Can You Afford a 50% Loss?

Global stock markets are selling off, oil is crashing, and the Coronavirus is spreading. Year-to-date, the Dow Jones is down about 15%, and things can get worse before they get better.

No one wants to experience a significant drop in stocks, but they do occur. Over the past fifty years, there have been three periods where stocks fell by 50% or more.[1]

Stocks fell 56% in 1973 and 1974 because of the Arab Oil Embargo.

Stocks fell 49% from 2000 to 2002 during the Tech Wreck.

Stocks fell 53% from October 2007 to March 2009 during the Great Recession.

The worst period for shareholders occurred during the Great Depression, where stocks fell 76%.

How will your life change if stocks fell by 50%? To find out, divide your assets by two and then multiply your answer by 4%. If your current assets are $1,000,000, divide by 2 to get $500,000. Multiply $500,000 by 4% to get $20,000. With assets of $1 million, you can expect an annual income of $40,000. At $500,000, the income declines to $20,000. Will the drop in assets impact your daily living or current activity? If so, consider adjusting your portfolio. But, before you make a major change, let’s look at a few investors – Ginny, Barbara, and Margaret.[2]

Ginny is 100% invested in stocks, so when stocks rise, she’ll benefit, when stocks fall, she’ll suffer. If she invested in the Dimensional Funds Global Equity Index Fund (DGEIX), she would have enjoyed an average annual return of 7.46% for the past 20 years. In 2008, her fund dropped 41.3%. Ginny invested $10,000 in this fund on January 2, 2000; it’s now worth $32,100.

Barbara is more conservative, and she allocates her investments 60% to stocks and 40% to bonds by investing in Dimensional Funds Global Allocation 60/40 Fund (DGSIX). Her fund has produced an average annual return of 6.01% for the past 20 years. Her fund lost 22.7% in 2008, considerably less than Ginny’s account. Barbara invested $10,000 in this fund on January 2, 2000; it’s now worth $25,750.

Margaret is very conservative, so she allocates 25% of her investments to stocks and 75% to bonds by investing in Dimensional Funds Global Allocation 25/75 Fund (DGTSX). Her fund generated an average annual return of 4.26% for the past twenty years. Her fund lost 7.3% in 2008. Margaret invested $10,000 in this fund on January 2, 2000; it’s now worth $19,670. Her fund didn’t lose much money during the Great Recession, but her assets are substantially less than Ginny’s.

To obtain high returns, you need to invest in risk assets, and that means enduring a few years where stocks underperform conservative assets.  If your risk level is high, allocate a significant proportion of your assets in stocks. However, if you’re not ready to lose 50% of your assets, diversify your holdings. A 40% bond allocation reduces risk by 33%, compared to an all-equity portfolio.[3]

A financial plan will help you refine your goals and determine how much money you should allocate to various asset classes. A plan will help you balance your short term needs with your long-term goals. An investor who is too conservative may run out of money when they’re older. Likewise, an investor who is too aggressive may lose their assets during a market downturn. Risk and reward will be forever linked.

Stock market corrections and downturns are normal. Since 1970, the S&P 500 has closed in negative territory ten times or 20% of the time, with an average drop of 14.9%. However, 80% of the time, stocks finished the year in positive territory. A $100,000 investment on January 2, 1970 is now worth $3,196,100.[4]

Here are some suggestions to help you through the market’s turbulence.

  • Don’t panic. Stocks rise and fall every day. If you want to sell, wait for them to rebound. On October 19, 1987, stocks fell 22.6%. In the next two days, the Dow Jones rose by 16%.
  • Diversify your assets. To reduce risk, add bonds and other asset classes to your portfolio. During the decade of the 2000s, The S&P 500 had a negative return, but if you added bonds, international investments, small company stocks, and real estate holdings, your account finished in positive territory.
  • Follow your plan. A financial plan will guide you through a market downturn. It will help you determine how much money you’ll need to fund your goals. It will also quantify your risk level.
  • Examine your risk level. How much risk is embedded in your portfolio? If you’re not sure, give us a call.
  • Look for opportunities. In a crisis, there’s always an opportunity. You’ll probably be early on the purchase, but, over time, your stocks may recover.
  • Don’t time the market. It’s tempting to hunt for bargains, but you’re not going to pick the bottom, so don’t worry about buying at the lowest tick. You’ll know in about five years if you made a wise investment decision or not.
  • Avoid margin. When stocks are falling, avoid margin. A margin balance will magnify losses.
  • Rebalance your account. An annual or quarterly rebalancing will keep your asset allocation and risk level intact.

Today is the eleventh anniversary of the stock market low of March 9, 2009. The S&P 500 closed at 676, and it currently is trading at 2,972 – a gain of 339%.[5] The phenomenal increase follows the bear market loss of 53%. It hardly makes sense to buy during the dark days of a stock market thrashing, but it’s in the depth of despair where you get the best prices. And, to quote my dad, the sun will come up tomorrow.

In the middle of difficulty lies opportunity. ~ Albert Einstein

March 9, 2020

Bill Parrott, CFP®, 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. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from 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] Dimensional Funds 2019 Matrix Book

[2] YCharts for the three portfolios – January 2, 2000 to March 9, 2009

[3] RiskAlyze

[4] YCharts

[5] Ibid

There Will be Blood!

There Will be Blood, a 2007 movie starring Daniel Day-Lewis, is based on Upton Sinclair’s book Oil!, published in 1927. Mr. Sinclair’s novel dealt with the struggle of greed and fear that many faced in the early days of the oil industry in Southern California. If Mr. Sinclair were writing his book today, 93 years later, the storyline would probably be similar.

The decline in the price of oil is one of the catalysts for the recent stock sell-off. Below is a look at some of the significant plunges in the price of oil since 1980[1].

  • April 2011, through the recent low, the price of oil is down 71%.
  • May 1980 to April 1986, the price of oil dropped 77.2%.
  • October 1990 to December 1998, the price of oil dropped 74.4%.
  • July 2008 to February 2009, the price of oil dropped 69.6%.
  • November 2000 to January 2002 the price of oil dropped 43.8%

The price of oil declined by 86% from May 1980 to December 1998, while the S&P 500 climbed 1,005%. The 18-year bull market in stocks averaged 17.6% per year. During this run, there were 2,526 up days and 2,193 down days. One of the down days was October 19, 1987, when stocks fell by 25.7%.

As markets remain volatile, stay diversified, focus on the long-term, and follow your plan. And, as a reminder, the stock market has always recovered.  It might take one week, one month, or one year, but it has always bounced back. If you need proof, please look at the following years: 1907, 1915, 1929, 1930, 1931, 1932, 1934, 1937, 1939, 1940, 1941, 1946, 1953, 1957, 1962, 1966, 1969, 1973, 1974, 1977, 1981, 1990, 2000, 2001, 2002, 2008, and 2018.

There is no free market for oil. ~ T.Boone Pickens

March 8, 2020

Bill Parrott, CFP®, 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. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and declines depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from 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] https://www.macrotrends.net/1369/crude-oil-price-history-chart, website accessed March 8, 2020

7 Reasons to Sell Stocks.

The Coronavirus is winning; global stock markets are losing. The Dow Jones is down 7.5% for the year, and volatility has spiked. In uncertain times, investors sell stocks to buy safe investments like U.S. Treasuries, CDs, or money market funds. Investors are seeking a port in the storm.

Does it make sense to sell stocks? Maybe. Here are seven reasons to sell.

  1. You’re 100% invested in stocks. If you’re allocated 100% to equities, sell shares to add bonds or cash to your portfolio. The bonds and cash will lower the volatility in your account.
  2. You need the money in one year or less. Stocks are unpredictable in the short term. On an annual basis, stocks finish in positive territory 73% of the time. Over twenty years, they have never lost money.[1]
  3. You need the money for a new home, to pay for college, buy a new car, or some other purpose. Invest in short-term bonds or keep your money in a money-market account. Liquidity is paramount.
  4. Your risk exposure is too high. Last year, stocks soared. If you didn’t rebalance your account, your stock exposure might be too high. For example, if your target equity exposure is 70%, and it jumped to 80% last year, sell 10% of your holdings to reduce your risk.
  5. Your goals have changed. If your financial goals changed, adjust your asset allocation to meet your current needs.
  6. You’re retiring this year. If this is your year to retire – congratulations! If so, buy bonds to cover three years of expenses, so you don’t have to worry about the stock market volatility. If your annual expenses are $100,000, purchase $300,000 in bonds.
  7. You’re donating your shares to charity. Donating stock to charity is not a sell, but a transfer. Regardless, you’re reducing your equity exposure. If you have appreciated securities or a concentrated position, consider donating your shares to your favorite charity. Your donation will lower your risk, but more importantly, you’ll help those in need. And, there’s always a need.

Selling from a position of fear has historically been a poor decision because stocks recover. When you react to volatility or a drop in prices, you’re probably selling near a bottom. If you sell your shares, when do you repurchase them? Uncertainty is a central theme for investors, and we never know what’s going to happen tomorrow. What is the price of safety? Currently, a one-year Treasury Bill is yielding .58%. The inflation rate is 2.49%, so if you invest your money in the T-Bill, you’re losing 1.91%, before taxes. Does it make sense to lose 2% per year while you wait for stocks to recover?

A financial plan will help you focus on your goals and your investment allocation. Most financial plans model for stock market drops through Monte Carlo simulations. Money Guide Pro, for example, will run a thousand scenarios to determine the soundness of your plan. It’s better to be partially right than completely wrong. The recent market swings have been wide, but, so far, it is not having any impact on our client’s financial plans.

If your time horizon is three to five years or more, use down days to buy great companies at lower prices. It’s hard to buy low and sell high, but if you dare to do so, you’ll be happy when prices rebound. Will people stop buying cell phones or hamburgers? I don’t think so, so take advantage of people’s fear to add to your stock holdings.

Stocks, like the tide, fluctuate daily, and they have been doing so for centuries. The Coronavirus will eventually pass as did SARS, Ebola, and Zika. And, unfortunately, we will have to battle another villain that will drive stock prices lower.

Create a plan, focus on your goals, think long-term, and good things will happen.

Therefore do not worry about tomorrow, for tomorrow will worry about itself. Each day has enough trouble of its own. ~ Matthews 6:34

March 4, 2020

Bill Parrott, CFP®, 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. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from 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] Morningstar Classic Year Book – 2015

Are You Emotionally Attached to Your Stocks?

It’s easy to fall in love with a stock, especially if you handpicked it yourself. Over the years, I’ve talked to scores of investors about their favorite stocks, and most prefer to hold on to them forever regardless of allocation or performance. If you’re emotionally attached to a company, try not to overlook several risk factors.

It’s easy to get anchored to your original purchase price. If your stock falls below your purchase price, you might be reluctant to sell it for a loss for fear of admitting you were wrong. Another challenge for investors is when a stock drops below the all-time high. If it hit the high price once, it must do it again. Of course, it doesn’t have to do anything.

Enron traded at an all-time high on August 23, 2000, closing at $90.75 per share. At its peak, Enron’s market-cap was more than $70 billion, and, at the time, it was the 7th largest publicly traded company.[1] Two years later, it would be worthless. As a comparison, Berkshire Hathaway is currently the 7th largest publicly traded company.

Here are a few companies that are currently trading off their all-time highs: IBM peaked at $215 on March 14, 2013. It’s now trading at $135, down 37%. Boeing peaked at $440 on March 1, 2019. It’s currently trading at $339, down 23%. Tesla traded to an all-time high of $385 on September 18, 2017. It’s currently trading at $328, down 15%. Exxon traded at $104.37 on June 28, 2014, and it is now $69.25, down 34%. 3M sold at $258 on January 26, 2018. It’s currently selling for $166, down 36%. These companies may return to their peaks, but in the meantime, they’re a drag on portfolios.

During my career, I’ve found investors fall in love with three types of stocks. The first is a company located in their backyard, the second is a story stock highlighted on TV, and the third is a mega-cap stock.

Locals in California, pick Apple. Oregonians run with Nike, Washingtonians click on Amazon or Microsoft. Texans ooze over Exxon and Tennesseans like the way FedEx delivers. Investors who own homegrown stocks like to hold them forever.

Story stocks get big headlines. Tesla gets a lot of screen time, as do recent IPOs like Uber, Peloton or Beyond Meat. If it’s new, it must be a winner, but not always.

Mega-cap stocks like Apple, Microsoft, Alphabet (Google), Amazon, Facebook, Berkshire Hathaway, Visa, JP Morgan, Walmart, and Procter & Gamble are popular holdings, and, rightfully so. These battleship stocks have stood the test of time and have rewarded shareholders handsomely. Mega-cap stocks also have another benefit to shareholders in that consumers use their products daily.

By investing in homegrown stocks, you might miss opportunities in companies scattered around the globe.  Advantest Corporation is a Japanese company, which is up 148% year-to-date. Fortescue Metals Group in Australia is up 137%. Li Ning Company in China is up 213%, and Hotai Motor in Hong Kong is also turning in a stellar performance, up 108%.

A basket of globally diversified index funds will remove the emotional attachment of investing and give you exposure to thousands of companies. It’s easy to fall in love with Tesla, not so much with a small-cap international index fund. Also, your diversified portfolio will allocate a portion of your assets to bonds, and no one falls in love with a bond fund. However, when the market corrects, you’ll be glad you own a bond fund or two.

A financial plan will also help you with your emotional attachment. A good plan will quantify and prioritize your financial goals. Your plan will also direct your advisor on how best to construct your investment portfolio. Your plan and portfolio will synch to your goals.

Despite the numerous benefits of financial planning, a recent study by Vanguard found, “many advisors are not preparing financial plans for their clients.” Their study found that only 47% of advisors created a formal plan for clients with $100,000 to $1,000,000.[2]

To achieve long-term financial success, create a financial plan, invest in a globally diversified portfolio of mutual funds, and keep your fees low.  If you follow this plan, you might fall in love with your results!

Love is patient and kind; love does not envy or boast; it is not arrogant or rude. It does not insist on its own way; it is not irritable or resentful; it does not rejoice at wrongdoing but rejoices with the truth. Love bears all things, believes all things, hopes all things, endures all things. ~ 1 Corinthians 13:4-7

 

October 28, 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. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from 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] https://www.begintoinvest.com/enron-stock-chart/, Website accessed on October 23, 2019

[2] The Vanguard Advisor’s Alpha® Guide to Proactive Behavioral Coaching, Donald G. Bennyhoff, November 2018.

Should You Invest in an IPO?

We like shiny new objects. For investors, the object is the initial public offering or IPO. Getting in on the ground floor of a hot offering is a huge draw. A few high-profile private companies are now publicly traded. Companies like UBER, Pinterest, Slack, Lyft, Chewy, Beyond Meat, Levi Strauss, Zoom Video, Smile Direct, and Peloton are now trading publicly. How have they performed?[1]

  • UBER = Down 24%
  • Pinterest = Up 11%
  • Slack = Down 41%
  • Beyond Meat = Up 110%
  • Lyft = Down 47%
  • Zoom Video = Up 28%
  • Chewy = Down 23%
  • Levi Strauss = Down 16%
  • Smile Direct = Down 13%
  • Peloton = Down 7%

According to CNBC, 120 IPOs have come public this year, and 57 are trading down, 48% of the issues are trading in negative territory.[2] Not all IPOs are bad, of course, as Coke, Pepsi, McDonald’s, Starbucks, Home Depot, Costco, Walmart, Amazon, Apple, and Google have performed well over time.

When a company issues shares to the public, the founders and early investors are cashing out. Companies hire investment banks like Goldman Sachs or Morgan Stanley to help sell and market their shares. The banks conduct roadshows to introduce the company to investors and receive indications of interests. If you’re lucky, your broker will give you a few shares of the offering. Once the deal closes, the stock will start trading on the open market where investors who weren’t able to get shares during the offering phase can now purchase the stock.

For Example, the IPO price for Beyond Meat was $25 per share. It started trading at $46 and quickly popped to $72.95 before closing at $65.75. The founders, owners, and early-stage investors were in well before the offering. Investors in the IPO received shares priced at $25. The public was able to buy it between $65.75 and $72.95. On the first day of trading Beyond Meat soared 192%! However, only early stage investors and IPO participants realized this gain. If you bought it at the top, you lost about 10% on the first day.

The IPO market is reeling because of the poor stock performance of Peloton, Uber, Lyft, Slack, and a few other high-profile names. As a result, We Work, and Endeavor Group Holdings canceled their offerings. Endeavor has sited “weak stock market demand” as a reason for suspending their IPO launch.[3] We Work, on the other hand, will be a Harvard Business School case study someday on how not to handle an IPO. Investors grew concerned with the company’s valuation, the CEO, and the lack of profitability. Since We Work announced they’re terminating their IPO, the CEO has stepped down and the company may lay off one-third of their workforce.

Mutual funds and large institutions are significant players in the IPO market, and some are speculating that they may forego investing in IPOs in the future because of the recent poor performance. Don’t hold your breath. Do you remember the Tech-Wreck? From April 2000 to October 2002, the S&P 500 fell 44% because of the extreme valuation in technology stocks, and the feeding frenzy with dot.com IPOs. Investors bid up the prices of Pets.com, eToys, and Webvan only to have them evaporate into thin air a few months later. Despite the disastrous performance of the IPOs in the early 2000s, large institutions are still investing in new offerings.

I worked at Morgan Stanley during the insane days of IPO listings and investors couldn’t wait to buy a new offering regardless of what the company did or where it would price. They didn’t care because their intent was to flip the stock as soon as possible and pocket big money. This strategy worked until it didn’t. Tulip Mania?

Should you invest in IPOs? Most brokerage firms have strict policies on who gets shares. You won’t be able to cherry-pick the best stocks and you’ll be forced to buy both good and bad names. And most allocations to retail investors are small. In a hot IPO like Peloton, you may only receive 25 shares. If you want to participate in this arena, limit your allocation to 3% to 5% of your investment capital.

Shiny objects eventually fade, but speculators will always be attracted to peddlers promising short-term gargantuan gains. If you’re late to the party, you could lose a significant amount of money.

Be careful. Do your homework. Invest wisely.

What has been will be again, what has been done will be done again; there is nothing new under the sun. ~ Ecclesiastes 1:9

September 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.

 

 

[1] YCharts

[2] CNBC, Carl Quintanilla Twitter @carlquintanilla, September 26, 2019 @ 10:54

[3] https://www.cnbc.com/2019/09/26/endeavor-pulls-plug-on-ipo-day-before-debut-wsj-reports.html, Riya Bhattacharjee, September 26, 2019

Stocks or Funds?

Is it better to buy individual stocks or mutual funds? It depends, of course, on several factors like how much to invest or how much risk you’re willing to take. If you have a high tolerance for risk and millions of dollars to invest, you may be a good candidate to own individual stocks. If you only have $1,000 to invest, a mutual fund is a better option.

When building a portfolio for your future focusing on your goals will help you determine the best strategy. How much to invest? What is your tolerance for risk? How involved will you be in managing your assets? How much time will you commit to researching new investment ideas?

A portfolio of 30 individual stocks or more is recommended for a diversified portfolio.[1] A report on Morningstar’s website suggests 18 to 20 names.[2] When individuals pick their own stocks, they focus primarily on large companies with brand name recognition like Apple, McDonald’s, or Pfizer. Few investors add small or international stocks to their portfolio.

RiskAlyze® helps investors and advisors quantify risk. The risk score for the S&P 500 is 74 on a scale of 1 to 99. A T-Bill, by comparison, has a risk score of 1. I sent a list of 20 large-cap companies to a client for review. The risk profile for the portfolio was 73, or 1 point lower than the S&P 500 Index. If the risk levels are similar, why not buy the index? The Vanguard S&P 500 fund owns 500 companies with exposure to every sector; it’s also cheaper than buying 20 individual stocks.

What about the FAANGs – Facebook, Amazon, Apple, Netflix and Google? Yes, if you owned these 5 stocks you destroyed the S&P 500 over the past 5 years. The FAANG portfolio soared 272%, bettering the S&P 500 by 205%!  How do you identify these companies in advance? The best performing stock in the S&P 500 index this year is Xerox, a stock that has underperformed the market by more than 100% for the past 10 years. Last year it dropped 30%. Xerox was probably not on your radar screen. The other stocks rounding out the top ten are Cadence Design, Advanced Micro Devices, Chipotle, MSCI, Anadarko Petroleum, Total System Services, Synopsys, Global Payments, and DISH Network. These 10 stocks have outperformed the FAANGs by 33% this year! Finding consistent winners to beat the market each year is tough – if not impossible.

Investing in large companies with brand name recognition makes sense on the surface, but it ignores a fair chunk of the global market. Vanguard’s Total World Stock fund invests 73% of its assets in large-cap stocks with 57% allocated to the United States. An all large-cap U.S. portfolio ignores bonds, small companies, real estate, gold, and international investments.

Picking individual stocks also takes time. An hour per stock, per week has been suggested. If you own 20 stocks, you’ll need to set aside 20 hours per week for research. Can you commit 20 hours per week to review your portfolio?

For most investors a globally diversified portfolio of low-cost mutual funds based on your financial goals is the best path to take.

Diversification is your buddy. ~ Merton Miller

July 5, 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.

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.

 

 

 

[1] https://www.investopedia.com/articles/stocks/11/illusion-of-diversification.asp, Jason Whitby, June 25, 2019.

[2] https://news.morningstar.com/classroom2/course.asp?docId=145385&page=4

Where Do Stock Returns Come From?

Peanut butter and jelly. Thelma and Louise. Calvin and Hobbes. Fish and Chips. Wayne and Garth. Some things are better in pairs!

Stock returns consist of two components: dividends and price appreciation. Dividends are paid to shareholders on a quarterly basis from the company’s profits regardless if the stock is up, down or sideways. In addition, investors can profit from price appreciation. Your total return is a combination of the two.

For example, you decide to purchase ABC company at $40 per share. If ABC pays a $1.00 dividend, your current yield will be 2.5% ($1/$40). If you sold your stock at $50, you made 25% ($10/$40). Combining your dividend income with the price appreciation, your total return was 27.5%. If you purchased 1,000 shares, you received $1,000 in income and gained $10,000 giving you a total return of $11,000.

Let’s look at a real-world example. Let’s say you purchased $100,000 worth of Coca-Cola (KO) stock on 8/1/1988 and held it through 8/31/2018. In this example, you generated an annual return of 12.66%. Your $100,000 investment grew to $3.62 million and you received $1.1 million in dividend income. Your dividend income accounted for 31.5% of the total return.

Currently there are 1,269 stocks with a dividend yield of 2% or more. Dividend Aristocrats are companies that have paid, and increased, their dividend for at least 25 years. A few companies on this elite list include: Aflac, Coca-Cola, McDonald’s, Pepsi, Procter & Gamble, Sherwin Williams, Target, and Walmart.

Of course, there are plenty of excellent companies that don’t pay a dividend. Two of the more popular ones are Amazon and Berkshire Hathaway. They plow their profits back into their company rather than pay them to you, the shareholder. In this case, the entire gain comes from price appreciation.  Amazon has generated a 10-year average annual return of 38% while Berkshire has returned 10.5% per year over the same time frame.

The key term to focus on is total return. It doesn’t matter how you make money, so long as you make money.

 two and two, male and female, went into the ark with Noah, as God had commanded Noah. ~ Genesis 7:9

9/12/2018

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.

Why Own Bonds?

Bonds are boring, secure and predictable.  Interest rates are at historical lows because of this high level of safety.   The 30-Year Treasury Bond is currently yielding 2.75%.  With rates this low does it make sense to own a bond for three decades?

Interest rates are low, but they’re expected to rise in 2018.  Rising rates means more income for bond holders.  However, this could be trouble because when rates rise, bond prices fall.   A 1% rise in interest rates will lower the price of the 30-Year Treasury Bond by 17.8%.

Investing is a tradeoff between short and long-term goals.   Stocks and bonds can be used together to help you achieve your financial goals.  A diversified portfolio of stocks, bonds and cash is recommended.

Stocks have outperformed bonds because of the risk associated when investing in the stock market.  This is referred to as the equity premium and economist have pegged it at 5.5% over a 30-year period.[1]   If a risk-free bond is paying 2%, then stocks should return 7.5%.

Three reasons to own bonds.

  1. If your time horizon is less than three years, owning high quality bonds is recommended.
  2. If you need to meet an obligation like a college tuition payment or the purchase of a new home.
  3. If you’re retired and need a secure income stream.

Three reasons to own stocks.

  1. If your time horizon is longer than 20 years, buy stocks. They’ve averaged a 10% return per year since 1926 and they’ve never lost money over a 20-year period.
  2. If you’re contributing to your company retirement plan, allocate a large percentage to stocks. Your money shouldn’t be touched for many years so take advantage of the long-term trend of the stock market. You’ll also purchase stock through a payroll deduction and this will help smooth out the short-term volatility of the stock market because you’re buying at different price points.
  3. If you want to create long-term wealth, stocks must be the focal point of your portfolio.

Let’s compare the performance of stocks to bonds with two Vanguard Funds – The S&P 500 Index Fund and The Total Bond Market Index Fund.   From 12/11/1986 to 11/30/2017, the S&P 500 Index Fund averaged an annual return of 9.74%.  A $100,000 investment 31 years ago is now worth $2.06 million.  A $100,000 investment in the Total Bond Market Index on the same day is worth $597,556 and it generated an average annual return of 5.94%.  The stock fund outperformed the bond fund by $1.46 million or 3.8% per year.[2]

A financial plan can assist you in deciding how much to allocate between stocks and bonds.  These two investments have different characteristics, and therefore they both belong in your portfolio.

Without good direction, people lose their way; the more wise counsel you follow, the better your chances. ~ Proverbs 11:14 (MSG)

 

 

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.

December 11, 2017

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog.  Investments aren’t guaranteed and involve risk.

 

 

 

 

 

[1] https://www.investopedia.com/terms/e/equityriskpremium.asp, website accessed 12/11/17.

[2] Morningstar Office Hypothetical Tool, 12/11/1986 to 11/30/2017.

A Tale of Two Companies.

It was the best of times, it was the worst of times for two companies, Qualcomm and GE.   These two companies have had a challenging year, and both were following a similar path until the first week of November.  On November 1st, Qualcomm closed at $53.46, down 15.7% for the year.  GE was selling for $20.02, down 35.15% for the year.

During the first week of November Qualcomm’s situation improved greatly and GE’s turned for the worse.  Broadcom announced a takeover for Qualcomm at $70 per share on November 6th.   At the time of the announcement Qualcomm was trading for $52 per share so the buyout price was a 25.71% premium to the current price.  The announcement was welcomed news for shareholders of Qualcomm.  Qualcomm has since rejected the overture and it’s currently selling for $66.

A few days later GE delivered horrific news to its shareholders.  They announced a major restructuring, lowered their earnings guidance for 2018, and reduced their dividend 50%.  The news caught most investors flat footed as the shares fell 15% over two days.

An investor who purchased Qualcomm and GE on November 1st saw their Qualcomm shares rise 23.4% and their GE shares fall 13%.

GE is down 41% for 2017.  GE is 125 years old, founded by Thomas Edison, and it has morphed multiple times so I’m pretty sure it will recover; however, it will take time.   Since 1962 GE has finished a calendar year with double digit losses ten times.  It dropped 47% in 1974, 37% in 2002, and 54% in 2008.[1]

These two companies share some similar metrics (see chart below).   Both companies held a Morningstar Fair Value rating of four (one being overvalued, five being undervalued) as of November 1st.  The largest shareholder for both companies is Vanguard.  The S&P rating for Qualcomm is A while GE’s is AA-.  The yield for Qualcomm was 4.62% and GE’s was 3.91%. The historical PE ratio for Qualcomm is 16 and GE’s is 15.

In 2015 Qualcomm had free cash flow of $4.5 billion, GE’s was $12.5 billion.   Today the free cash flow for Qualcomm is $4 billion and GE’s has gone negative. The debit level for Qualcomm is 36%, GE’s is 46%.  Institutions own 79% of Qualcomm and 61% of GE.

Of course, no one can predict the price movement for stocks so what can investor do when stocks start to diverge from your price target?

  • Diversify. Diversifying your investment holdings may help you increase your odds of finding winners while potentially limiting your losses from the losers.  To be diversified you should own at least 30 companies with some studies suggesting a minimum of 1,000![2]   My recommendation is to limit each stock holding to 1% to 3% of your total investable assets.
  • Plan. A trading plan will help you deal with the ups and downs of your investment portfolio. Setting a price target before you buy a stock can remove the emotions when it rises or falls to your predetermined sell level.
  • Buy Funds. A better alternative for most investors is to purchase mutual funds or exchange traded funds (ETFs).  These funds will own hundreds, if not thousands, of companies and give you instant diversification.  For example, the Dimensional Core Equity I Fund owns over 2,600 companies.
  • Review.  I recommend reviewing your stock holdings quarterly to make sure you still want to own the company.  If the answer is yes, let it ride.   If no, sell it and move the money into a new investment.

Here is a side by side comparison of Qualcomm and GE as of November 1, 2017.

Category Qualcomm GE
Morningstar Fair Value Ranking 4 (1 is lowest, 5 is highest) 4 (1 is lowest, 5 is highest)
Average PE Ratio 16 15
Fair Value Price Target $68 $26
EPS Projection $3.40 $1.75
Average Dividend Yield 3% 3.5%
Current Price $53.46 $20.02
Current Dividend Yield 4.49% 4.80%
S&P Rating A AA-
Debt Level 36% 46%
Institutional Ownership 79.32% 61.17%
Largest Shareholder Vanguard Vanguard
Price Target (PE x EPS) $54.40 $26.25
Price Target (Dividend/Yield) $80 $27.42
Free Cash Flow – 2015 $4.53 Billion $12.5 Billion
Price on 11/15/2017 $66 $18.25

As you build your investment portfolio focus on your plan and diversification.  Reviewing your plan and investment strategy on a regular basis is wise counsel and it may require you to be patient at times.

Rejoice in hope, be patient in tribulation, be constant in prayer. ~ Romans 12:12

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

November 15, 2017

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog.

Data:  Morningstar, Value Line & Fast Graphs.

 

 

[1] Morningstar Office Hypothetical Tool, GE stock return – 1962 – 2017.

[2] https://www.investopedia.com/articles/stocks/11/illusion-of-diversification.asp, By Jason Whitby, website accessed 11/15/2017.

October 19, 1987.

Today marks the 30-year anniversary of Black Monday when the Dow Jones Industrial Average fell over 22%!  It was a dark day as stocks fell to historic lows.  Despite the drop, the Dow finished the year with a gain of 2.26% and it climbed 11.85% in 1988 and 26.96% in 1989.

In 1937, during the Great Depression, Sir John Templeton purchased $100 worth of every stock trading below $1 per share.  A few years later he sold most of them for a substantial profit.[1]  The Standard & Poor 500 fell 35% in 1937.  It’s not easy, but when investors are in a panic selling mode it allows the patient investor to buy great companies at bargain prices.

Here are a few stocks you could’ve purchased on Black Monday.[2]

  • Coca-Cola: A $10,000 investment in KO is now worth $453,514.
  • Boeing: A $10,000 investment in BA is now worth $556,532
  • McDonald’s: A $10,000 investment in MCD is now worth $590,529.
  • Johnson & Johnson: A $10,000 investment in JNJ is now worth $634,413.
  • Apple: A $10,000 investment in AAPL is now worth $1.44 million.

Will we ever experience another Black Monday?  Forever is a long time so it’s likely we’ll witness another dramatic drop.  When the market does fall again, here are a few survival tips to help you navigate the correction.

  • Buy. Stocks sell for bargain prices when individuals sell out of fear.  I’d recommend creating a list of companies you want to purchase before the correction arrives so you’ll be ready to pounce on your ideas during the market turmoil.
  • Wait. If you’re not sure what to do during a market meltdown, don’t do anything.  Your best strategy may be to wait until the storm passes and then you can make changes to your portfolio.
  • Diversify. A diversified portfolio will help reduce the losses in your portfolio.  In 1987 the international index (MSCI-EAFE Index) was up 24.6% and the one-month T-Bill was up 5.5%.[3]
  • Rebalance. During a steep stock market drop your asset allocation will change significantly.  Rebalancing your portfolio will return your account to its original allocation.
  • Review. Reviewing your investment plan and financial goals is always recommended, especially when the stock market is falling.  Are your goals still intact or do you need to make changes?
  • Think. What’s the root cause of the correction?  Flash crash?  Political event? Failed merger?  Knowing the reason behind the crash may give you some time to think about selling your holdings.

From October 2007 to March 2009, the Great Recession, the Dow Jones Industrial Average fell 53.5%.  It bottomed on March 9, 2009 and since then it has climbed 257%.

Corrections are petrifying but markets have always recovered.  In fact, today, the Dow Jones closed at an all-time high of 23,157!

“Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.” ~ Warren Buffett

Bill Parrott is the President and CEO of Parrott Wealth Management.  For more information on financial planning and investment management, please visit www.parrottwealth.com.

October 19, 2017

Note:  Your returns may differ than those posted.  Past performance isn’t a guarantee of future performance.

[1] http://www.investopedia.com/university/greatest/johntempleton.asp, By Nathan Reiff, website accessed 10/16/17.

[2] Morningstar Office Hypothetical Tool – 10/19/1987 to 9/30/2017.

[3] Dimensional Funds 2017 Matrix Book.