Sixteen Ways to Manage a Concentrated Position

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

A Few Ways to Lose Money in The Stock Market

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

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.

A New Year

2018 was less than kind to investors as all major asset classes finished in negative territory. Cash was the best performing asset for the first time since 1994 and only the 10th time since 1926.

Diversification is still vital for investors to obtain and maintain wealth. A mix of stocks, bonds and cash based on your goals and risk tolerance is recommended. In a “normal” market stocks outperform bonds and cash. Stocks have risen about 75% of the time over the past 100 years, but, on occasion, they drop in value like they did last year.

Investors question the wisdom of owning bonds and cash during a rising market. From March 9, 2009 to October 1, 2018, the market rose 307% or 15.7% per year! It was a great bull run. When stocks are rising 15% per year who wants to own bonds paying 2%? But when stocks fall, bonds don’t look so bad. During the 4th quarter the Dow Jones fell 12.4% while long-term bonds rose 4.6%.

Rather than trying to time the market and move in and out of stocks with precision, focus on your goals and asset allocation. Here are a few suggestions to get you started.

  • Write down your goals. What do you want to achieve in 2019 – financially, personally, professionally? If you write down your dreams, they become goals.
  • Do you have any immediate financial needs? If so, attack these items first. Don’t let them fester. It’s not possible to pursue your financial dreams if something is holding you back. A boat can’t leave the harbor if it’s tied to a dock.
  • Create a financial plan. Your plan will help you quantify and prioritize your goals. It will also determine your asset allocation and risk tolerance.
  • Develop a spending plan. Do you know where your money is going? A budget will help you create wealth over time by redirecting your spending to savings.
  • Diversify your assets. As I mentioned, stocks, bonds and cash are essential to your long-term investment success. Adding international and alternative investments to your portfolio will also help your results.
  • Rebalance your accounts. January is a great time to rebalance your accounts and return them to your original asset allocation. If you didn’t make any changes to your accounts last year, it’s possible your equity exposure is below your target allocation because of the market drop.
  • Payoff debt. Do you have car loans, credit card debt, student loans or a mortgage? If you have assets to pay off these debts, do it today! Reducing your debt level is freeing financially and emotionally. In addition, you’ll save thousands of dollars in interest payments over the life of your loan. Let’s say you owe $30,000 on a car loan with a 4% interest rate. If you paid it off, you’d eliminate your $552 monthly payment and save over $3,100 in interest payments. Can you find a better way to spend $552 per month?
  • Establish an emergency fund. The goal is to reach three to six months of expenses in short-term savings like CD’s or T-Bills. For example, if your monthly expenses are $10,000, then try to save $30,000 to $60,000. I’ve run several marathons and the hardest part has always been the first day of training. Once I started, however, the training became easier.
  • Give money to groups or organizations you support. Giving will loosen your grip on your money, help others, and make you happier.
  • Health is wealth. January is a great time to start working out. Invest some time in walking, hiking, biking, running, climbing, skiing, swimming, lifting, or anything that gets you moving.

Focus on the future. Don’t let last year’s lousy market hold you back. The Baylor Bears won 1 football game in 2017 finishing with a dismal record of 1-11. However, they didn’t let the disappointment of their horrible season ruin their plans for 2018. Rather, they trained with a process and a purpose, concentrating on those items they could control. How did they do in 2018? They won 7 games and beat Vanderbilt in the Texas Bowl – quite a turnaround.

A new year gives you 365 new opportunities – so get going!

Let your eyes look straight ahead; fix your gaze directly before you. ~ Proverbs 4:25

January 2, 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 to help our clients pursue a life of purpose.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog.

Di-worse-i-fi-ca-tion?

Diversification or concentration? To create wealth, concentrate; To preserve it, diversify. A concentrated portfolio can produce huge gains, if you own the right stocks. Of course, if you own the wrong ones, your wealth will be wiped out. Buying the right sector, at the right time, at the right price requires multiple factors, most of which are out of your control. The primary ingredient for consistently picking a winning stock is luck.

Let’s look at the best performing sectors for the last 10 years and the returns they generated.

2008: Long term bonds = 33.92%

2009: Emerging Markets = 76.28%

2010: Real Estate = 28.37%

2011: Long term bonds = 33.96%

2012: International Small Cap Stocks = 21.28%

2013: U.S. Small Cap Stocks = 41.32%

2014: Real Estate = 30.36%

2015: International Small Cap Stocks = 9.10%

2016: U.S. Small Cap Stocks = 26.61%

2017: International Small Cap Stocks = 32.73%

2018 U.S. Small Cap Stocks = 14.47%

It might appear easy to pick the winner in advance, but this is not the case. For example, the emerging markets rose 76% in 2009, but lost 51% in 2008. How many investors had the courage or wisdom to invest in emerging markets in 2008? If they did, they were rewarded handsomely one year later.

International small-cap companies have been the best performing sector for 3 out of the last 10 years, so it would make sense to allocate some money to this sector. However, it does come with risks because it generated negative returns in 2008, 2011, and 2014.

Warren Buffett prefers a concentrated portfolio and it doesn’t pay to argue with the greatest investor of all time. Mr. Buffett concentrates his wealth in Berkshire Hathaway stock. Is Berkshire a concentrated or diversified holding?

Let’s look at some of the holdings listed in the 2017 Berkshire Hathaway annual report.[1] Berkshire owned the following publicly traded companies: American Express, Apple, Bank of America, Bank of New York, BYD Company, Charter Communications, Coca-Cola, Delta Airlines, General Motors, Goldman Sachs, Moody’s, Phillips 66, Southwest Airlines, U.S. Bancorp and Wells Fargo.

In addition, Berkshire also owned several privately held companies, including: Acme Brick, Ben Bridge Jeweler, Benjamin Moore, Brooks, Borsheim Jewelry, Burlington Northern, Clayton Homes, Duracell, FlightSafety International, Fruit of the Loom, GEICO, General Re, Helzberg Diamonds, Johns Manville, Jordan’s Furniture, Justin Brands, Kraft Heinz, Lubrizol Corporation, Marmon Holdings, McLane Company, MidAmerican Energy, MiTek Industries, NetJets, Nebraska Furniture Mart, Oriental Trading Company, Pampered Chef, Precision Castparts, Precision Steel Warehouse, Scott Fetzer Companies, See’s Candies, Shaw Industries, and Star Furniture.

Is his portfolio concentrated or diversified? I’ll let you come to your own conclusion, but I think it’s the later.

A balanced portfolio of 60% stocks, 40% bonds generated a 6.93% return for the past 10 years – including the sharp drop in 2008. A million-dollar investment on 8/1/2008 is worth $1.97 million today.[2]

It would be great, and financially rewarding, to always invest in the best investment but this is not possible. For most investors, a diversified portfolio of low-cost mutual funds is recommended. Your portfolio will benefit from the long-term growth generated from global markets.

I am not saying this because I am in need, for I have learned to be content whatever the circumstance. ~ Philippians 4:11

9/27/2018

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.

 

[1] http://www.berkshirehathaway.com/subs/sublinks.html

[2] Morningstar Office Hypothetical – 8/1/2008 – 8/31/2018. IVV, IJR, EEM, EFA, AGG. Returns are gross of fees and taxes.

No. How Can I Help You?

Are customers always right?   Employees who work in the retail sector are trained to say “yes” to client requests and that they’re always right.  They sell the client what they want, not what they need. It’s hard to find a salesperson who says “no” to client requests.

If I order a triple bacon cheeseburger with guacamole, chili-cheese fries, and a chocolate shake the clerk is going to take my order, deliver my food, and move on to the next customer.  He doesn’t question my order or the ramifications it will have on my health.

My role as an advisor, however, is to recommend what clients need, not what they want. This means I regularly say “no” to client requests especially when it’s not in their best interest.  My goal is to make sure they follow their financial plan.  I want to say “yes”; I want to be the good guy but not at the expense of their financial wellbeing.

In December of 1999 I met with a client who wanted to know why he didn’t have a larger exposure to high-flying technology and internet stocks.  He was questioning his allocation to international, real-estate and bond investments.  He wanted to sell these holdings to buy NASDAQ traded stocks.  I told him “no” because of their rich valuations and that they didn’t fit into his long-range plans.  He didn’t like my answer, so he asked the branch manager to transfer his account to another broker.  A few months later the NASDAQ peaked and proceeded to fall 70%.

Today, investors are once again questioning the wisdom of diversification as bonds, real-estate investment trusts and value stocks underperform growth stocks like Facebook, Amazon, Netflix and Google (Alphabet).  Investors are ready to abandon their asset allocation models to chase returns. Of course, the path of least resistance would be for me to cave into these requests and give them what they want, but is this prudent? Let’s look at a few examples.

  1. From October of 1989 to December of 2016 stocks averaged 9.38% per year. If an investor missed the 25 best days during this stretch his returned dropped to 3.98%.[1]
  2. In 2008 the S&P 500 fell 37% and long-term government bonds rose 25.9%.[2]
  3. From 1994 to 2016 stocks generated an average annual return of 7.3%. If an investor didn’t own the top 25% of performers each year, he lost an average of 5.2% per year.[3]
  4. In 2015, Denmark was the best performing stock market in the world and Canada was the worst. A year later they switched places.  Canada was first; Denmark was last.[4]
  5. International stocks returned a paltry 1.6% in 2016 but gained 25% in 2017.[5]
  6. In Barron’s 2017 Roundtable one prediction called for interest rates to rise and stocks to fall.[6] What happened?  Rates, stocks soared.

It would be nice to own investments that only went up, but this isn’t possible.  Markets rise and fall. Sectors move in and out of favor.  After all, if all your investments went up at the same time you wouldn’t be diversified!

A wise strategy is to follow your financial plan, diversify your investments and rebalance them annually.

“Never ask a barber if you need a haircut.” ~ Warren Buffett

But about that day or hour no one knows, not even the angels in heaven, nor the Son, but only the Father. ~ Matthew 24:36

Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX.  For more information please visit www.parrottwealth.com.

3/1/2018

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog and investments aren’t guaranteed.  Photo credit = lisafx

 

 

[1] DFA –  Investor Discipline – Reacting Can Hurt Performance

[2] 2016 – Dimensional Fund Advisors Matrix Book

[3] DFA –  Diversification May Prevent You from Missing Opportunity

[4] 2016-Dimensional Fund Advisors Matrix Book

[5] http://awealthofcommonsense.com/2018/01/updating-my-favorite-performance-chart-for-2017/, Ben Carlson, 1/14/2018

[6] https://www.barrons.com/articles/stocks-could-post-limited-gains-in-2017-as-yields-rise-1484376687, Laurin R. Rublin, 1/14/17.