Month: August 2019

Sixteen Ways to Manage a Concentrated Position

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Warren Buffett, Bill Gates and Jeff Bezos bet on themselves by concentrating most, if not all, their wealth in their company stock. Shares of Berkshire Hathaway, Microsoft, and Amazon have created enormous wealth for these billionaires, and they’re currently the three wealthiest individuals in the United States.

A concentrated equity position is a blessing and a curse. Shareholders of Berkshire Hathaway, Microsoft, and Amazon have enjoyed significant price appreciation and wealth creation from their stock holdings.  Investors in Enron, Lehman Brothers, and WorldCom lost everything.

What is a concentrated equity position? A stock position accounting for more than 25% of your investable assets is considered concentrated. Your definition may vary depending on your appetite for risk. It can be as low as 5% or more than 50%. You may have acquired your stock through incentive stock options, restricted stock grants, an employee stock purchase plan, 401(k) contributions, company bonus, or acquisition. Regardless, protecting your asset should be a primary goal.

Concentration is a great way to create wealth; diversification is the best way to keep it. Dealing with a large stock position presents unique challenges.

Let’s examine a few strategies to help you manage your position. The ideas range from holding your stock to giving it all away. As a note, these strategies assume your shares are free and clear, and you’re not subject to insider information, trade windows, lockups, vesting, or other restrictions. If you’re not sure, please check with your corporate counsel or attorney.

Hold. Retaining your current position may pay dividends, especially if you want to increase your wealth. As we have seen, this strategy has treated Warren Buffett, Bill Gates, and Jeff Bezos well. Your tolerance for risk is a factor if you want to retain your shares as some stocks carry more risk than others. For example, Amazon has a daily standard deviation of 3.7%, Pepsi’s is 1.53%, and Beyond Meat is 8.7%. Holding your stock will also allow you to defer your gains if you own them in a taxable account.

Sell. Selling your shares is the fastest way to reduce your position and diversify your holdings. However, if you sell your shares in a taxable account, it can trigger substantial capital gains.

Direct Gift. A direct gift to your favorite charity is efficient and straightforward. In transferring your shares to a charity, you’ll be able to deduct the fair market value of your gift at the time of the transfer. The charity can sell your shares in their account and avoid capital gains.

Gift to Children. You can gift your shares to your children, but they’ll retain your cost basis. This strategy will reduce your estate while building up theirs. You’re allowed to give away $15,000 per person, per year so donating stock to your kids below this threshold does make sense.

Retirement Account. If you hold your stock in your 401(k) or IRA, you can sell them without tax consequences allowing you to reduce your position and diversify your assets. Distributions from your retirement account are taxed as ordinary income, and you won’t be able to take advantage of more favorable capital gain rates.

Qualified Charitable Deduction (QCD). If you’re older than 70 ½, the government allows you to distribute up to $100,000 to charities directly from your IRA. This type of distribution will satisfy your required minimum distribution (RMD). For example, if your RMD is $100,000 and you donate $40,000 to your favorite charity, then your taxable distribution will be $60,000. You won’t be able to deduct your charitable contribution since it’s being sent directly from your IRA.

Net Unrealized Appreciation (NUA). The net unrealized appreciation allows you to transfer shares of your employer stock from your 401k to your taxable account at a more favorable tax treatment than a distribution. The NUA is the difference between the fair market value and your cost basis.[1] When you receive your shares from your plan, only the cost basis is taxed. The remainder will be taxed as capital gains when you sell your shares. For example, at the time of your distribution, your cost basis is $25 per share, and the fair market value is $60. The $25 is taxed as ordinary income, the remainder, $35, will be taxed at long-term capital gain rates when the shares are sold. If the stock rises to $80 per share, then the $20 gain above $60 will be short or long-term depending on when they are sold.[2] If your shares had been withdrawn from your IRA, without the NUA, your entire $60 position would be taxed as ordinary income.

Put Options. If you want to hold your shares, but you’re concerned about a falling stock price, you can purchase put options. Put options increase in value when stocks fall. It’s a short-term insurance policy against a market decline. This strategy allows you to retain your stock, but at a price. Buying put options to protect your shares is expensive, especially if you repeat the process a few times a year. Let’s look at buying put options to protect 10,000 shares of XYZ Inc. trading at $215 per share. The January 2020 $215 strike price is offered at $15.75 per contract, so protecting your shares will cost you $157,500. One contract equals 100 shares of stock. If XYZ Inc. falls below the $215 strike price at expiration, the option will increase in value. If XYZ Inc. closes above $215 at expiration, you’ll lose 100% of your proceeds on the put purchase. If the put is losing value, your stock is gaining value. Ten thousand shares of XYZ Inc. at $215 per share equals $2.15 million. The put purchase represents 7.3% of your holdings. You can sell your option at any time before it expires in January.

Call Options. A call option replacement strategy allows you to sell your equity shares and purchase a corresponding amount in the form of call options. The ratio is 100 shares to 1 option contract. If you own 10,000 shares, you can buy one hundred contracts. This strategy allows you to sell your stock but maintain a position in the company at a reduced amount through your option contracts. For example, 10,000 shares of ABC Inc. are currently worth $2.2 million at $220 per share. The January 2020 $220 strike price has a current price of $14.25 per contract, so 100 contracts cost $142,500. The contract value represents about 6.5% of your stock holdings. If you sell your shares, you can use a small percentage of the proceeds to buy the option contracts and diversify the remainder. The downside is that you’ll pay taxes when you sell your shares.  Another disadvantage is the call option has a limited life; it will expire on January 17, 2020. If ABC Inc. is trading above $220 at the time of expiration, the call option will finish in the money, and you can take your gains. If ABC Inc. is trading below $220, your option will expire out of the money, and you’ll lose 100% of your investment.

Option Collar. A collar utilizes calls and puts to generate income and protect your equity position. The collar surrounds your stock. For example, If ABC Inc. is trading at $220 per share, you can sell a call option at $220 to generate income and buy a $210 put to protect the downside. If ABC Inc. rises above $220 at expiration, you must sell your shares at $220 regardless of how high the market price rises above the strike price. If ABC Inc. falls below $210, your put option will protect the downside. The ABC Inc. January $220 call strike price is currently selling for $14.25 per contract. If you own 10,000 shares, you will sell 100 contracts to generate $142,500 in income (before fees). The ABC Inc. January $210 put currently costs $13.25, so your cost to purchase the put is $132,500. The call generated $142,500 in income, and the put cost you $132,500, for a credit of $10,000. The collar can be widened or narrowed based on your situation. If the collar expands, you’ll generate less revenue.

10b5-1 Plan. A 10b5-1 plan allows insiders to sell their stock holdings without regard for trade windows, corporate events, or insider activity. You can determine the number of shares, price limit, and duration. If the price of the stock trades at your limit, the shares will be sold regardless of a trade window or other insider activity. For example, if you want to sell your shares at $100, then they’ll be sold at that price or higher.[3]

Donor-Advised Fund (DAF). A Donor Advised Fund allows you to transfer appreciated shares to the fund. Once inside the DAF, you can sell your shares and purchase new investments without realizing a capital gain. You can deduct the contribution from your taxes, and it occurs in the year of your gift, not in the year of distribution. You don’t have to distribute the proceeds immediately, so if you’re not sure which charities to support, you can defer the payment until you identify the organizations. For example, if you transfer $100,000 worth of ABC Inc. stock to your Donor Advised Fund, sell it, reinvest the proceeds, and then send a portion of the funds to your favorite charity. The funds that remain inside your DAF will grow tax-free.

Charitable Remainder Trust (CRT). This trust allows you to transfer your shares to a Charitable Remainder Trust, sell your holdings, diversify your assets, and receive income from the proceeds. At your death, the remainder of the trust assets will be sent to your pre-determined charity. The stock, once transferred, can be sold free of taxation and the proceeds reinvested into a diversified portfolio of stocks, bonds or funds. Your contribution to the trust qualifies for a charitable deduction. The amount of income you can receive from the trust is between 5% and 8% of the portfolio value. You will pay ordinary income tax on the income you receive.

Exchange Fund. As the name implies, you exchange your shares for a basket of stocks allowing you to defer your gains. The minimum is steep, and you’re required to hold the fund for several years.  According to a Forbes article on exchange funds, the minimum investment for some funds is $5 million with a required holding period of seven years.[4]

Private Annuity.  A private annuity works well with colleges and universities. If you donate your stock to your alma mater, they can establish a private annuity for you so that you can receive income for life or a certain number of years. Your alma mater can sell the stock free of taxation and use it to fund their operations. You’ll get a deduction based on the fair market value of your gift.

Pledged Asset Line (Loan). If you’re heavily concentrated in stocks and you need liquidity, consider a pledged asset loan. The amount of your loan is based on the equity of your investment holdings, like a line of credit on your home. The loan will allow you to access capital without selling your investments and realizing capital gains. If your holdings aren’t restricted, this strategy makes sense, and it’s a better option than using margin to access the capital in your account.

The only difference between death and taxes is that death doesn’t get worse every time Congress meets. ~ Will Rogers

August 29, 2019

Bill Parrott is the President and CEO of Parrott Wealth Management firm located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. Options involve risk and are not suitable for every investor. Please consult your CPA or tax advisor before implementing any of these strategies to see if it makes sense for your situation.

[1] https://www.investopedia.com/terms/n/netunrealizedappreciation.asp#targetText=The%20net%20unrealized%20appreciation%20(NUA,market%20value%20of%20the%20shares., Reviewed by Alicia Tuovila, July 1, 2019

[2] Cannon Financial Institute: A Complete Library of Essential Financial Concepts, 2008. Net Unrealized Appreciation page 538.

[3] https://www.investopedia.com/terms/r/rule-10b5-1.asp, Reviewed by Will Kenton, updated on April 2, 2019.

[4] https://www.forbes.com/sites/agoodman/2016/01/10/one-way-some-wealthy-investors-can-avoid-big-capital-gains-taxes/#1680ec4f324e, Andrew Goodman, 1/10/2016

The Crow and the Pitcher

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The Crow and the Pitcher is a famous Aesop fable. The crow is thirsty and stumbles across a pitcher of water, but he can’t reach the water because the neck of the pitcher is too narrow. The crow picks up small rocks and pebbles to drop them into the pitcher and raise the water level. His plan works, and he’s able to get his drink.

As investors, we can learn much from the action of the crow. If we invest a little money systematically, it will eventually grow.

Investing $100 per month into Vanguard’s S&P 500 index fund grew substantially over time. Here’s how much the account balance was worth after each decade.[1]

  • 10 years = $23,812.
  • 20 years = $64,815.
  • 30 years = $180,228.
  • 40 years = $673,745.

Ignore the market turbulence, invest always, focus on your long-term goals, and good things will happen.

A bird is three things: feathers, flight and song, and feathers are the least of these. ~ Marjorie Allen Seiffert

August 27, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

Illustration credit = Campwillowlake

 

[1] Morningstar Office Hypothetical. VFINX, month end July 31, 2019.

How to Survive A Recession

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Hurricane Harvey blasted Texas and left a trail of debris in its wake. The refineries couldn’t produce gasoline, and, as a result, Texans faced a gas crisis. As pumps ran dry, people panicked and emptied grocery stores and ATM’s. It was a few days of bedlam.

Barron’s Magazine this week ran several stories about preparing for the worst. One article had the ominous headline: “9 Meals Away from Disaster.” In the article, it quoted British MI5 as saying: “At any given time, we’re nine meals away from anarchy.”[1] Nine meals equate to three days’ worth of food. If Texans panicked over a lack of gas, can you imagine the reaction people would have if they couldn’t feed their families?

Since the Dow Jones peaked July 23rd, it has fallen 6.25% as investors react to recession fears. The Twitter Trade war escalated this past Friday, sending the Dow down by 623 points, or 2.4%. Also, interest rates are inverting, a semi-valuable predictor of recessions. Currently, the 1-month Treasury rate is 2.07% while the yield on the 30-year is 2.02%. You earn more interest in 30 days than you do for 30 years.

What exactly is a recession? Here’s a definition from Investopedia: “A recession is a macroeconomic term that refers to a significant decline in general economic activity in a designated region. It is typically recognized after two consecutive quarters of economic decline, as reflected by GDP in conjunction with monthly indicators like employment. Recessions are officially declared in the U.S. by a committee of experts at the National Bureau of Economic Research (NBER), who determines the peak and subsequent trough of the business cycle which demonstrates the recession.”[2]

A recession is identified by a “committee of experts” after they determine the “peak” and “trough” of the business cycle. In other words, we won’t know we’re in a recession until it’s almost over.

If GDP (Gross Domestic Product) is the barometer, how’s it doing? Currently, real GDP growth is 2.1%. Since 1947 it has averaged 3.2%.[3] During the Great Recession (2007 – 2009) GDP growth bottomed in the fourth quarter of 2008 when it fell 8.4%. In 1954 GDP growth fell 10%.

Since March 1989, GDP has averaged 2.5%. During the past three decades, we’ve had 110 quarters with positive growth and 12 negative ones. We’ve had three recessions: 1989, 2001 and 2008, or about once in every ten years. Below is a chart of the GDP growth with a recession overlay.

IUSRGDPG_chart

How did the market perform over the past 30 years? Since August 1989 it has risen 966.7%. The Dow Jones closed at 2,402.68 on August 24, 1989. It closed at 25,628.90 yesterday. During the Great Recession, the market started to rebound in March 2009, six months before GDP growth turned positive and the recession was declared over.

What should you do if we’re on the edge of another recession? Here are a few suggestions.

  • Buy Gold. From 2007 to 2010 gold (GLD) appreciated 120%. Since 2011 it’s down 5.15%. The precious metal performs well during times of fear, chaos, and duress.
  • Buy Bonds. Long-term bonds soared 28% in 2008. During the Great Recession, they were up 6.4%.
  • Buy Small Caps (Maybe). During the last recession, small-cap stocks rose 3.84%, primarily due to their lack of financial leverage.
  • Raise Cash. Money market funds, savings accounts, or T-Bills will allow you to pay your bills and preserve your assets. How much? According to Mark Zandi, Chief Economist at Moody’s Analytics, recessions last about ten months.[4] So, if you’re concerned about a prolonged recession, then keep two to three years’ worth of household expenses in cash or short-term investments.
  • Store Cash. Keep a few thousand dollars in your household safe in the unlikely event you can’t access your bank or ATM.
  • Buy Stocks. The best time to buy stocks is when everybody else is selling. Wealth creation starts during bear markets. When fear is high, values are low. It takes courage to buy when others are selling. Sir John Templeton bought 100 shares of every stock on the New York Stock Exchange trading below $1 during the Great Depression. His two investment themes were “avoid the herd” and “buy when there’s blood in the streets.” He died in 2008 with a net worth of $13 billion.[5]
  • Doing nothing is a prudent strategy. A balanced portfolio of large, small, and international stocks and bonds produced an average annual return of 7.42% from January 2007 to July 2019. Investing monthly, through the recession, improved your performance to 8.4% per year. If you bought the portfolio on January 1, 2007, and sold on December 31, 2010, you would have made 3.13% – not significant, but positive.[6]  A buy and hold investor survived the Great Recession by doing nothing.
  • Reduce Debt. The last ten years have treated investors well, and you may have substantial capital gains. If so, take your profits and pay off your debt. Reducing your debt level will allow you to survive a recession if your cash flow drops.
  • A recession impacts human capital. If you’re fortunate enough to have financial assets, use them to help others during a time of crisis. Your gift may allow another family to recover from the pit of despair.

Recessions are frightening to be sure. However, no one can predict when, where, or how they’ll arrive. It’s impossible to forecast what factor will take down our economy, and no two recessions are alike. You will die a thousand deaths worrying about an economic collapse, especially if you’re watching the evening news or reading social media sites.

Jesus said it best in Matthew 6:25-34: “Therefore I tell you, do not worry about your life, what you will eat or drink; or about your body, what you will wear. Is not life more than food, and the body more than clothes? Look at the birds of the air; they do not sow or reap or store away in barns, and yet your heavenly Father feeds them. Are you not much more valuable than they? Can any one of you by worrying add a single hour to your life? “And why do you worry about clothes? See how the flowers of the field grow. They do not labor or spin. Yet I tell you that not even Solomon in all his splendor was dressed like one of these. If that is how God clothes the grass of the field, which is here today and tomorrow is thrown into the fire, will he not much more clothe you—you of little faith? So do not worry, saying, ‘What shall we eat?’ or ‘What shall we drink?’ or ‘What shall we wear?’ For the pagans run after all these things, and your heavenly Father knows that you need them. But seek first his kingdom and his righteousness, and all these things will be given to you as well. Therefore, do not worry about tomorrow, for tomorrow will worry about itself. Each day has enough trouble of its own. 

I been to the edge, an’ there I stood an’ looked down. ~ Van Halen, Ain’t Talkin’ ‘Bout Love

August 24, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

 

 

 

[1] 9 Meals Away from Disaster. Financial Advisors on How to Prepare for the Worst. Mike Zimmerman, August 23, 2019

[2] Investopedia, Recession definition, reviewed by Jim Chappelow, Updated May 6, 2019

[3] YCharts US Real GDP Growth

[4] https://www.usatoday.com/story/money/2019/08/19/recession-what-does-mean-and-what-like/2030642001/, Janna Herron, August 19, 2019

[5] https://en.wikipedia.org/wiki/John_Templeton, website accessed August 24, 2019

[6] Morningstar Hypothetical. Equal weighted portfolio rebalanced annually: IVV, EFA, IJR, TLT.

A Few Ways to Lose Money in The Stock Market

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The market loves to rip wealth from the hands of investors who panic as stocks fall. The Dow Jones fell about 7% from its high last week because the yield curve inverted for a few minutes.

Markets have been rising and falling for centuries. Since 1926 they’ve risen about 75% of the time. A quarter of the time they’re falling – hard. When stocks fall, investors panic.

Stocks have risen 173% over the past ten years. A $10,000 investment in 2009 is now worth $27,260. However, during this great bull run, the Dow Jones has fallen several times. It fell more than 10% in 2010, 2011, 2015, 2016 and 2018. In December it fell 25% from its high-water mark. Despite the drops, the market has always recovered. Investors who sold their stocks last December missed a 19% rebound in 2019.[1]

The graph below shows all the drops in the market for the past ten years. Despite these drops, the market has risen substantially since 2009.

^DJI_chart

The chart below shows the gain in the Dow Jones Industrial Average from 1950, producing a gain of 17,790%. Since 1950 the U.S. economy has experienced 17 recessions.

^DJI_chart (1)

As stocks gyrate, here are a few ways to lose money in the stock market.

  • You don’t have a plan on how to invest your assets. You trust your financial future to luck, hope, and chance, playing a guessing game as to which investments will do well.
  • Your investment ideas come from cable television shows or social media sites. Remember, the commentators aren’t talking to you directly; they’re broadcasting their message to millions of viewers.
  • You don’t do any research or homework before you buy a stock. And, more importantly, you don’t have a sell strategy. To make money in stocks, you must have discipline when you buy and sell. Knowing your entry and exit points are paramount to make money when you invest.
  • Investors mistake volatility for risk. If you do, you’re more likely to sell stocks when they’re down. The Dow Jones has a standard deviation of 1%, meaning a 1% drop in the Dow is about 260 points. When investors hear that the market is down 260 points, they panic. However, this move is typical and expected.
  • Time matters when you invest in stocks. The market is efficient in the long-term, but not so much in the near term. If you need money in one year or less, don’t buy stocks.
  • Trying to time the market is impossible. From 1990 – 2018, the S&P 500 returned 9.29%. If you missed the 25 best days, your return dropped to 4.18%.[2]
  • A lack of diversification hurts investors in a downdraft. A well-diversified portfolio owns several investments that rise and fall at different times. If all your investments are moving in the same direction, you’re not diversified. For example, the Dow Jones has fallen 5% for the past month, but long-term bonds have risen 10%.

Over the next 100 years, the U.S. will experience several recessions, maybe even a depression. The market will rise substantially and fall dramatically. No one knows! It’s impossible to predict a recession since most of the economic data is trailing, so by the time it’s been identified, it’s probably half over.

I do understand that market drops are scary. However, holding and buying stocks through market troughs has proven to be a winning strategy. If you invested $10,000 in the Dow Jones on October 1, 2007, just before the start of the Great Recession, your balance would be worth $18,340 today. At the market low, your balance dropped to $6,547. If you sold, you locked in a loss of $3,453. If you held on, you made $8,340.

What I do know is that investors who follow their plan, save money, diversify their assets, invest for the long-term usually win in the end.

Stay the course, my friends.

Even though I walk through the darkest valley, I will fear no evil, for you are with me; your rod and your staff, they comfort me. ~ Psalm 23:4

August 23, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

[1] YCharts. Website Accessed August 23, 2019

[2] Dimensional Fund Advisors, Investment Principles

Headwinds

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The stock market has hit a rough patch recently, falling 5.75% since the Federal Reserve cut interest rates on July 30. Headwinds have been stout as market participants react to the trade war, protesters in Hong Kong, Brexit, Trump’s tweets, and calculated language from Chairman Powell.

The recent selloff follows the May decline when stocks fell 7%. For the past 50 years, the average decline from a market top has been 10.7%.[1]

Are this year’s headwinds worse than in previous years? You might say yes because of recency bias. However, it’s in-line with previous market pullbacks.

Here are a few facts.

  • The Dow Jones is up 9.23% for the year and 171% for the past ten.
  • International markets are up 4.32% for the year and 19% for the past ten.
  • Long-term bonds are up 20.8% for the year and 57% for the past ten.
  • A globally diversified portfolio of stocks and bonds (60% stocks, 40% bonds) is up 10% for the year and 104% for the past ten.
  • The 30-Year U.S. Treasury bond is currently yielding 2.03%, a historic low. In 1990, it paid 8%.
  • The current U.S. inflation rate is 1.81%. In 1980 it was 14.5%.

Let’s review how a 60% stock, 40% balanced index performed during past routs if you held on until the end of last year.[2]

  • Stocks fell 48% from 1973 to 1974. If you purchased the index before the drop, your average annual return was 10.4%.
  • Stocks fell 19% in 1990 during the Gulf War. If you purchased the index before the drop, your average annual return was 8%.
  • Stocks fell 43% during the Tech Wreck. If you bought the index in 2000, before the drop, your average annual return was 6.8%.
  • Stocks fell 53% during the Great Recession. If you bought the index in 2007, before the drop, your average annual return was 4.7%.

Markets turn quickly, so it’s best to own a globally diversified portfolio of low-cost funds.

I understand that emotions trump facts when stocks fall 500 points or more. It’s human nature to want to sell your investments and wait for trouble to pass. When fear is high, investors want to trade stocks for bonds until the coast is clear. If you invest in a portfolio of U.S. Treasuries, your current yield would be approximately 1.8%, or about the rate of inflation, so after subtracting inflation, your net return would be zero. It will be less than zero after paying taxes on the income you received.

Are you concerned about the loss of your principal? If so, here are a few steps you can employ today.

  • Reduce your stock exposure. If your stock allocation is 60%, lower it to 40%. Lowering it will reduce your risk by 25%.
  • Increase your cash position to cover three years’ worth of household expenses. If your annual expenses are $100,000, keep $300,000 in cash or short-term investments. A three-year cash cushion will allow you to ride out most market corrections. For example, if you had a high cash reserve from October 2007 to October 2010, it would’ve allowed your stock investments time to recover. In other words, you didn’t need to sell your stocks at the bottom of the Great Recession.
  • Rebalance your accounts to keep your allocation and risk level in check. Since stocks and bonds fluctuate, your asset allocation will change if you do nothing. If you started with a 50% stock, 50% bond portfolio ten years ago, it would have a current allocation of 72% stocks, 28% bonds. By doing nothing, your risk level increased by 37%. An annual rebalance will keep your portfolio allocation at 50/50.[3]
  • Buy the dip. It takes courage and wisdom to buy stocks after they’ve fallen dramatically. Investors who purchased stocks in March 2009, after falling 53%, were rewarded with a gain of 322%! An investment of $100,000 is now worth $422,200.[4] Using the past 100 years as a guide, then buying stocks when they’re down is an intelligent strategy.

Investing is a courageous act, especially when your investments are tumbling. Short-term trading, mixed with short-term thinking, will derail your long-term plans. Rather than acting on impulse, focus on your financial plan. A well-designed plan accounts for multiple scenarios, including broad market declines. If you’re not sure how your investments will impact your financial future, give me a call and let’s figure it out.

I believe the market is going to fluctuate. ~ J.P. Morgan

August 15, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

 

 

[1] YCharts: August 1, 1969 – August 14, 2019

[2] Dimensional Funds 2018 Matrix Book. Returns ending 12/31/2018.

[3] Morningstar Office Hypothetical.

[4] YCharts: March 9, 2009 to August 14, 2019.

Trifecta

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Picking a trifecta is difficult, at best. Identifying the first three winners of a horse race, in order, is called a trifecta. The 2019 Kentucky Derby had 19 finishers, so you had to choose from 5,814 potential combinations! If you were correct, the $2 trifecta paid $22,950.

During my career in financial planning, I’ve found three things to be true: individuals aren’t aware of the type of investments they own, how much risk they’re taking, or what level of fees they’re paying.

After meeting with someone, I’ll review their investments to give them an idea of their financial situation. Often, they’re surprised how they’re allocated, their risk level, and the fees they’ve paid. I’ll then compare the results to their financial plan to make sure all three (allocation, risk, and fees) are in sync. The goal is to achieve a financial balance.

Let’s look at the three components.

Asset allocation. Your asset allocation determines most of your returns and your risk level. You might be able to improve your results by investing when the market is low; However, the odds of picking a bottom are extremely rare.

For the past 45 years, a portfolio of 100% stocks generated an average annual return of 12.9%. A portfolio consisting of 100% bonds produced an average annual return of 6%. A balanced portfolio of 60% stocks, 40% bonds made an average annual return of 10.4%.[1]

The returns varied depending on the market conditions. The 100% bond strategy never lost money from 1973 to 2018. The returns have dropped dramatically since 1999; the average annual return has been less than 3% for the past 20 years.

The 100% equity portfolio has produced the best returns, but with the highest risk. From 1973 to 1974, it dropped 41.5%. In 2008 it fell 41.8%. Last year it was down 11.8%. To achieve double-digit returns, you need to take some risk.

The balanced portfolio had considerably less downside than the all-equity portfolio. From 1973 to 1974, it dropped 20.8%. In 2008 it fell 24.8%. Last year it was down by 6.2%. The losses have been about half those of the all-equity portfolio.

Risk level. Risk has several definitions. Losing money is a risk. Volatility is a risk. Longevity is a risk. Inflation is a risk. Liquidity is a risk. Investing all your money in a fixed income portfolio will expose you to inflation and longevity risk. Investing everything in the stock market exposes you to volatility and principal risk. It’s hard to identify your risk level, especially after a 10-year bull market. One test is to review your trading during the 2008 Great Recession. When stocks fell 50%, what did you do? Did you sell your shares? Did you buy stocks? Did you buy bonds? Did you do anything?

Using a service like RiskAlyze or Finametrica can help you determine your risk tolerance. If you’re curious, you can take a quiz on my website by clicking on the “free-portfolio risk analysis” tab located on the upper right-hand corner of my website. Here’s the address: www.parrottwealth.com.

Fees. The fees you pay for your investments matter. Of course, the lower your costs, the higher your return (all things being equal). If you and your brother-in-law own the same fund, but your advisor charges you 2% per year, and his advisor charges .5%, he’ll have better returns. Fees vary, so be aware. Your advisor may bill you by the hour, charge a flat fee, assess a percentage of your assets, or take a commission. Regardless, a fee is a fee. Also, your investments may include other charges if you own mutual funds, exchange-traded funds, or insurance products. If your investment is sold with a prospectus, you’re paying a fee.

If you’re not sure about your investments, then hire a Certified Financial Planner® to help you figure it out. But, before you do, ask your planner how they get compensated and what type of investments they recommend.

Last, completing a financial plan will help you organize and quantify your goals, so they’re in sync with your asset allocation, risk level, and fee structure – a trifecta!

A horse gallops with his lungs perseveres with his heart and wins with his character. ~ Federico Tesio

August 13, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

[1] 2019-Dimensional Matrix Book returns from 1973 – 2018.

50 Days or 50 Years?

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The summer season started 50 days ago, and 50 years ago, Neil Armstrong walked on the moon. One short-term, one long.

Traders are short-term focused, and they use a bevy of indicators to try to gain an edge. One of their tools is the moving average. What is a moving average? Here is a definition from Investopedia: “A moving average (MA) is a widely used indicator in technical analysis that helps smooth out price action by filtering out the “noise” from random short-term price fluctuations. It is a trend-following, or lagging, indicator because it is based on past prices.” Since it’s a trend following system, traders will try to ride it for as long as possible.

Traders can focus on several moving averages – 10, 20, 30, 50, 100, or 200 days. When an index trades above its moving average, it’s considered a bullish sign for it to climb higher. When the index dips below it, traders consider it a bearish sign that the market will fall further.

Traders and commentators love to focus on a moving average as a key indicator of short-term moves in the market because it’s an easy indicator to follow. When the index crosses above the moving average, buy. When it dips below, sell. It sounds so simple.

Here’s a look at the most recent 50-day moving average for the S&P 500.

^SPX_chart

Currently, the S&P 500 is trading below it’s 50-day moving average. Should you sell? If you bought the index 50 days ago when the index was trading above the moving average, you’d be down 1.2% if you held on through yesterday’s close. In the past 50 days, the index has crossed through its 50-day moving average six different times.

Traders also rely on the Golden Cross and Death Cross. The Golden Cross occurs when the 50-day crosses above the 200-day, a bullish sign. The Death Cross occurs when the 50-day crosses through the 200-day and falls below it, an extremely bearish signal.

Should you trade the moving averages? If you’re a disciplined short-term trader, it may give you an edge. However, stocks and indices move through their moving averages constantly so you may get whipsawed by the numerous buy and sell signals.  And which indicator should you follow? A 10-day indicator will give a different signal than the 200-day moving average.

A buy and hold investor can save time and stress by ignoring the moving averages. Rather than looking for trading indicators, focus your efforts on identifying your financial goals so you can take advantage of the long-term trend of the stock market.

Fifty years ago, the S&P 500 closed at 93.94. This past Friday the index closed at 2,918.65 – a gain of 3,006%! If you tried to trade each move through the moving average, your returns probably would’ve been a lot less.

^SPX_chart (2)

The long-term trend of the market is hard to beat, but it hasn’t been a straight line. It has been littered with violent moves. The index has fallen 30% or more seven times since 1969, or about 1 in every 7 years. From September 2000 to February 2013 the index traded flat. Investors who grew frustrated with 13 years of poor performance and sold their holdings missed a 93% return from 2013 to 2019.

Is it better to focus on a short-term trading strategy or concentrate on a long-term buy and hold model? I prefer the buy and hold model. Here are a few suggestions to help you answer your own question.

  • If you need the money in one year or less, keep your assets in short-term vehicles like CDs, Treasury Bills, or money market funds.
  • If your money is earmarked for something like paying for college or buying a new home, then keep your money in short-term investments regardless of the time frame. For example, if you plan to buy a new home in three years, then your money should be kept in short-term, conservative investments.
  • If you want to try your hand at short-term trading, limit your risk capital to 3% to 5% of your investable assets. If you’re successful, it will enhance your returns. If you’re not, it won’t bring financial ruin.
  • If your time horizon is 3 to 5 years or more, invest in stocks.
  • Work with a Certified Financial Planner® to help you identify and quantify your goals.

Timing the market is extremely difficult regardless of the indicator you choose. Rather than trying to time the market, spend time focusing on your financial goals.

We don’t really look at the stock, you know. Because for us, it’s about the long term. And so, we’re very much focused on long-term shareholder value but not the short-term kind of stuff. ~ Tim Cook


August 11, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.