Hoover in the 1930s, and you can see that good president or bad, Republican or Democrat, they all eventually experienced significant down markets.  Some might be surprised to see Ronald Reagan’s 25% and 33% drop from high to low, or the nearly 52% draw down experienced during George W. Bush’s presidency.  Weren’t these pro-business Presidents?

recessions

What the chart doesn’t show, but you know already, is that after every single one of these scary drops, the markets recovered to post new highs, which we’re experiencing today.  So don’t listen to anybody who talks about “if” the markets are eventually going to go down sometime in the next four years.  We’re going to experience a bear market—time, date, duration and extent unknown.  And then, if history is any indication, we’ll see new highs again eventually.

Higher Rates: The Tempest in the Teapot

By Bob Veres

Anybody who was surprised that the Federal Reserve Board decided to raise its benchmark interest rate this week probably wasn’t paying attention.  The U.S. economy is humming along, the stock market is booming and the unemployment rate has fallen faster than anybody expected.  The incoming administration has promised lower taxes and a stimulative $550 billion infrastructure investment.  The question on the minds of most observers is: what were they waiting for?

The rate rise is extremely conservative: up 0.25%, to a range from 0.50% to 0.75%—which, as you can see from the accompanying chart, is just a blip compared to where the Fed had its rates ten years ago.

The bigger news is the announced intention to raise rates three times next year, and move rates to a “normal” 3% by the end of 2019—which is faster than some anticipated, although still somewhat conservative.  Whether any of that will happen is unknown; after all, in December 2015, the Fed was telegraphing two and possibly three rate adjustments in 2016, before backing off until now.

The rise in rates is good news for those who believe that the Fed has intruded on normal market forces, suppressed interest rates much longer than could be considered prudent, and even better news for people who are bullish about the U.S. economy.  The Fed may have been the last remaining skeptic that the U.S. was out of the danger zone of falling back into recession; indeed, its announcement acknowledged the sustainable growth in economic activity and low unemployment as positive signs for the future.  However, bond investors might be less pleased, as higher bond rates mean that existing bonds lose value.  The recent rise in bond rates at least hints that the long bull market in fixed-rate securities—that is, declining yields on bonds—may finally be over.

For stocks, the impact is more nuanced.  Bonds and other interest-bearing securities compete with stocks in the sense that they offer stable—if historically lower—returns on your investment.  As interest rates rise, the see-saw between whether you prefer stability or future growth tips a bit, and some stock investors move some of their investments into bonds, reducing demand for stocks and potentially lowering future returns.  None of that, alas, can be predicted in advance, and the fact that the Fed has finally admitted that the economy is capable of surviving higher rates should be good news for people who are investing in the companies that make up the economy.

The bottom line here is that, for all the headlines you might read, there is no reason to change your investment plan as a result of a 0.25% change in a rate that the Fed charges banks when they borrow funds overnight.  There is always too much uncertainty about the future to make accurate predictions, and today, with the incoming administration, the tax proposals, the fiscal stimulation, and the real and proposed shifts in interest rates, the uncertainty level may be higher than usual.

A Market High—But Is It a Market Top?

by Bob Veres

In case you hadn’t noticed, the S&P 500 index reached record territory yesterday, and the Nasdaq briefly crossed over the 5,000 level before settling back with a more modest gain.  At 2,137.6, the S&P 500 finished above the previous high of 2,130.82, set on May 21, 2015.

We’ve waited more than a year for the market to get back to where they were before the downturn this January, before Brexit, before a lot of uncertainties in the last 12 months.  The market top itself is an uncertainty; after all, many investors regard market tops warily.  When stocks are more expensive than they have ever been (so goes the thinking) it may be time to sell and take your profits.  However, if you followed this logic and sold every time the market hit a new high, you’d probably have been sitting on the sidelines during most of the long ride from the S&P at 13.55 in June 1949, which was the bull market high after the index started at 10.  New highs are a normal part of the market, and it is just as likely that tomorrow will set a new one as not.  In fact, overall, the market spends roughly 12% of its life at all-time highs.

We all know that the next bear market will start with an all-time high, but we can never know which one in advance.  Market highs do not necessarily become market tops.  Let’s see if we can all celebrate this milestone without the usual dose of fear that often comes with new records.

New guidelines, better advice?

By Bob Veres

Most people think that the Securities and Exchange Commission (SEC) regulates the investment markets and providers of investment advice, and that the Financial Industry Regulatory Authority (FINRA) regulates the Wall Street sales agents.

But in fact, when it comes to your retirement plan, like a 401(k) account, the chief regulator is actually the United States Department of Labor.  Anybody who provides advice to these plans has to meet standards generally defined in the 1975 law known as ERISA (Employee Retirement Income Security Act), which is administered by the Department of Labor.

The list of retirement plan advisors is a long one.  There are independent financial advisors who receive fees directly for their work, and act in the best interests of the plan participants.  But many plans have been sold by insurance agents and brokers, who creatively introduce a growing array of hidden charges and fees and high-cost investments which, according to analysis by the White House Council of Economic Advisors, together have been quietly shifting roughly $17 billion a year out of the pockets of American workers into Wall Street bonus pools and insurance company coffers.

This month, the Department of Labor issued rules designed to stop these brokers and agents from working in their own interests rather than the interests of American workers.  The rule imposes iron-clad fiduciary requirements on anyone who provides investment advice to these plans or plan participants.  “Fiduciary” is a legal term that is grounded in case law, but essentially it means that the customer’s interests must be the priority when any investment recommendation is made.

In addition, the Department of Labor extended these new, stronger protective rules to anyone who recommends that consumers roll their money out of a retirement plan into an IRA.  Those investment recommendations, too, must also be made in the best interests of the customer.  This was intended to prevent insurance agents and brokers from recommending that their customers move money out of the newly-cleaned-up plan into the same high-commission products (like variable annuities and non-traded real estate investment trusts) that they had been recommending in the plan.

How well will this new set of rules protect consumers?  At this point, there is reason to be optimistic.  The larger sales organizations on Wall Street and in the insurance industry could be sued under this strict fiduciary standard if their brokers and agents continue their current practices, and they would be unlikely to prevail in court.  The safest course would be for these organizations to set up divisions made up of people who would be trained to recommend only lower-cost or high-performing investment options, meanwhile giving up the sly hidden fees that they have been collecting for decades.

Alas, the rule specifically states that existing arrangements will be grandfathered, which means that if you’re a participant in a plan at your workplace, you may not immediately feel the impact of new fiduciary obligations.  But over time, most companies are expected to take a closer look at their fee structure, and as they amend their plans, the money leaks will gradually be repaired.

Eventually, if the analysis is right and workers suddenly find themselves with, collectively, $17 billion a year more in their retirement accounts than they were getting before, we could see a difference in the number of people who can afford retirement.  The only losers would be Wall Street bonus pools, which, for most observers, actually makes this a win-win.

Cheaters, Thieves and Tax Havens

By: Bob Veres

Leaked information tells the story of prominent world leaders who avoided taxes or looted their country’s treasuries in order to squirrel away not only money, but expensive yachts, luxury homes, ownership of a candy company and investments in construction companies.  The Prime Minister of Iceland has already resigned as a result of the leaked client files of a Panamanian-based law firm that specializes in creating secret tax havens.

What, exactly, are we to make of the Panama Papers leak?

The sometimes shocking revelations that are making their way into news outlets is the result of a hack into the files of a giant Panamanian law firm known as Mossack Fonseca, which had apparently become the world’s go-to resource for kleptocrats and tax avoiders who wanted to hide assets away in shadowy offshore shell corporations.

The hackers ultimately sent 11.5 million records to the German newspaper Suddeusche Zeitung, which promptly shared the massive data trove with the various news organizations that are members of the International Consortium of Investigative Journalists.  Their analysis is far from complete, but what we know so far is what you probably already suspected: the leaders of certain countries like the Ukraine, Syria, Saudi Arabia and Russia have been squirreling away state resources into their own secret personal accounts, while prominent leaders in less corrupt nations have been quietly funneling money into offshore havens to avoid having to pay their fair share of taxes.  And this activity has apparently been going on for decades.

Nobody should be terribly surprised that close associates of Russian president Vladimir Putin—including cellist Sergei Roldugin, along with brothers Arkady and Boris Rotenberg—are connected to more than $2 billion in shadowy assets, some of which found their way back into Russia’s TV advertising business.   The Rotenbergs are also proud owners of seven British Virgin Islands-based companies that, in turn, control investment assets around the world.

Nor was the world astonished to learn that two cousins of embattled Syrian President Bashar Assad have been filtering tens of millions of dollars worth of the country’s oil revenues through numerous offshore accounts.  Former Iraqi interim prime minister Ayad Allawi managed, in his brief kleptocratic term in office, to secret away assets in a Panama-registered company called I.M.F. Holdings and a British Virgin Islands company called Moonlight Estates Ltd.

The embattled people of Ukraine are doubtless outraged to discover that Ukranian President Petro Poroshenko is sole owner of a British Virgin Islands firm that secretly controls a European candy factory, auto plants, a TV channel, a chocolate business and a shipyard.  And one wonders why Saudi Arabian king Salman Bin Abdulaziz Bin Abdulrahman Al Saud would want to hide assets offshore in several British Virgin Islands companies that hold $34 million in mortgages for luxury homes in London, and a fancy yacht that he uses for pleasure cruises.

The most immediate fallout from the released files is the resignation of the Prime Minister of Iceland, Sugmundur Gunnlaughsson, after it was revealed that the Panamanian law firm had secreted $4 million of bonds in his name through a British Virgin Islands shell company—assets he had never gotten around to revealing to the nation’s tax collector.

The list of offshore cheats also includes the former Prime Minister of the nation of Georgia, Argentine President Mauricio Macri, former Jordanian Prime Minister Ali Abu Al-Ragheb, former Qatari Prime Minister Hamad Bin Jassim Bin Jaber Al Thani, and some people whose names you might recognize: soccer player Lionel Messi and the late father of UK Prime Minister David Cameron, who apparently avoided British taxes for 30 years on his investment fund by employing accounts based in the Bahamas but incorporated in Panama.

High-ranking Chinese and Spanish officials, and six members of the British House of Lords also made the list.

As the hacked files are sifted through for more revelations, it reminds us that, while data security issues are a huge nuisance for all of us, they not an unalloyed evil.  Hacked files can sometimes lead to greater social transparency, and help us spot the people who cheat or steal, some of whom, by strange coincidence, happen also to be among the world’s wealthiest individuals.  But, if these assets are frozen by international monetary authorities, perhaps not for long.

Many Guns, Many Deaths

by Bob Veres

The recent news of three gunman shooting innocent civilians in San Bernardino, CA has prompted a number of news outlets to point out that this is nothing new.  Mass shootings—defined at shootings at a public place in which the shooter murdered four or more people, excluding domestic, gang and drug violence—are happening more than once a day in 2015.  Indeed, an interactive map that identifies each location since the December 2012 Sandy Hook shooting gives an alarmingly dense coverage of the U.S.  The map included in this article only shows the locations (deep red circles indicate places where more than one shooting took place), but the actual map (located here: http://www.vox.com/a/mass-shootings-sandy-hook) tells the actual date and location of each incident.

The total: 1,042 mass shootings, 1,312 people killed, 3,764 wounded.  These numbers are compiled by Mass Shooting Tracker, which, the website notes, is crowdsourced and requires that all circles on the map be verified with news reports.  It may be missing some incidents.

Despite these alarming numbers, mass shootings still make up a small minority of all firearm deaths in America—which total more than 32,000 each year.  However, contrary to what you may hear, two-thirds of those deaths are suicides, not homicides.  Nevertheless, when you add in all the statistics, in 2012, the most recent year that we have accurate numbers, there were 29.7 firearm related deaths per 1 million Americans.  The comparable statistic in Canada: 5.1.  In Germany, the rate is even lower: 1.9 per 1 million citizens.  One possible explanation for a violent death rate that is orders of magnitude higher than other countries: more guns.  The U.S. makes up about 4.4% of the total global population, but owns 42% of the world’s civilian-owned guns.