And the Winner is _______?
I've ceased making predictions on things because we'll see how they turn out.
A lot can happen in 10 years! Can you even think back to what you were doing 10 year ago in October? Perhaps you were enjoying the start to a nice autumn, watching college football or taking in the fall colors. Maybe you were planning for Halloween, Thanksgiving and Christmas. Whatever the case maybe, I am sure you did not realize that on October 9, 2007, the stock market would peak before cascading into the Financial Crisis of 2008. While you may not remember specifically that the market peaked in October 2007, I am sure you remember 2008, and certainly the depths of financial pain felt on March 6, 2009 when the stock market hit bottom.
Now I am sure your interest is mildly piqued! You might be thinking “Uh-Oh they are talking about the October before the financial crisis.”
Here is an interesting question posed by our friends at First Trust* – Imagine if you had a crystal ball, and knew that the financial crisis was going to happen, supposedly like Doctor Doom and others who perhaps were somewhat clairvoyant, would that crystal ball have told you to invest in the S&P 500, a 10-year Treasury Note, gold, oil, housing, or cash? What do you think? Be honest!
Well, we looked into our revisionist-history-crystal-ball…. And the Winner is… the S&P 500!
“The S&P 500 has generated a total return (capital gains plus reinvested dividends) of 7.2% per year, essentially doubling in value in ten years. Gold did well, but lagged stocks, increasing 5.7% per year. A 10-year Treasury Note purchased that night (now coming due), would have generated a yield of 4.7%. Oil was a laggard, down 4.3% per year. Home prices increased about 1% per year, on average, and “cash” averaged 0.4%, both trailing the 1.6% average gain in the consumer price index.”1
At the risk of sounding like a broken record, a skipping CD or the silence of a failed music stream (whatever your generation happens to be), we still believe that investors are better off ignoring all those pessimists who became famous in 2008-09, invest in companies, and allow world class business managers to use your money to build wealth. We believed that ten years ago, and we believe it today.
Thus, as we move into the 4th Quarter, we continue to have the same outlook: we should have a favorable market for the next 12-18 months bolstered by solid economic growth, good corporate earnings and low inflation and interest rates. Of course, we may experience bouts of volatility and/or pullbacks while Congress muddles rather ungracefully through healthcare and tax reform, and while the Fed pundits vacillate over the pace of interest rate hikes. Nevertheless, we will continue to stay optimistic, diversified and disciplined to achieve your long-term goals and objectives.
Kabarec Financial Advisors, Ltd.
*Referenced First Trust Article – dated 10/2/2017
Nothing in life is to be feared, it is only to be understood.
Now is the time to understand more, so that we may fear less.
If you follow the financial news daily, you are constantly bombarded with headlines predicting the best of times or the worst of times. Case in point – The Fear Gauge! The Fear Gauge or CBOE’s Volatility Index (ticker symbol VIX) just hit a 23-year low or three week high or maybe as some suggest the fear gauge may not be that significant after all… So which is it?
What is the Fear Gauge?
I bet many of you are asking, so what exactly is the Fear Gauge? The following is a definition from Investopedia:
“VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking. It is calculated from both calls and puts, and is a widely used measure of market risk, often referred to as the "investor fear gauge."
That was helpful… right?
Perhaps Wikipedia can help us understand how to interpret the VIX (volatility index):
“Although the VIX is often called the "fear index", a high VIX, is not necessarily bearish for stocks. Instead, the VIX is a measure of market perceived volatility in either direction, including to the upside… Hence high VIX readings mean investors see significant risk that the market will move sharply, whether downward or upward. The highest VIX readings occur when investors anticipate that huge moves in either direction are likely. Only when investors perceive neither significant downside risk, nor significant upside potential will the VIX be low.”
If I were to read between the lines – The VIX measures how volatile investors think the market will be going forward; with a low VIX reading implying that investors don’t expect the market to move sharply in either direction. A high VIX reading implying investors expect the market to move sharply in either direction. This would imply that directional changes to the VIX might have some predictive correlation of the directional changes to the market.
The Relationship of the S&P 500 to the VIX
The chart and table below from the CBOE explores the relationship between the S&P 500 and VIX Index. Essentially, the chart and table show that directional changes to the VIX are about 80% accurate in predicting the direction of the S&P 500. For example, when the VIX is going down, the S&P 500 is going up 82.15% of the time.
Is the Fear Gauge Broken or is it the economy, stupid?
Today the VIX is hovering around all-time lows (see chart below), which has led many commentators to question the validity of the VIX or for the negative market pundits to call this the quiet before the storm – there is a “black swan” event looming that will take down the market.
The VIX doesn’t appear broken; rather like Bill Clinton once said… “It’s the economy, stupid”. In our view, the VIX is hovering near long-term lows because the economy is actually plodding along with good corporate earnings and private sector job growth. In addition, it is interesting to note that market fear hasn’t ticked up significantly with the technology profit taking over the past few days. To be clear, it has hit a 3-week high, but the VIX is still hovering around long-term lows. Investors don’t appear to be fleeing to the safety of bonds; rather we have seen a quiet rotation in the past few days, from technology stocks to financials and to dividend payers. It is too early to consider this rotation a trend; however, in our portfolios we have slowly added to our dividend payers while taking some profits from the technology sector.
At Kabarec Financial Advisors, Ltd., we will continue to monitor the VIX for directional changes that could truly indicate volatility ahead. In the meantime, I hope this has helped you understand more so you can fear less.
"If you fail to plan, you're planning to fail!"
- Benjamin Franklin
Over the years, I have talked to hundreds of investors. Far too often I find that investors start with the investments; specifically the greed of investment returns or the fear of investment loss, as opposed to a Financial Plan. Greedy investors frequently take more risk than their financial plan requires; many times that risk is not rewarded when viewed through a Monte Carlo simulation – the probability of not outliving your retirement savings. Fearful investors can be found to not take enough risk to give them a statistically significant probability to meet their long-term cash flows. Both are examples of failing to plan.
Before investors even consider putting their hard earn savings into tit-for-tat investments, they should start with the question of “Why do I need to invest in the first place?”. Well, as the quote above states, “if you fail to plan, you are planning to fail!”. I’m certain you have heard that quote, probably a hundred times. Of course you believe it and live it every day… right? I am sure you have a budget, savings and tax strategy, financial plan, debt strategy, will and estate plan, and have insured properly for life insurance and long-term care. I am also sure your investments are tuned tightly to all these topics… right?! If you are like most investors, you are nearing retirement and are scratching your head as to how you got to today… some money and uncertainty about your financial future.
Today, let’s talk about the financial plan, a comprehensive financial plan; primarily because almost everything else listed above is solved for or evaluated using this tool. Let’s not get this confused with a complimentary plan which is really nothing more than a sales tool. On the surface, it is fine because most clients do need to know if they will outlive their investments. Unfortunately, when clients receive a complimentary plan, often times advisors do not continue to plan for their clients to make sure their financial path is clear or look deeper than the investments and cash-flow projections.
At Kabarec Financial Advisors, Ltd. (KFA), we believe clients should receive a comprehensive financial plan. Below is what we recommend looking for in a comprehensive financial plan:
- Certifications and Fiduciary Standard –You should look for a fee-only, fiduciary with a CFP®, who must put your interests before their own interests.
- Cash-flow analysis with ongoing monitoring – As markets shift, expenses go up for an unforeseen reason or inflation unexpectedly rises. The financial plan is the tool that helps clients understand what Minimum Acceptable Return (MAR) they need and are comfortable to earn in order to meet their long-term financial cash-flows (i.e. retirement, education planning, legacy planning, etc.) while considering variables like budget, savings, investment risk profile, etc. and solving for a range of statistical success through a Monte Carlo simulation. That said, the financial plan should be routinely monitored, including the Monte Carlo simulation, to ensure the client will successfully reach their goals as life happens.
- Financial Manager –Financial planning should also include a financial manager (see below)– the process of routinely evaluating all areas of your financial life with you and your other key advisors (i.e. CPAs, attorneys, insurance agents). This tool helps to ensure that you and your loved ones not only have enough money in retirement, but also have planned appropriately for such things as disposition and taxation of your estate, financial protection in case of an unexpected loss or tax planning so that the IRS doesn’t erode your hard earned nest egg. In addition, the financial manager should include organizing your financial life in one place so that you have the comfort of knowing that your family will be able to find all your important financial documents and have a team of advisors ready to help them when that time arrives.
"You must pay your taxes. But, there's no
law that says you gotta leave a tip."
–Morgan Stanley advertisement
As the relief of tax season fades into the deep corners of our memory, many taxpayers may be sitting back thinking they’re done; they’ve successfully filed their taxes so they can relax and (hopefully) wait for that refund to hit their account. Before you start putting your legs up and planning that summer vacation, remember that if you are not careful you may inadvertently be giving away your hard earned money to the IRS by delaying in planning and preparing for next year’s return.
At Kabarec Financial Advisors, Ltd. (KFA), we are routinely tax planning for our clients to generate tax alpha - the value-add that an advisor provides by implementing “proactive tax strategies that generate tax savings, particularly in a portfolio (where the larger the portfolio, the larger the potential tax benefits).1 As reputable sources like Vanguard, Morningstar and Envestnet point out, strategic tax planning is worth 0.70% to 3%in annual tax alpha, and that estimate does not include the potential benefits of income tax planning, such as tax bracket management - the process of strategically managing your controllable income in conjunction with marginal tax rates to improve overall tax efficiency. We consider the following high level strategies for all of our clients:
Asset Location– Vanguard research shows that asset location can provide clients with up to 0.75% of additional annual return2. Asset location is a tax minimization strategy that locates investments based on two primary factors: an investments tax-efficiency and its expected returns. For example, placing traditionally high growth and high turnover assets, such as emerging markets and sector rotation fund in the tax-free Roth, or sheltering investments that generate high ordinary income, such as taxable bonds in a tax-deferred IRA. A good asset location reference is Chart 1, “the full asset location smile and the asset location priority list” from The Kitces Report, “Advanced Concepts & Strategies in Asset Location”. In addition, asset location is most effective when the strategy is implemented at the “household level” versus at the account level. Therefore, when considering an asset location strategy for your investments look for firms (like KFA) that can diversify your investments at the “household” level.
Source: Michael Kitces, The Kitces Report
Municipal bonds– One of the principal assumptions of an effective asset location strategy is to use taxable bonds in tax-deferred accounts. However, in certain situations where the tax-deferred accounts are not large enough to properly diversify a client’s investments between stocks and bonds, tax-exempt municipal bonds are a good option. In addition, when considering municipal bonds in a taxable account, investors should review their tax bracket to determine if tax-exempt municipal bond yields are comparable to U.S. Treasuries. For example, 10-year AAA municipal are currently at 1.32 relative 10-year U.S. Treasury bonds, and the tax equivalent yield for a 15%, 28% and 35% tax brackets are 2.03, 1.83 and 1.18 relative to 10-year U.S. Treasury bonds. Table 1 shows the comparison of the U.S Treasury Yield Curve to the AAA Municipal Yield Curve.
Tax loss harvesting– Tax loss harvesting is the strategy of selling securities at a loss to offset a capital gains tax liability, without permanently changing the underlying investment/portfolio. Evestnet’s “Capital Sigma: The Return on Advice” shows that a properly tax managed portfolio may be worth 0.60% annually over a buy-and-hold portfolio.3 Investors should be aware that Congress has passed a 30 day “wash sale” to limit potential abuses. The wash sale rule requires that a tax loss can only be claimed by investor’s if the replacement investment is not “sustainably identical”. In addition, investors should note that tax loss harvesting may trigger a future gain, and thus the value of tax loss harvesting is really in the tax deferral of the loss from time originally claimed until the recovered loss is triggered. For example, an investor buys a stock for $10,000 and its value declines to $6,000. The investor can harvest a $4,000 tax loss, but in doing so, the investment will now have a cost basis of $6,000. When the client sells the stock for $10,000 (the original purchase price), the investor’s gain will be $6,000 (so the net gain is $0). 1
Income Tax Planning– The 3rd and 4th quarter of every year, KFA helps clients’ tax plan going into the end of the year. This includes running illustrations to help minimize a client’s tax burden. We use various strategies, including harvesting gains, tax bracket maximization strategies such as Roth conversions or retirement withdrawal ordering optimization, charitable giving and gifting strategies, and the classic tax deferral strategies (e.g. IRA’s). As Michael Kitces points out, “the tax bracket arbitrage opportunity… is often the biggest tax planning opportunity available”, but it is difficult to quantify.1
Kitces, “Evaluating Financial Planning Strategies and Quantifying Their Economic Impact” The Kitces Report, Volume 3, 2015.
Kinniry Jr, Jaconetti, DiJoseph, Zilbering, Bennyhoff, “Putting a value on your value: Quantifying Vanguard Advisor’s Alpha”, September 2016.
Envest PMC’s Quantitative Research Group, “Capital Sigma: The Return of Advice”, 2016.
By: Lisa Thuer - Senior Trading and Research Specialist
The dust is still settling in Washington as the new administration takes office. The markets started like gangbusters in January and February, which was based on the upbeat news that a Donald Trump presidency would result in pro-growth policy changes, which is good for the stock market and businesses as well. However, in March the markets hit the brakes when the new Healthcare Bill failed to be brought to vote. This is being viewed as, perhaps the Trump administration will not be able to get all their policies and their campaign promises passed as quickly as anticipated. Failure of the Healthcare Bill, contributed to the March stock market being a relatively flat month.
Letís review the positives that we saw in the first quarter of 2017. The technology sector was a top performer, and we were pleased that we made the decision to add to our current positions in this sector at the end of 2016. Other areas that have done well are consumer discretionary, staples, and utilities. The financial and industrial sectors continue to hold their own, as decrease in regulations will benefit the financials and infrastructure spending will be beneficial to the industrial sector. The worst performers were energy and telecommunications. However, we are underweighted in those two sectors, but our minimal exposure in those sectors are holdings that have a significant dividend yield. Small companies have had some mixed results this quarter but the forecasted future is still pro- growth. Fixed income continues to show mixed results, nonetheless we continue to hold investments in the fixed income sector that are non-traditional, income generating holdings.
Any pullback in the markets that we have seen recently can be viewed as a pause in the markets, because bull markets often take a breather. As much as we would all love to see the markets continue to go up, we also know it is not realistic. Investing on political noise at home and abroad can be detrimental to a portfolio. We know that there are many good things happening here in the U.S., Technology innovations, medical breakthroughs, and oil production, just to name a few, but the good tends to be overshadowed by all the noise in Washington. As we have mentioned before, the media tends to focus on the negatives.
There will come a time in the future for us to start dabbling in investments outside of the U.S. as we continue to watch and monitor other areas of the world. For the last several years, we have been reluctant to any foreign investment because of their uncertainty.
Our outlook continues to be relatively optimistic, especially if Washington can put some of this political gridlock aside and focus on getting something done. It would be positive if we could see some, Tax Reform, the easing of some regulations, as well as some type of Healthcare Reform, and it would be best if it came sooner rather than later. Good things are already happening with a pickup in business as well as consumer confidence, along with job creation and wage increases. Regardless of what happens in Washington D.C., companies will continue to innovate and produce, life will not come to an end.
As always, should you have any questions, comments or life changing events that you need assistance with, do not hesitate to contact one of the KFA team members. It is always good to review your own risk tolerance that may change overtime. Are you able to weather the markets ups and downs and focus on your goals? Letís talk about it, please give us a call, Mike Kabarec has been doing this for 35 years. He has seen lots of different markets through his career, he might not have all the answers, but he does have a lot of answers.