Preparing Young Adults for their Financial Future

With back-to-school right around the corner, we wanted to use this blog to address preparing young adults for their financial future. particularly those between the ages of 15-24. While some of these topics are especially important for young people, many are relevant for all ages.

Budgeting

There is a common misconception that “budgeting” is restrictive – that one must eliminate life’s pleasures – trading a night out with friends for a single serving of Cup Noodles ramen at home. Not so.

Rather, having a budget simply means that you’re thinking about money decisions before making them. The idea is to become more intentional with your spending so that you’re not forced to stay home, alone, eating Cup Noodles simply due to short-sighted planning.

So, in the same way that a recent college entrant has to learn about balancing their classes, homework, study hours, extracurriculars, and social life, they also need to learn how to prioritize their financial wants vs. needs.

Not having experience managing month-to-month living expenses is no excuse for unconsciously blowing through funds – whether their own funds, loaned funds, or the supplemental money provided by the bank of mom & dad.

Budget Practice for Young People

One way for our children to manage their wants vs. needs as it relates to finances is to give them a sense of agency and personal responsibility in how funds are spent.

High Schoolers

When it comes to back-to-school shopping, consider giving your high schooler a budget to spend on new clothes, shoes, backpacks, and other discretionary items they may need. If you’re feeling generous you can even let them know that whatever they don’t spend, they can keep.

“Want those new Jordan’s? Have at it! But don’t complain when you’re remaining funds only afford you a pair of shorts and a t-shirt!”

Those $60 Vans almost immediately begin looking more appealing.

College-aged Kids

For parents providing their college-aged kids with supplemental funds, consider setting parameters around monthly living expenses.

Always re-funding their checking account and/or paying off the credit card bill in full each month is unlikely to instill personal responsibility as it relates to finances.

Instead, consider setting a monthly amount that you’ll contribute to their debit account. If you’re child exceeds that and there’s still five days left in the month they’ll either learn to love those Cup Noodles or they’ll adapt… or they’ll get frustrated and tell you you’re a bad parent.

In any case – they’re learning through living.

Big Ticket Expenses

Inevitably, there will be cases when your child asks for your support for bigger ticket expenses.

Examples: a spring break trip, studying abroad, or purchasing a car.

Does your child need to fund any one of these fully through their summer job, work-study, or internship? As parents, that’s your call. It’s likely that many parents reading this either self-funded these things or skipped out on them because both parental support and personal funds were lacking.

However, for parents that are lending financial support to children, getting your child to contribute towards the larger goal – perhaps a defined percentage or an agreed upon amount – is a great way for them to have skin in the game.

Developing a Good Credit History

Building good credit history is an important task. In an increasingly cashless society, creating a track record that shows you are a reliable borrower is a major step in the right direction towards financial independence. The sooner one begins, the better.

Secured Credit Cards

Getting a credit card can be a challenge for those without a credit history. This is where secured credit cards come in. Children over the age of 18 can qualify, regardless of income.

REASON: A secured credit card requires putting down a security deposit (think: collateral) that acts as the card’s credit limit. It’s kind of like your little one riding with training wheels again… but it builds their credit history.

We found Bankrate’s list of secured credit cards helpful to sort through the variety of options.

Do note that secured credit cards are not the only way for a young person to get access to a card that builds their credit history – they can also be added as an authorized user on a family member’s credit card.

Establishing good credit at a young age can open up opportunities down the road and credit scores can impact all of the following:

  •  Leasing an apartment
  • Setting up utilities
  • Applying for a job
  • Buying or leasing a car
  • Purchasing a cell phone plan
  • Interest rates for credit cards and various loans

Additionally – there are some basic rules of thumb to ensure that credit is being used appropriately and improving a new borrower’s credit score:

  • Set up automatic payments (to ensure no missed payments)
  • Keep credit utilization below 30% credit utilization (i.e. staying below 30% of total credit limit)
  • Pay off your balances in full when due (i.e. not paying off immediately after each transaction)
  • Make student loan payments on time

DID YOU KNOW: Your three free credit reports can be accessed directly from annualcreditreport.com – the only source for free credit reports as authorized by Federal law.

Other important financial know-hows for young adults:

Knowing How a Bank Account Works

Do they understand:

  • minimum balance requirements?
  • overdraft and service fees and how to avoid them?
  • how long it can take to transfer funds between different accounts and institutions?

Being Smart About Cybersecurity

Many students use shared Wi-Fi networks that are not secure – are they aware of this?
Consider investing in a Virtual Private Network (VPN) to establish a secure, encrypted connection between your child’s computer and the internet.

Renting Textbooks

No need to buy new if you can rent or buy used.

Student Loans & Delayed Gratification

For those that take out student loans, it’s not uncommon to have some extra funds available after tuition/room/board fees are paid.

No – these funds are not fun money. Student loan borrowers should be reminded that the longer these surplus loan funds can be stretched, the less they’ll need to fork over for monthly repayment when they begin working.

Long-term Investing

Children with on-the-books earned income are also likely to be in a low (or zero %) tax bracket. This presents a great opportunity to open and fund the golden egg of their future financial plan: a Roth IRA.

Final Thoughts:

Discussing household finances is, unfortunately, a taboo subject in many families. However, the more proactive we can be in preparing young adults for their financial future the better we can equip them with information to help them avoid common pitfalls and succeed.

So – please – think about those young adults (or soon-to-be young adults) in your life and share what you can. Each of us stands on the shoulders of those before us. Even if you don’t feel that your lived experience is worth sharing, it’s highly likely that a young person could glean gems of wisdom from both your financial successes and your defeats.

Parents: Also be aware of recent FAFSA updates and the pros and cons of cosigning a student loan.

CLIENTS: We are offering an on-demand financial literacy course that your children have access to for FREE. This is not only a great educational opportunity for them, but also something they can leverage on their resume or school application.

Please be in touch if this might be of interest.

The Dreaded “R” Word

The Dreaded "R" Word

Probably like you, we’re hearing the dreaded “R” word – recession – being referenced quite a bit lately.

In fact, in the month of June, Google Trends – which analyzes the popularity of Google Search across various regions and languages – indicated that searches for “recession” have officially surpassed those for “inflation.”

What’s causing the dim outlook?

In simplest terms: Uncertainty.

Most of that uncertainty lands squarely around the recently overtaken Google Search favorite: inflation.

At the European Central Bank Forum in Sintra, Portugal last week, Fed Chair Jerome Powell – the man with quite possibly the most unenviable job in America right now – said:

“I think we now understand better how little we understand about inflation” and that there is “no guarantee the central bank can tame runaway inflation without hurting the job market.

Not the most reassuring words.

Inflation Blame

A succinct summary of inflation contributors (credit to Barry Ritholtz):

  1. Covid-19
  2. Congress
  3. President Biden CARES Act 3
  4. President Trump CARES Act 2
  5. Consumers (who overspent without regard to cost)
  6. Consumers (shift to goods)
  7. Russian invasion of Ukraine
  8. Just In Time Delivery (supply chain)
  9. Fed/Monetary Policy
  10. Wages/Unemployment Insurance
  11. Home Shortages
  12. Semiconductors/Automobiles
  13. Corporate Profit Seeking
  14. Tax Cuts (2017) / Infrastructure (2022)
  15. Crypto

Inflation: The Path Forward

Between a rock and a hard place, the Fed has made clear that it will prioritize reining in inflation.

To do this, the Fed will continue tightening monetary policy. Quantitative easing (QE discussed more in previous contribution) has been discontinued and additional interest rate increases are planned.

The question then becomes – as Powell alluded to in Sintra – whether the Fed can achieve this without further upending the broader economy.

So, does all this point towards the inevitability of a recession?

Let’s start with the basics.

What is a Recession?

Recessions are an unavoidable contraction in a nation’s economy, a natural part of the business cycle.

While many consider two consecutive quarters of declining GDP to be a recession, the non-partisan National Bureau of Economic Research (NBER) – the official arbiter of recessions – defines it slightly different.

According to NBER, “a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months” that manifests itself in the data tied to “industrial production, employment, real income, and wholesale-retail sales.”

Essentially three criteria that must be met to officially qualify as a recession: depth, diffusion, and duration.

What causes a recession?

Recessions can be set off in a variety of ways. Some causes include:

  • Sudden economic shocks (1973 OPEC energy crisis)
  • Bursting of asset/debt bubbles (‘01 dot-com bubble, ’08 subprime mortgage crisis)
  • Too much inflation/deflation (US inflation in ‘70s, Japan deflation in ‘90s)

Is another recession inevitable?

It’s pretty much guaranteed, yes.

Since 1854 (the first year we have official economic data), the United States has experienced 35 recessions which have occurred, on average, nearly every 4-5 years.

A chart outlining some of these recessions (and their respective GDP contractions and durations) was featured in a blog post of ours from 2019 (also a timely read considering Le Tour just started!):

The Next Recession and What We Can Learn from the Tour de France.

Why do we care about recessions?

Recessions have real world consequences:

  • Unemployment can rise: Recessions can lead to less spending/consumption which can result in layoffs, pay/benefit cuts, and heightened job insecurity. For job seekers, recessions can be a challenging time because there is less hiring and employees will typically have less leverage in pay negotiations.
  • Businesses can fail: The same reduction in spending/consumption that leads to unemployment can also directly lead to businesses being forced into bankruptcy.
  • Retirement plans can be upset: The retirement landscape is already full of landmines for the average American. Sprinkle in a recession + inflation and you have an environment that will be unforgiving to overspending/mistakes. Those that retain jobs may decide to stick around longer to weather the storm.
  • Borrowing can get more difficult: As the broader economy slows down, or backtracks into recession territory, it’s not uncommon for lenders to tighten their standards for mortgages, vehicle financing, and other types of loans.

Is the United States heading for a recession?

It’s all opinion and speculation until it’s here. Poll various economists, strategists, and bankers and you will get inconsistent answers.

Even better yet – and perhaps just as reliable – ask your neighbor what they think. Consumer sentiment alone speaks volumes.

While recessions are hard to predict, leading indicators are pointing to the U.S. inching closer to one:

Room for optimism?

The consumer makes up 70% of the economy and there is an argument that, based on US household holdings of cash and cash equivalents, that the US consumer has never been more prepared for a slowdown:

US Household Holdings of Cash & Cash Equivalents

And no, the cash is not necessarily being hoarded by just the wealthiest households. Those in the bottom half are holding 45% more cash than from two years earlier.

Growth in total household wealth also provides a glimmer of hope.

Between Q4 2019 and the end of Q1 2022, total household wealth increased from $109.9T to $141.1 T – an increase of nearly 30%. All this while the ratio of household debt to disposable income dropped to the lowest levels of anytime seen between 1980-2020.

Air flight – another indicator of consumer sentiment measured by TSA checkpoints – is also seeing it’s highest levels of passengers since the start of the pandemic. This is a great sign when considering that business travel is still down 30%.

Will this continue? Anyone’s guess. But at the moment the average US consumer has more cash, less debt, and more overall wealth than they’ve ever experienced.

Closing Thoughts:

The next time you hear the dreaded “R” word referenced, consider taking a page out of the Stoics’ playbook: prioritize the things within our control, and ignore the rest.

We have no way of knowing, or control over, when the economy will rebound, when inflation will subside, or when the market will be primed to recover it’s losses.

However, the things we can control include:

Financial:

  • Spending habits (and potentially adjusting in light of inflation)
  • Making strategic tax-planning decisions
  • Paying down high interest debts
  • Continuing to invest in the market.

Life:

  • What we consume (food, media)
  • Our mental and physical fitness
  • Who we choose to spend time with
  • The amount of sleep we get
  • Our body language and breath
  • Our opinions, attitudes, aspirations, dreams, desires, and goals.
  • The number of times we smile, say “thank you,” or express gratitude for all we do have today
  • Our level of honesty with self and others

In the words of Epictetus, “He is a wise man who does not grieve for the things which he has not, but rejoices for those which he has.”

The Federal Reserve’s Toolkit + Market Hangover

Federal Reserve

The Federal Reserve’s toolkit consist of two blunt tools: the fed funds rate + quantitative easing. In this month’s contribution we’ll discuss the potential short and long-tail impacts of both.

On Wednesday (5/4/2022), in an effort to bring down rising inflation without disrupting economic activity, the Federal Reserve boosted interest rates by 50 basis points (.50%).

Like downing a Pedialyte following a three-day bender, the markets initially reacted positively. However, nausea quickly set in and the previous day gains were quickly reversed. By the end of the following trading day, ol’ S&P 500 and it’s tech pal Nasdaq were both sitting on the toilet holding trashcans, down 3.6% and 5% respectively. The single worst day for the market since June 2020.

In fact, last week marked the fifth consecutive weekly decline in the S&P 500, it’s longest losing streak since June 2011.

April CPI data released the following Wednesday (5/11/2022) showed another upward inflation surprise (above analyst expectations) and suggests that the deceleration is going to be painstakingly slow.

What’s going on?

In short: A lot.

  • Covid Supply & Demand Constraints: Domestically, although things are beginning to look better, the dust has still not settled from the logjams created by Covid. Internationally, China’s most recent bout of Covid-19 lockdowns has reduced the supply of Chinese exports and dampened demand for imports.
  • Oil Shock: Sanctions against Russia are forcing countries reliant on Russian oil to explore other energy suppliers/solutions which has driven up global oil prices.
  • Inflation: No matter how transitory the Fed believes inflation may be, they’re no longer sitting around and waiting for the situation to rectify itself. They are now deploying their limited arsenal of blunt tools to bring this down.

This last point re: inflation/Fed tools deserves some extra attention.

Federal Reserve: The Bartender

As already mentioned, the primary tools in the Federal Reserve’s toolkit are:

  1. controlling the federal funds rates (which impacts interest rates)
  2. quantitative easing (QE) which introduces new money into the money supply.

In another alcohol analogy, imagine the Fed as our bartender.

Interest rates:

If the bartender wanted to incentivize drinking (helllllllo happy hour!), the bartender could lower the prices which might increase consumption. The drink servers (banks) would let all the patrons (individuals/investors etc.) know that drink prices are down – get ‘em while you can! This is, in effect, what lowering the fed funds rate does for our economy – it lowers the cost of borrowing and incentivizes investment.

Conversely, perhaps the party is really hoppin’ and there’s a line around the corner to get in, the bartender might then increase drink prices (i.e. increase the fed funds rate) to slow down the debauchery (i.e. irrational exuberance).

 Quantitative Easing:

QE is the other strategy that the bartender (Fed) deploys to get a dreadfully boring party (i.e. crashing economy) poppin’ again.

In this scenario, you can only order drinks (i.e. do business) with the drink servers (banks). During happy hour, the bartender notices that the servers (banks) aren’t hawking drinks (lending), they have empty trays. To get them up and active again, the bartender loads up the drink trays (i.e. Fed buys long term securities from the open market) but lowers the amount of alcohol in each cup (i.e. the fed’s asset purchases increase the banks’ reserves which results in lowers yields + more money in circulation).

This action results in the drink servers (banks) being flush with heavy trays of drinks (excess reserves) and incentivized to get back out to doing business (lending).

Ugh, yes – monetary policy is nuanced and there are some obvious holes in these oversimplified analogies but hopefully this is kinda helpful?!

A Recent History of Fed Interventions

While the Fed has deployed it’s influence on interest rates by increasing/decreasing the federal funds rate in the past, this tool had traditionally been reserved to rein in inflation and/or unemployment.

However, beginning with Alan Greenspan following the 1987 stock market crash, Federal Reserve chairs began lowering interest rates for one additional reason besides controlling inflation/unemployment: to proactively halt excessive stock market declines. This “Greenspan Put,” as it became known, acted as a form of insurance against market losses.

Since then, the Fed has intervened with lowering interest rates on a number of occasions to minimize stock market volatility/losses: the savings and loan crisis, the Gulf War, Mexican peso crisis, Asian financial crisis, Long-Term Capital Management (LTCM) crisis, Y2K, dotcom bubble, and 2008 financial crisis.

Quantitative easing (QE), on the other hand, is a more recent monetary policy first deployed by Japan in 2001 to stymie the collapse of their financial market. In the US, QE was deployed following the 2008 crisis in three separate waves: in 2009, 2010, and 2012.

As mentioned earlier, QE is when central banks introduce new money into the money supply. In practice, this is done by central banks purchasing longer-term securities from the open market. This action drives up money supply and encourages institutions to keep lending (and investing!).

While it’s the Treasury that controls the printing of money, it’s the Federal Reserve that effectively decides how much money is created (in the form of actual paper money + credit).

What the Fed is doing now

Most recently, as global financial markets began nosediving due to Covid-19 lockdowns, the Federal Reserve stepped in with a broad array of actions to limit the damage.

First, they reduced the fed funds rate to ground zero (0.0%-0.25%) which brought the cost of borrowing to historic lows. They also pursued quantitative easing (QE) which included large purchases of U.S. government and mortgage-backed securities as well as lending to support households, employers, financial market participants, and state and local governments.

Through quantitative easing (QE), the Fed’s balance sheet has now swelled to nearly $9T (nearly double that following the ’08 financial crisis).

The Hangover

The combination of lower interest rates and $9T of QE is like a shot of adrenaline, or a Red Bull Vodka – it gives an immediate bump but a potentially painful come-down.

At wHealth Advisors, while we’re rationally optimistic that the long-term return potential in the stock market remains strong, there a number of hurdles facing the short/medium term:

  • Increasing National Deficit: The current national debt is approaching $30T. The 2017 Tax Cuts and Jobs Act resulted in record corporate profits and strong stock market performance. However, the cuts essentially 1) borrowed economic growth from the future and 2) are expected to add $2-2.2T to the national deficit over the next six years. The 2017 tax cuts + QE response to Covid-19 have swelled the deficit and put the US on a “fiscally unsustainable” path, to quote the Government Accountability Office (GAO).
  • Tax Hikes Likely: There seems to be little interest in reducing federal expenditures. As such, without extreme austerity, the only other solution to combat rising deficits is increasing taxes (likely impacting both individual/corporate rates).
  • Slower Growth: Economists expect 2.3% GDP growth per year, on average, over the next 10 years, even after accounting for expectations of increased economic activity in the near term. This compares to historical average GDP growth of 3.1% per year since 1948.
  • Muted 10yr Equity Outlook: A lower economic outlook combined with record high equity valuations has many fund companies bracing investors for lower expected returns going forward. Vanguard forecasts US equities to have a 10yr annualized return between 2.0-4.0% and international equities to range between 5.1-7.1%.

 Final Thoughts:

The Fed’s QE actions, creating $9T more or less out of thin air, is somewhat uncharted territory. It will take time to fully understand the ramifications of this. For the time being, we’ve got inflation and a choppy stock market.

In the immediate future, the Fed has made clear that they are willing to increase unemployment to slow down inflation. To do this, the Fed is targeting a 2.25% fed funds rate and aiming to reduce their $9T balance sheet by $1T over next 12 months.

Over the short-medium term, continued stock market volatility will be inescapable. Actively reducing equity allocations in anticipation of, or in reaction to, fed funds rate increases is unlikely to lead to better investment outcomes.

Over the longer-term, investors who maintain a broadly diversified portfolio and use information in market prices to systematically focus on higher expected returns (i.e. exactly what we do for our clients at wHealth Advisors) should be better positioned for long-term investment success.

Resilient financial plans are designed with unpredictable, gloomy outlooks in mind. Please be in touch if you have any questions or concerns regarding your plan’s resiliency for the road ahead.

The SEC Finally Enforces ESG

SEC enforces ESG disclosure

With Earth Month upon us, we’re happy to report one small, incremental bit of progress in finance:

The Securities and Exchange Commission (SEC) will finally enforce ESG disclosure and begin requiring public companies to share their greenhouse gas pollution and climate risks.

Pressure Has Mounted – The SEC Finally Enforces ESG Disclosure

Back in a 2019 blog post we wrote about our key takeaways from three finance-focused climate events we attended.

The events had confirmed our understanding that ESG investing – that is, investing in funds that claim to prioritize environmental, social, and governance (ESG) factors – was subjective and, at best, financial industry greenwashing.” 

Reason: Up until now, the SEC has not required public companies to disclose any ESG metrics. Without metrics, ESG fund managers were forced to make subjective judgement calls about their fund’s holdings (note: unless explicitly stated, ESG funds rarely divested from any specific companies or asset classes). Despite this reality, fund companies marketed these funds as fuzzy, feel-good environmentally-socially-conscious investment solutions.

At the time, the SEC defended it’s position by claiming that ESG metrics were nonmaterial to shareholders/investors.

Since then, and considering that there is now over $40 trillion in assets globally invested in ESG funds, there has been significant pushback from nearly all corners of the investment world. Individual and institutional investors, state pension funds, endowments, and even sovereign wealth funds have all pushed for more ESG disclosure.

Why Do Investors Want More ESG Disclosure?

One possible answer is, for the same reason they want good consistent financial disclosure: They want to be able to understand how companies work, so that they can buy the good ones and avoid the risky ones.

And most of the SEC’s proposal is about that sort of thing: Climate risks can affect a company’s business and financial results, so investors need to understand those risks to understand the business.

In other words, an about-face:

Emissions + climate risks = material information for shareholders/investors

Major Shift

This marks a major shift in how corporations must show they are dealing with climate change.

For the first time ever, the SEC finally enforces ESG and plans to require businesses to outline the risks a warming planet poses to their operations. In fact, some large companies will have to provide information on emissions they don’t make themselves, but come from other firms in their supply chain.

The rules will require companies to:

  • describe what climate-related risks they face and how they manage those risks
  • disclose, if applicable, a “transition plan” to adapt to a warming world, or whether they “use scenario analysis to assess the resilience of their business strategy to climate-related risks,”
  • disclose and quantify the use of carbon offsets
  • disclose how their financials are affected by climate risk

In essence, the SEC is proposing a complex accounting regime for ESG, a legally approved set of Generally Accepted Climate Principles, with its own body of technical standards and its own set of climate attestation professionals.

Takeaway:

While we’re optimistic that these new disclosure requirements will improve ESG investing, do note that it will take time. Implementation will take place between fiscal year 2023 and 2026 (depending on the size of company).

While increased disclosure of public companies is good, the UN’s Intergovernmental Panel on Climate Change’s (IPCC) latest climate report suggested that ESG investing “does not yield meaningful social or environmental outcomes.”

Instead, the report cited, in order to avert the increasingly likely scenario of catastrophic global warming, the world needs stronger government policy and enhanced regulation.

Happy Earth Month. 

How will you do your small part to honor Mother Earth this year?

Let us know!

When Worlds Collide

Micro vs Macro

Investors need to be prepared for when worlds collide. Collisions – whether they be on a macro level (like war, famine, geopolitical strife etc.) or on the micro level (a professional transition, the loss of a loved one, a disability etc.) – can disorient even the most emotionally stable.

In this piece, a contribution from our March 2022 newsletter, we share our thoughts on what we’re seeing from the 30,000ft, global viewpoint. We also narrow our scope and discuss what you – personal finance investors – can do in light of all the noise, volatility, and events that are beyond your control.

The Macro

Russia-Ukraine:

The events in Ukraine are heartbreaking. We’re certainly not qualified to speak about the political implications of this invasion, but anytime there is aggression and loss of life, it is a tragedy.

From a financial perspective, markets had been bracing for a possible Russian invasion for much of February. Leading up to the invasion there was increased market volatility and a drop in the major indexes.

Oil Ban:

Just yesterday, the Biden administration announced an executive order halting all imports of Russian oil.

Roughly 8% of US imports of crude oil and petroleum products came from Russia in 2021, representing just 1% of Russia’s total oil exports globally. However, some US allies have indicated they may follow our lead with similar embargos.

These oil bans will impact global oil supply and inevitably result in gas prices continuing their steady incline (which have already climbed more than 60% this year).

Macro Movers and Market Impact:

Between the growing Russia-Ukraine crisis, continued inflation, rising commodity/metal prices, and the anticipated Federal Reserve interest rate hikes, it’s anyone’s guess just how much corporate profits (and your portfolios) will be impacted.

The image (below) shows how the market has fared during previous global events.

Our advice: Ignore the Macro

As we look ahead, from a personal finance standpoint, we encourage you to not react emotionally (i.e. buying/selling in a panic) based on macro events that are beyond your control. Reacting to events is, in essence, just another form of market timing.

If you flee the market after a major crisis, you are faced with yet another market timing dilemma: when to reenter. In many cases, the decision to reinvest comes after a rebound has already begun, resulting in missed opportunity (think back to March 2020).

Moving in and out of the market can also incur additional costs and have potential tax implications for investors.

The Micro

Instead, we encourage you to focus on the micro – that is, the levers that are within your control:

  • Saving at least 15% (ideally 20%) of income
  • Controlling your household expenses
  • Maximizing tax savings and tax-efficiency
  • Having a globally diversified portfolio for long-term resiliency

Parting Thoughts:

Let us all reflect on how much we do have during these times of crisis. Out of all the hands we could have been dealt, we got ours. We made it through a global pandemic, we have safety/security, and our physiological needs are met (i.e. clean air, food, water, shelter, clothing). Many of us are especially lucky and also have meaningful relationships, connection, and love with friends and family.

To quote Viktor Frankl:

“For the world is in a bad state, but everything will become still worse unless each of us does his best.”

Have gratitude for what you have, ignore what’s beyond your control, and give it your best.

The 101 on I Bonds

Before diving into a 101 on I Bonds, let’s first acknowledge that they’re the most boring investment that we’re recommending to… just about everyone*. If inflation is something that’s top of mind, they may be a good addition to your portfolio. For more on our thoughts on inflation, see our piece from a few months back.

What are I bonds?

I Bonds are a type of U.S. savings bond designed to protect the value of your cash from a rise in inflation. They are meant to give investors a return + inflation protection on their purchasing power. An I bond earns interest monthly from the first day of the month in the issue date.

Interest is paid in two components: a fixed rate of return plus a semi-annual variable rate which fluctuates with inflation.

How is interest calculated?

Currently, I bonds provide an interest rate of 7.12%, and this rate is good through April 30, 2022. A portion of this rate is tied to inflation, so the rate adjusts every six months, on May 1 and November 1.

How do I bonds work?

When you purchase an I bond, you pay the full face value of the bond. Bonds can be purchased two ways: paper I Bond certificates or electronically registered I bonds through the TreasuryDirect.gov website.

I bonds earn interest each month, and the interest is compounded every six months. However, you don’t get access to the interest until you cash out the bond. Interest that you earn gets added to the value of the bond twice per year.

How much can I purchase?

Investors can buy up to $10,000 worth of I bonds annually through the TreasuryDirect website. In addition, you can purchase another $5,000 by applying your federal tax refund towards a paper certificate purchase. For instance, a family of four would be able to purchase $40,000 in I bonds annually via TreasuryDirect.gov, and up to an additional $5,000 (per SSN, per year) if they had a federal tax refund in at least that amount.

When do I bonds mature?

I bonds have a maturity of 30 years, so you can earn interest on them for 30 years. NOTE: You cannot cash out of your I bond during the first 12 months of ownership. If the bond is cashed out between years 1 and 5, the most recent three months’ worth of interest is forfeited.

Do I have to pay taxes on I bonds?

I bonds are exempt from both state and local tax, but you do have to pay federal tax on the interest. However, if used to pay for college, the interest is completely tax exempt. For reporting taxes, there are two options: report interest annually or at maturity when the bond is sold.

How do I cash in my I bond?

This will depend on whether you own a paper bond or an electronic bond:

  • Paper Bond
    • Bring physical bond and proof of identity to a bank or financial institution that will cash it in (recommendation: call in advance, not all institutions accept).
  • Electronic Bond
    • Can cash out directly through the TreasuryDirect website.

Should I bonds be a part of my portfolio?

Although purchase amounts are quite limited, there are a few advantages to I bonds that make them a consideration for any portfolio:

  • Inflation protection
  • Less volatile than equities
  • Essentially no default risk, they are backed by the US Treasury
  • Interest is exempt from state and local taxes
  • Interest is exempt from federal tax if bonds are used to pay for college

*Disclosure: Everyone’s situation is unique. Please speak with a financial professional before following any of this advice.

End of Year Planning

Some end-of-year housekeeping and planning strategies to close out the year on a good note:

Review your portfolio:

  • with upcoming transitions in mind. Are allocation changes needed to begin preparing for an upcoming milestone (i.e. retirement) or transition (i.e. job change, relocation etc.)?
  • for (in)appropriate risk. Has your risk tolerance or risk capacity (i.e. how much risk you can take without interrupting other goals/priorities) changed? Can you now take on more/less risk?
  • for rebalancing opportunities. Is your portfolio properly allocated based on a target model? Or has your overall allocation drifted due to outsized gains/losses?
  • for gain/loss harvesting. If you invest in a taxable brokerage account, and depending on your tax bracket, there may be opportunities to realize additional capital gains (while in a lower tax) bracket or offset capital gains with losses.

Required Minimum Distributions (RMD)

  • What they are: The minimum amount that must be withdrawn from pre-tax retirement accounts annually once reaching age 72. This does not apply to post-tax Roth IRAs.
  • Inherited IRAs: Have their own rules.
  • Deadline: All RMDs must be taken by December 31st.

Contribute to a Roth or Traditional IRA

  • Roth IRAs: Contributions grow tax-free and qualified distributions come out tax free. Income limitations apply.
  • Traditional IRA: Contributions may be fully, partially, or non-deductible, depending on your income and circumstances.
  • Annual contribution limit (per person): For 2020, 2021, and 2022 is $6,000, or $7,000 if you’re age 50 or older. This limit applies to all IRAs. Example: An individual could fund a Roth IRA with $6k, or fund a traditional IRA with $6k, or fund each with $3k. You (or your spouse) must have taxable income in order to make a contribution.
  • Deadline: You can make 2021 IRA contributions until April 15, 2022.
  • Backdoor Roth: Depending on your circumstances, and for those who exceed the contribution/deduction income limits, you may be eligible to make a “backdoor” Roth contribution. Read more about it here and be sure to do it under the guidance of your financial planner and/or tax advisor.
  • Roth Conversions: If you are currently in a low tax bracket and expect your tax bracket to increase in future years, you may consider converting some pre-tax funds to your post-tax Roth. Essentially, paying taxes now so that your retirement funds can grow tax-free into the future. Deadline: 12/31/2021.

Charitable Donations

  • Deadline: All 2021 cash/non-cash donations must be completed by December 31st.
  • Deduction: Those that do not itemize their taxes can still deduct donations: up to $300 for single filers and $600 for joint filers.
  • Donor Advised Funds: Gifting appreciated stock to a Donor Advised Fund avoids recognizing capital gains and potentially pre-funds future year gifting.
  • QCDs: If over age 70.5, you can avoid recognizing IRA RMD income by directing some/all of your distribution to go directly to charity via a Qualified Charitable Distribution.

All advice listed here is for informational purposes. Please consult your financial planner or tax advisor before implementing.

The Role of Alternative Investments in Your Portfolio

Alternative Investments

For decades, pundits have taken a stab at writing the obituary for the traditional 60/40 portfolio (i.e. 60% stocks/40% bonds).

At first glance, this seems laughable. Over the last 90 years, a traditional 60/40 portfolio returned over 8% per year – like the S&P 500 which returned 9.5% over that period – but… with 40% less volatility!

However, these days, when accounting for historically low interest rates and rising inflation (which may or may not be transitory), the 60/40 bears may have their strongest case in recent memory.

This then begs the question: what now?

For a variety of reasons, there is still plenty of merit to 60/40 portfolios. However, we do appreciate the potential of certain investments to increase portfolio diversification. For investment opportunities beyond that of traditional stocks and bonds, we classify these in the portfolio as Alternative Investments (or, alts).

What are alternative investments?

Alts are essentially a catchall for any investment besides stocks, bonds, and cash (or cash equivalents). They provide an opportunity to gain exposure to areas not traditionally captured in a stock/bond portfolio that may or may not offer above market returns. Some of the more common types of alternative investments include:

  • Real Estate – crowdsourced or private commercial/residential property ownership, private/public Real Estate Investment Trusts (REITs)
  • Commodities – such as crude oil, corn, soy, wheat, and coffee
  • Precious metals – such as gold, silver, and lithium
  • Cryptocurrency – purchasing coins, NFTs, or investing in public companies at the fore of crypto/blockchain/web3
  • Private Equity – locking up funds with a private equity firm to invest in non-public, private companies often via leveraged buyouts and/or venture capital
  • Collectibles – tangible assets such as art, fine wine, and vehicles

What are the benefits of alternative investments?

  • Diversification. This is the primary benefit. Alternative investments are typically a counterweight to conventional stock/bond assets and may perform well even if stock/bond returns are poor due to low correlations.
  • May have greater upside. Alternative investments, often due to their concentrated positions, can potentially offer outsized returns compared to traditional mutual fund/ETF investments.
  • Expertise can be an edge. An example of this would be an experienced real estate fix-and-flipper who can spot an opportunity and has the team/know-how to carry out the vision. Another example might be an art collector that knows how to spot undervalued works of art. All this to say, unique skills/interests in niche areas can set you apart.

What are the drawback of alternative investments?

  • Illiquidity. Many alternative investments may be illiquid and difficult to exit. In the case of most non-tradable private REITs, your investment might be tied up for 7+ years before you can access the funds.
  • Lack of regulation. Reporting requirements for many alternative investments are minimal compared to those of public companies in the stock market. This can create difficulty when valuing the alt’s underlying assets, which can make pricing and price transparency less straightforward.
  • Investment platforms can fail. Many online platforms for alternative investing are start-ups that may or may not succeed. You need to understand how your funds will be handled should the company fail or be acquired.
  • Investment minimums may apply. High investments minimums are common and may make certain alts impractical/inaccessible for smaller investors.
  • High fees. Alternatives can have many fees that are unique to the investment. Private equity typically charges large asset management fees. Real estate can have many unplanned repair/maintenance/legal expenses. Wine collecting through Vinovest charges 2.5%-2.85% for climate-controlled and insured wine storage! Compare those fees to traditional index funds which have small expense ratios, no purchase fees, no redemption fees, and no 12b-1 fees.
  • Complexity. Alternative investments are often complex instruments and may require a higher level of due diligence. If you are considering alternative investments, you also want to be sure that you research and understand the potential tax implications associated with them.

Takeaway

Ultimately, investors need to be aware of both the upside and downside potential of any investment. The suitability of any given alternative investment should be considered against an individual investor’s:

  1. time horizon
  2. appetite for risk
  3. ability/capacity to take on outsized risk, and
  4. any unique skills/interests that strengthen the odds of making a profitable investment.

S&P Gains 100% from March 2020 Low: Now what?

S&P 500 marks 100% gain since March 2020

After hitting “rock bottom” following global shutdowns related to the coronavirus in March 2020, the S&P 500 has roared ever since delivering a 100% return. You read that right: 100%.

SIDEBAR: Someone out there is highlighting this past 18 month window in their investing masterclass, illustrating that in times of financial crisis, the best action for your portfolio is inaction. Don’t sell. Be patient. Ride it out. But we digress…

What now?

After living through the shortest bear market in history, we’re now witnessing company valuations being pushed to new heights only surpassed by the dot-com bubble of the late 1990s. While this may sound unsettling, also consider that with interest rates so low, it would be equally worrying if equities weren’t expensive (reason: low interest rate yields push investors to equities).

So, at this juncture and with cash to invest, should you a) lean towards low interest fixed income that’s not (or barely) keeping up with inflation, or b) buy potentially overvalued equities? Pick your poison.

From our vantage point, choosing low interest debt or expensive equities is not an either/or proposition – everything comes back to diversification. Instead of chasing returns, we prefer the approach of aligning portfolio decisions to your unique life: your upcoming cash needs (and/or life transitions), your tax bracket, and your tolerance + ability to take risk.

While we’re not ones for reading the tea leaves, we did appreciate reviewing the latest JP Morgan Long-Term Capital Market Assumptions report. In it, they had a stark quote that stuck out:

“The price for dealing with the pandemic today comes at the cost of tomorrow’s returns in many conventional asset markets.”

Not exactly a glass half-full outlook for the road ahead.

The biggest challenges outlined by the report included:

  • Whether governments/business can rise to the climate challenge
  • Increased sovereign debt balances and an expectation for fiscal stimulus to continue
  • Stagnating globalization, companies shortening their supply chains
  • Era of US “exceptionalism” possibly coming to an end, leading to a weaker dollar

While we certainly believe that all challenges present opportunities, we feel equally strong that investors should prepare for muted annual returns over the next decade. We touched on this topic not long ago.

According to the same JP Morgan LTCMA report, over the next 10-15 years, inflation is anticipated to flatten at an overall rate of 2.0%. This is a tough pill to swallow when the same report projects compound return rates for the same period to be 1.10% for cash, 1.50% for intermediate Treasuries, and 2.50% for US investment grade corporate bonds.

For equities, the LTCMA report outlined the following predictions for the next 10-15 year investment time horizon:

  • 4.10% for US Large Cap
  • 4.60% for US Small Cap
  • 6.20% for US Value
  • 6.50% for US REITS
  • 5.20% for Euro equities
  • 6.10% for UK equities
  • 5.10% for Japanese equities
  • 6.80% for emerging market equity

Compare these expected returns to the 10% average annual return that the stock market has delivered over the last century. Not ideal.

Instead of guessing which asset class will perform best, or searching for the next Amazon to invest in, legendary investor and founder of Vanguard, John Bogle (who’s 3-fund “boring” portfolio outperformed the largest endowments in 2020, yet again), said it best:

“Don’t look for the needle in the haystack. Just buy the haystack.”

As evidence-based investors, we wholeheartedly agree with this approach.

Beware of Financial Scams

Scam Alert

A personal contact shared a story with us regarding their friend who recently fell victim to an online gift card scam.

The friend received an email from “Target” and was prompted to provide certain information to “verify their gift cards.” Unfortunately, the friend fell for the scam and within a few days had money withdrawn directly from their bank account. The impacted individual is now in the process of working with their bank to recover the stolen funds.

The State of Fraud

Scamming shows no signs of letting up. In its most recent report from the Internet Crime Complaint Center, the FBI saw the largest number of complaints, and the highest dollar losses, since the center was established 20 years ago. According to the FBI, the costliest scams involved business email compromise, romance or confidence fraud, and mimicking the account of a person or vendor known to the victim to gather personal or financial information.

How to avoid

  1. Beware of suspicious email address and fake invoices/attachments: Fraudsters are masters of deception. It’s not uncommon for them to send emails from addresses that might look familiar to you but which contain one spelling difference, or end in .net instead of .com. Never open links or attachments from email addresses that are unfamiliar. Additionally, if you receive a link or attachment that you weren’t expecting from what appears to be recognizable/legitimate email address, it never hurts to send a quick call or text to the sender to confirm.
  2. Ignore scammers pretending to be from the government: Most of us have probably received one of these phone calls. Someone reaches out on a phone call claiming to be from the IRS. In some cases, most recently, the caller will claim you are eligible for an “additional stimulus check.” In others, they’ll say you owe money and will warn that non-payment will result in legal recourse and penalties. Take note: the IRS will never make first contact via a phone call or request payment details for money-owed over the phone. If you receive a call, simply hang up the phone. The same goes for calls from the Social Security Administration and other government organizations.
  3. Be aware of the Social Security scam: Also done via phone call, the caller says your Social Security number has been linked to a crime involving drugs and/or sending money out of the country illegally. They inform you that your Social Security number is blocked and that by simply confirming your SSN and paying a small fee, it can be reactivated. Again: Hang up! The Social Security Administration will never call you on the phone and ask for your Social Security number.
  4. Scammers will tell you how to pay: All successful scams entail coercing the victim to part with sensitive information or to pay the scammer. Scammers may insist that you pay by sending money through a money transfer company. Others may suggest putting money on a gift card and then giving them the number on the back. Some will send you a check (that will later turn out to be fake), tell you to deposit it, and then send them money.
  5. Don’t fall for online pop-up warnings: Tech support scammers may try to lure you with a pop-up window that appears on your computer screen. It might look like an error message from your operating system or antivirus software. It may also use logos from trusted companies or websites. The message in the window warns of a security issue on your computer and directs you to call a phone number to get help. Simply ignore. If you are unsure of whether the message was legitimate, you can use your antivirus software to run a scan or contact the soliciting organization directly.

What to do if you are scammed

Anyone can fall victim to these scams. If you have paid someone, call your bank, money transfer app, or credit card company and see if they can reverse the charges. The Federal Reserve Board notes that if you report the fraud within two business days, liability is limited to $50. If you report it after that, you could face liability of up to $500, and if you report it after the 60-day window, subsequent fraudulent charges can wipe out your account entirely.

Final thoughts

Whether online or via phone, stay vigilant. Avoid clicking on suspicious links, and never give out personal information to a stranger over the phone. For online accounts, steer away from using short passwords which can be easily hacked by password cracker software. Instead, use strong passwords that are at least 12 digits long and contain numbers, letters, special characters, and a mix of lowercase and uppercase letters.

If you know someone who has been impacted, Identitytheft.gov is a great resource for mapping out a recovery plan.

Should I Be Worried About Inflation?

Inflation

The topic of inflation is getting lots of attention these days.

Inflation, for starters, is defined as the decline in purchasing power of a given currency. So, as an example, if the US Dollar experienced 2% inflation over a given period, the purchasing of $1 gets reduced to $0.98. Because a dollar is worth less, you must spend more to fill your gas tank, buy a gallon of milk, get a haircut etc. In other words, inflation increases your cost of living.

Is inflation good or bad?

Inflation can be a tricky economic indicator: If it is too high, it erases the purchasing power of consumers; if it is too low, it can reduce economic growth. Inflation can also be bad for stock markets as it often leads to higher interest rates, meaning big firms have to pay more to service their debts which can then erode their earnings.

What is causing inflation now?

Over the past 10 years inflation has basically held steady, averaging a bit under 2%.  However, over the past year, inflation has increased at a rate of 5%, well above the ten-year average.  While it is easy to point the finger at the Federal stimulus plans that pumped money back into the economy as the world came to a halt, the real cause of inflation seems to be a bit more nuanced.

Members of the Federal Reserve, along with a chorus of economists, argue that most of the inflation we are experiencing now can be attributed to bottlenecks in a variety of supply chains as demand surges with a reopening economy.

Translation: Consumers have cash to burn and suppliers are struggling to meet demand! The overwhelming majority of recent inflation is derived from spikes in industries that were hammered by the pandemic. Demand has skyrocketed in a few notable areas: raw materials, energy, metals, food, used automobiles, appliances, and travel.

Where does inflation go from here?

Whether inflation is transitory (i.e. brief, short-lived) or not is a common question being asked. If employment reports start to outpace analyst estimates, or, if inflation gets too high, the Federal Reserve may pull back on their $120B monthly bond purchases and eventually raise interest rates.

At their June meeting, the Fed moved up their targeted interest rates increase from 2024 to sometime in 2023. There are some members of the Federal Open Market Committee (FOMC) that believe the U.S. should start raising rates as early as 2022.

What’s it mean for you?

There is a possibility, not a certainty, that inflation may impact the everyday investor. Even if inflation moderates, as the Fed anticipates, it is still expected to run at almost 2.5% over the next five years, resulting in a negative inflation-adjusted return on Treasuries. With all that said, though, the economy is an incredibly complex and unpredictable system.

Should you be concerned? For those in, or nearing, retirement who live on a fixed income, any reduction in purchasing power can be unsettling. While there is no way to truly “inflation-proof” your portfolio, there are strategies that can lessen the blow:

  1. Maintain a globally diversified portfolio!
  2. Hold a portion of fixed income in Treasury Inflation-Protected Securities (TIPS)
  3. Consider Real Estate Investment Trusts as a hedge against inflation and underperforming equities (rents and values tend to increase when prices do)
  4. Avoid fixed income assets that have long durations (5+ years)
  5. Prioritize fixed rate debt > adjustable rate debt, and/or consider converting adjustable rate debt to fixed rate where practical.

Cryptocurrency: Should I invest?

Crypto’s place in a portfolio:

Cryptocurrency has an identity crisis. Depending on who you ask, some view it as a security (like a stock), a commodity (like gold/oil), or a currency (like the US Dollar). Instead of adding to the semantics, we at wHealth Advisors take a more macro approach to crypto and view it simply as an “alternative asset.”

Besides cryptocurrency, some other examples of alternative assets are real estate investment trusts (REITs), art/collectibles, venture/angel/private equity investing, and commodities – to name a few.

Alternative assets can certainly have a place in the portfolio, however we always suggest minimizing personal expectations for investment returns. If you assume your alternative investment goes bust, how much does that hurt you (emotionally, financially etc.)? Does the loss impact your future goals, or is it just another blip on the radar? Similar to gambling, when it comes to alternative assets, only consider risking money that you are comfortable losing.

Depending on individual preferences/circumstances, an allocation of 0-10% of the overall portfolio to alternative assets can make sense. Additionally, and perhaps no surprise, but alternative assets are best suited for those with longer time horizons and/or higher tolerances for taking risk.

 So, should cryptocurrencies such as Bitcoin be a part of your portfolio?

For starters, investing in crypto is incredibly speculative. As we have seen over the past few weeks, a single tweet by a person of influence can spark extreme volatility. When taking a step back, there’s an argument to be made that cryptocurrency – and really, blockchain technology as a whole – is in its infancy a la the internet in the 80s/90s.

In some ways this is promising: the space will evolve, new entrants will emerge (and thus create new opportunities), and transactions will become more and more cost/energy efficient.

On the other hand, the larger and more mainstream this technology and way of transacting becomes, the more scrutiny it will be under (by domestic regulatory agencies and sovereign nations alike).

Before investing in cryptocurrencies, it is important to begin with the basics:

  • Have an emergency fund that is funded with 3-6mths (or more!) of living expenses.
  • Pay off any high interest debt.
  • Invest at least 15% of your gross income towards your long-term future (utilizing diversified mutual funds & ETFs).
  • Invest in your human capital i.e. your skills/career.

If, after satisfying the basics, you are willing to take on higher levels of risk and believe cryptocurrencies may be the next big thing, consider asking yourself the following questions:

  • How much am I willing to risk (i.e. between 0-10% of overall portfolio)?
  • What’s my endgame? How long will I hold? Or, at what target price will I sell?
  • Do I have a rudimentary understanding of cryptocurrency and blockchain technology?

If the answer to the last question is no – begin there.

Some resources to begin self-educating:

[PODCAST] Invest Like the Best: Chris Dixon and the potential of blockchain technology

[PODCAST] The Tim Ferriss Show: Balaji Srinivasan on the future of Bitcoin and Ethereum

[BOOK] Cryptocurrency Investing for Dummies

Estimating Returns: Hope for the Best, Plan for the Worst

Between 1926-2020, the US stock market return was basically 10% per year.

While it’d be great to bank on 10% per year, it unfortunately does not work that way. For those that want consistency over the long haul, they will have to accept lower returns (think: CDs, bonds). For those that truly want higher returns over the long haul, they’ll have to accept more volatility (i.e. the stock market, other speculative investments). Either way, you can never fully escape risk.

Interestingly, though, is how infrequent annual US stock market returns actually fall within the long-term 10% average.

If we look at the calendar year returns +/- 2% from the 10% average (so 8% to 12%), this has happened in just five calendar years (1926-2020). So around 5% of all years since 1926 have seen what would be considered “average” returns. In fact, there have been just as many yearly returns above 40% as returns in the 8% to 12% range. Just 18% of returns have been between 5% to 15% in any given year.

The only way to truly take the randomness out of the stock market is to have a multi-decade time horizon. The best 30 year return was 13.6% per year from 1975-2004. And the worst 30 year return was 8.0% per year from 1929-1958.

 What you can do about it:

It’s impossible to say if the next 30 years will be as kind to investors as the previous 30 were. For those that are still on the journey towards financial independence, it would be best to assume lower returns going forward. Instead of relying on continued 8-10%+ average annual returns (something beyond your control), personal savings and frugality are parts of the money equation that are more in your control and have a 100% chance of being as effective in the future as they are today.

As Morgan Housel, author of the “Psychology of Money” writes, “You can build wealth without a high income, but have no chance of building wealth without a high savings rates, it’s clear which one matters more.”

The Latest Investment Craze: Non-Fungible Tokens

Over the past month nonfungible tokens, or NFTs, have been all over the news. Saturday Night Live even got involved.

 What are they?

NFTs are cryptographic assets that are on the blockchain with unique identification codes and metadata that distinguish them from each other. Since they are unique, they cannot be traded or exchanged at equivalency, which differs from cryptocurrencies such as Bitcoin, which are identical to each other and therefore can be used in transactions (i.e. you can now buy a Tesla with Bitcoin).

 Why buy an NFT?

People are spending millions of dollars on NFT collectibles including artwork, digital images, sports cards, GIFs, music, video games, and other forms of creative art. By purchasing an NFT, you have a secure certificate of ownership over a digital object. As a collector, you are hoping that the value of the purchased item increases in value. For those that still remember the non-blockchain days, think of NFTs as a modern form of purchasing and collecting baseball cards. You buy them for your personal enjoyment and they may/may not appreciate in value.

 How to buy:

NFT’s can be bought on a variety of platforms, such as Nifty Gateway, Rarible, Open Sea, and The Sandbox. Each platform has an online gallery where you can browse, purchase, or bid on items in a similar fashion as an auction house. A purchase or winning bid is paid for with cryptocurrency. A digital wallet is necessary to store your purchase.

 Final thoughts:

NFT’s are relatively new. The current market is largely speculative and as with all markets, prices will fluctuate. In the modern and digital world we live in, NFTs will be another option for artists, creatives, and others to monetize their work, for collectors to purchase direct with fewer intermediaries, and for brands to establish their presence in the growing metaverse. Some further reading:

Lessons from 2020

Lessons from 2020

2020 will be a year we will never forget. From a global pandemic and civil unrest, to an economic downfall that we continue to battle through today, it has been a challenging year that has impacted millions of individuals around the world. For investors, as we reflect on the past year, it’s critical we revisit some lessons learned to better ourselves moving forward. While it’s unlikely we’ll ever experience a year like 2020 again, many of the principles outlined below are timeless, and can serve as foundational reminders that are applicable every year.

 Having an investment philosophy you can stick with is paramount

While there is no silver bullet, understanding how markets work and trusting market prices are good starting points. By adhering to a well-thought out investment plan, ideally agreed upon in advance of periods of volatility, investors may be better able to remain calm during periods of short-term uncertainty. 

Create an investment plan that aligns with your risk tolerance

You want to have a plan in place that gives you peace of mind regardless of the market conditions. Over time, capital markets have rewarded investors who have taken a long-term perspective and remained disciplined in the face of short-term noise.

Don’t try and time the market

The 2020 market downturn offers an example of how the cycle of fear and greed can drive an investor’s reactive decisions. Back in March, there was widespread agreement that COVID-19 would have a negative impact on the economy, but to what extent? Who would’ve guessed we would’ve experienced the fastest bear market in history in which it took just 16 trading days for the S&P 500 to close down 20% from a peak only to be followed by the best 50-day rally in history?

Stay disciplined through market highs and lows

Financial downturns are unpleasant for all market participants. When faced with short-term noise, it is easy to lose sight of the potential long-term benefits of staying invested. While no one has a crystal ball, adopting a long-term perspective can help change how investors view market volatility.

Focus on what you can control

To have a better investment experience, people should focus on the things they can control. It starts with creating an investment plan based on market principles, informed by financial science, and tailored to your specific needs and goals.

2020: Market Review

Market Review 2020 Cover

The year 2020 proved to be one of the most tumultuous in modern history, marked by a number of developments that were historically… wait for it… unprecedented. But the year also demonstrated the resilience of people, institutions, and financial markets.

The novel coronavirus was already in the news early in the year, and concerns grew as more countries began reporting their first cases of COVID-19. Infections multiplied around the world through February, and by early March, when the outbreak was labeled a pandemic, it was clear that the crisis would affect nearly every area of our lives. The spring would see a spike in cases and a global economic contraction as people stayed closer to home, and another surge of infections would come during the summer. Governments and central banks worked to cushion the blow, providing financial support for individuals and businesses and adjusting lending rates.

On top of the health crisis, there was widespread civil unrest over the summer in the US tied to policing and racial justice. In August, Americans increasingly focused on the US presidential race in this unusual year. Politicians, supporters, and voting officials wrestled with the challenges of a campaign that at times was conducted virtually and with an election in the fall that would include a heightened level of mail-in and early voting. In the end, the results of the election would be disputed well into December. As autumn turned to winter, 2020 would end with both troubling and hopeful news: yet another spike in COVID-19 cases, along with the first deliveries of vaccines in the US and elsewhere.

For investors, the year was characterized by sharp swings for stocks. March saw the S&P 500 Index’s1 decline reach 33.79% from the previous high as the pandemic worsened. This was followed by a rally in April, and stocks reached their previous highs by August. Ultimately, despite a sequence of epic events and continued concerns over the pandemic, global stock market returns in 2020 were above their historical norm. The US market finished the year in record territory and with an 18.40% annual return for the S&P 500 Index. Non-US developed markets, as measured by the MSCI World ex USA Index,2 returned 7.59%. Emerging markets, as measured by the MSCI Emerging Markets Index, returned 18.31% for the year.

EXHIBIT 1 – Highs and Lows

MSCI All Country World Index with selected headlines from 2020

2020 Market Review

As always, past performance is no guarantee of future results.

Fixed income markets mirrored the extremity of equity behavior, with nearly unprecedented dispersion in returns during the first half of 2020. For example, in the first quarter, US corporate bonds underperformed US Treasuries by more than 11%, the most negative quarterly return difference in data going back a half century. But they soon swapped places: the second quarter was the second-most positive one on record for corporates over Treasuries, with a 7.74% advantage.3 Large return deviations were also observed between US and non-US fixed income as well as between inflation-protected and nominal bonds.

Global yield curves finished the year generally lower than at the start. US Treasury yields, for example, fell across the board, with drops of more than 1% on the short and intermediate portions of the curve.4 The US Treasury curve ended relatively flat in the short-term segment but upwardly sloped from the intermediate- to long-term segment. For 2020, the Bloomberg Barclays Global Aggregate Bond Indexreturned 5.58%.

EXHIBIT 2 – Sharp Shifts

US Credit minus US Treasury: Quarterly Returns, March 1973–December 2020

Past performance is no guarantee of future results.

 

Uncertainty remains about the pandemic and the broad impact of the new vaccines, continued lockdowns, and social distancing. But the events of 2020 provided investors with many lessons, affirming that following a disciplined and broadly diversified investment approach is a reliable way to pursue long-term investment goals.

 

Market Prices Quickly Reflect New Information about the Future

The fluctuating markets in the spring and summer were also a lesson in how markets incorporate new information and changes in expectations. From its peak on February 19, 2020, the S&P 500 Index fell 33.79% in less than five weeks as the news headlines suggested more extreme outcomes from the pandemic. But the recovery would be swift as well. Market participants were watching for news that would provide insights into the pandemic and the economy, such as daily infection and mortality rates, effective therapeutic treatments, and the potential for vaccine development. As more information became available, the S&P 500 Index jumped 17.57% from its March 23 low in just three trading sessions, one of the fastest snapbacks on record. This period highlighted the vital role of data in setting market expectations and underscored how quickly prices adjust to new information.

One major theme of the year was the perceived disconnect between markets and the economy. How could the equity markets recover and reach new highs when the economic news remained so bleak? The market’s behavior suggests investors were looking past the short-term impact of the pandemic to assess the expected rebound of business activity and an eventual return to more-normal conditions. Seen through that lens, the rebound in share prices reflected a market that is always looking ahead, incorporating both current news and expectations of the future into stock prices.

Owning the Winners and Losers

The 2020 economy and market also underscored the importance of staying broadly diversified across companies and industries. The downturn in stocks impacted some segments of the market more than others in ways that were consistent with the impact of the COVID-19 pandemic on certain types of businesses or industries. For example, airline, hospitality, and retail industries tended to suffer disproportionately with people around the world staying at home, whereas companies in communications, online shopping, and technology emerged as relative winners during the crisis. However, predicting at the beginning of 2020 exactly how this might play out would likely have proved challenging.

In the end, the economic turmoil inflicted great hardship on some firms while creating economic and social conditions that provided growth opportunities for other companies. In any market, there will be winners and losers—and investors have historically been well served by owning a broad range of companies rather than trying to pick winners and losers.

Sticking with Your Plan

Many news reports rightly emphasized the unprecedented nature of the health crisis, the emergency financial actions, and other extraordinary events during 2020. The year saw many “firsts”—and subsequent years will undoubtedly usher in many more. Yet 2020’s outcomes remind us that a consistent investment approach is a reliable path regardless of the market events we encounter. Investors who made moves by reacting to the moment may have missed opportunities. In March, spooked investors fled the stock and bond markets, as money-market funds experienced net flows for the month totaling $684 billion. Then, over the six-month period from April 1 to September 30, global equities and fixed income returned 29.54% and 3.16%, respectively. A move to cash in March may have been a costly decision for anxious investors.

 

EXHIBIT 3 – Cash Concerns + Global Equity Returns

Past performance is no guarantee of future results.

 

It was important for investors to avoid reacting to the dispersion in performance between asset classes, too, lest they miss out on turnarounds from early in the year to later. For example, small cap stocks on the whole fared better in the second half of the year than the first. The stark difference in performance between the first and second quarters across bond classes also drives home this point.

 

A Welcome Turn of the Calendar

Moving into 2021, many questions remain about the pandemic, new vaccines, business activity, changes in how people work and socialize, and the direction of global markets. Yet 2020’s economic and market tumult demonstrated that markets continue to function and that people can adapt to difficult circumstances. The year’s positive equity and fixed income returns remind that, with a solid investment approach and a commitment to staying the course, investors can focus on building long-term wealth, even in challenging times.

FOOTNOTES

  1. 1S&P data © 2021 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment.
  2. 2MSCI data © MSCI 2021, all rights reserved. Indices are not available for direct investment.
  3. 3US corporate bonds represented by the Bloomberg Barclays US Credit Bond Index. US Treasuries represented by the Bloomberg Barclays US Treasury Bond Index. Bloomberg Barclays data provided by Bloomberg. Indices are not available for direct investment.
  4. 4ICE BofA government yield. ICE BofA index data © 2021 ICE Data Indices, LLC.
  5. 5Bloomberg Barclays data provided by Bloomberg. All rights reserved. Indices are not available for direct investment.

DISCLOSURES

The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. wHealth Advisors accepts no responsibility for loss arising from the use of the information contained herein.

 

The Coronavirus and Market Volatility

Coronavirus

The world is watching with concern the spread of the new coronavirus. The uncertainty is being felt around the globe, and it is unsettling on a human level as well as from the perspective of how markets respond.

At wHealth Advisors, we accept the fundamental principle that markets are designed to handle uncertainty, processing information in real-time as it becomes available. We’ve witnessed this volatility over the past 3-4 weeks. Such declines can be distressing to any investor, but they are also a demonstration that the market is functioning as we would expect.

Market declines can occur when investors are forced to reassess expectations for the future. The expansion of the outbreak is causing worry among governments, companies, and individuals about the impact on the global economy. As an example, last month Apple announced that it expected revenue to take a hit from problems making and selling products in China. Airlines are preparing for the toll it will take on travel. Local businesses are worrying how their bottom lines will be impacted from preventive measures such as self-quarantines and social distancing. From the largest companies in the world down to our corner coffee shops, these are just a few examples of how the impact of the coronavirus is being assessed.

The market is clearly responding to new information as it becomes known, but the market is pricing in unknowns, too. As risk increases during a time of heightened uncertainty, so do the returns investors demand for bearing that risk, which pushes prices lower. Our investing approach is based on the principle that prices are set to deliver positive future expected returns for holding risky assets.

We can’t tell you when things will turn or by how much, but our expectation is that bearing today’s risk will be compensated with positive expected returns. That’s been a lesson of past health crises, such as the Ebola and swine-flu outbreaks earlier this century, and of market disruptions, such as the global financial crisis of 2008–2009. Additionally, history has shown no reliable way to identify a market peak or bottom. These beliefs argue against making market moves based on fear or speculation, even as difficult and traumatic events transpire.

When it comes to managing your portfolio, it’s prudent to develop (and stick with!) a long-term plan than can be maintained in a variety of conditions. For our clients, we consider a wide range of possible outcomes, both good and bad, when helping to establish an asset allocation and plan. Those preparations include the possibility, even the inevitability, of a downturn. Amid the anxiety that accompanies developments surrounding the coronavirus, decades of financial science and long-term investing principles remain a strong guide.

We send our best to you and yours. Wash your hands, avoid touching your eyes/nose/mouth, and, as always, feel free to contact us at hello@whealthfa.com.

10/16/2020 Editor Note: Our co-founder, Dennis McNamara, was featured as a financial expert on Dr. Wealth where he weighed in on investing in a post-COVID world. Link to contribution here: https://www.drwealth.com/investing-in-post-covid19-world/ 

Climate Change and Your Portfolio

Written by: Dennis McNamara

Introduction

 As financial planners that adhere to an evidence-based investment philosophy, we at wHealth Advisors use historical stock market data to infer a potential range of future outcomes. With reliable data only going back to the mid-1920s, trying to predict future market performance based on these “historical” figures is a fool’s errand. Instead, we like to work with our clients to focus on the things that they can control:

  • Increasing saving rates, decreasing spending rates
  • Reducing the cost of asset management and investment expenses
  • Minimizing tax liabilities by proactive tax planning
  • Aligning stock market exposure to tolerance/ability to take risk
  • Ignoring market noise and sticking to the plan

An evidence-based climate scientist, on the other hand, relies on data that goes back roughly 11,500 years to the Paleolithic Ice Age – a more robust sample study, to say the least. So, let’s get right to the point of this blog: Climate change is real and it is going to impact the long-term performance of our global markets (and thus, our portfolios) in unpredictable ways. This is factual science, not a controversial position. For starters, look to PG&E, the California utility company that filed for bankruptcy this January after facing $30 billion in fire liabilities after its power lines sparked what became California’s deadliest wildfire yet last fall. Besides utility companies, climate change will inevitably impact business in nearly all industries – agriculture, insurance, and energy to name a few. All industries operate within a global ecosystem and any climate event that results in a negative outcome (regardless of region or industry) will have negative downstream effects to our financial markets.

In an effort to stay abreast of these potential impacts from an investment (and humanity) standpoint, I attended four events as part of Climate Week 2019 in NYC:

  • NYC Climate Strike (marched with my wife, son, and mother)
  • Climate Finance & Investment Summit hosted by the London Stock Exchange
  • 2019 Annual Climate Week Briefing hosted by Moody’s Investor Services
  • Quantifying Climate Risk hosted by S&P Global

What the world’s largest asset managers are doing:

Of the many speakers I had the pleasure to listen to, Hiro Mizuno, the Chief Investment Officer of the Government Pension Investment Fund (GPIF) of Japan, shared some of the most thought-provoking insights. As the CIO of GPIF, Hiro manages the single largest sovereign pension fund in the world. In a room full of big fish that included the NY State Comptroller (oversees NY State pension, 3rd largest in US, $210B) and Investment Director for CalSTRS (CA state pension, 2nd largest in US, $238B) – Hiro was the whale (manages over $1.5 TRILLION – approximately 1% of all assets in the world).

What makes Hiro’s insights so valuable is that, unlike a typical investor whose long-term outlook spans roughly 15-30 years, GPIF’s long-term outlook extends somewhere between 50-100 years. To Hiro, climate change is not some abstract thing, it’s a very real threat to the world (and thus, the world economy) and it requires action across all of society and industry today. Given GPIF’s size and time horizon, the fund is in a unique position to change the world. One way that it attempts to do this is by rewarding companies for behavior that it deems good for the world economy over the long-term while penalizing behavior that is bad. In theory, and in oversimplified terms, this rewarding/penalizing is done by overweighting (i.e. investing more) in the companies doing good and underweighting (i.e. investing less) in the companies that need to do better.

In order to judge whether a company is doing good or needs to do better, they are first compared to the other companies within the sector they operate. If the sector is energy, for example, we might compare Exxon, Shell, and BP. Companies are then compared to each other based on their Environmental, Social, and Governance (“ESG”) conduct. Breaking these three ESG legs down further:

  • Environmental: Considers a company’s greenhouse gas emissions, their waste and pollution outputs, and their water and land use.
  • Social: Considers workforce diversity, workplace safety standards, customer engagement, and community impact.
  • Governance: Considers company structure, transparency, and disclosure reporting.

When deciding which companies to reward/penalize, GPIF and other asset managers would consider factors that are common across all industries while also including factors that are unique to the sector. In this example, some of these factors would include the energy company’s greenhouse gas emissions, their investments in renewable energy and carbon capture technology, and their level of transparency/disclosure. In a perfect world, Exxon, Shell, and BP could be compared apples to apples and rewarded/penalized commensurate with their efforts. For example, if Exxon was doing the most to limit greenhouse gases, if it invested the most in renewables/carbon capture, and if it disclosed these metrics with reasonable transparency, they might receive a larger investment from GPIF. Inversely, if BP was the environmental laggard of the energy industry, GPIF could reduce their investment exposure on the basis that BP is not being a good environmental steward which is bad for the world economy over the long-term.

The Dilemma

According to Hiro and the other keynote speakers and panel participants, the biggest wrench that prevents this process from working as intended is the lack of transparency and disclosure by public companies (specifically, public companies in the US). The Securities and Exchange Commission (“SEC”) currently limits mandatory disclosure to issues that materially impact shareholders/investors. Unfortunately, the SEC does not deem the ESG metrics as having any “material” impact (despite a petition from $5 trillion worth of institutional investors that do deem ESG factors as having a “material” impact). Unlike the US, two dozen other countries require this type of mandatory reporting and seven stock exchanges already require ESG disclosure as a listing requirement.

Long story short: If a company is not measuring or reporting their greenhouse gas emissions, and the SEC does not mandate this reporting as part of shareholder disclosure, GPIF and other asset managers have little to no ability to factor ESG measures into their overweighting/underweighting analysis.

While there is much promise that modern finance can play a role in the fight against climate change, the current bureaucratic roadblocks make this an uphill battle. Withdrawal from the Paris Climate Agreement and the repeal of the Clean Power Plan make it clear that the current political environment does not favor enhanced ESG disclosure. According to S&P Global, only 15% of public companies have acceptable ESG reporting disclosures while 37% have taken NO action to disclose. Asset managers have since lowered the bar and are now rewarding companies simply on the basis of whether or not the company disclosed any ESG details/disclosures.

What this means for you, the individual investor

With the rising popularity of ESG-focused mutual funds and ETFs targeted towards individual investors, there are options to invest in funds that underweight greenhouse gas intensive industries (i.e. energy/utility companies) in favor of less environmentally offensive industries. However, similar to the dilemma faced by Hiro and GPIF, a lack of mandatory ESG disclosure means that these ESG-focused funds are being designed without any uniformly reported data (remember, 37% of companies don’t even report on ESG!).

There is also the question of subjectivity. What about companies with poor track records that are trying to improve? Take Dow Chemical Company, they (and acquired company, Dupont) have committed environmental travesties but recently pledged $1 billion to “nature-enhancing” projects between now and 2025. Does Dow belong in an ESG fund*? Given the chemical industry’s lack of transparency and disclosure, how does an ESG fund determine whether to overweight or underweight Dow vs. its competitors? Combine these subjectivity concerns with the fact that a) ESG mutual funds typically cost more than comparable index funds and b) many are still new and have a limited performance history – the decision to invest in ESG is complicated.

Conclusion

In order for the financial industry, and Chief Investment Officers such as Hiro, to have an impact on climate change, reporting requirements need to include ESG metrics. At this moment in time, even as a staunch environmentalist, I do not view an individual’s portfolio as an effective tool to combating climate change. My hope is that with increased ESG reporting standards that this will change. For now, and like the recommendations we provide to our clients, let’s focus on what we can control.

The most effective ways individuals can mitigate their carbon emissions (listed in order of impact**):

  • Have one fewer child (pound for pound the most environmentally impactful decision an individual can make. NOTE: Prince Harry and Meghan Markle recently committed to having just two children for this very reason.)
  • Live car-free (unrealistic for many, so consider hybrid/EV when purchasing a new vehicle)
  • Avoid airplane travel (also unrealistic for many, consider purchasing carbon offsets to minimize carbon footprint from air travel through social enterprise firms such as Terrapass)
  • Eat a plant-based diet (bonus: this is also linked to improved health and longevity)

In a time where many of us feel overwhelmed or disheartened about the risks ahead, I consider myself rationally optimistic. With risk comes opportunity. Capitalism, whatever your opinion on it, has afforded us a standard of living beyond what our ancestors could have ever imagined. By combining capitalistic forces with sound environmental policy (i.e. policy that is rooted in science!) I am confident that we can (and will) pivot to a more environmentally and financially sustainable future. The onus begins with each and every one of us – so ditch the car, go for a walk with your intentionally small family, and eat some veggies!

Hope that you enjoyed and thanks for taking the time to read! Please feel free to contact our team at hello@whealthfa.com.

*Dow Chemical Company is included in the Dimensional US Sustainability Core Fund (DFSIX).

** Seth Wynes and Kimberly A Nicholas 2017 Environ. Res. Lett. 12 074024

How Much Are You Really Paying For Your Investments?

Lady counting money

Written by: Dennis McNamara

In a recent Wall Street Journal article , Andrea Fuller recounts her experience of searching for the fees that she is paying for her financial advisor and investments – the advisor is an employee of one of the largest financial advisory companies. What Andrea did not expect is that this hunt would require a steadfastness and rigor similar to that of Indiana Jones searching for the Holy Grail.

 

The first place that Andrea looked to find her fees was in her monthly statements. No luck. Next, she explored the company website. Again, no dice. She then spoke with various customer service representatives who were unhelpful and opaque. Ultimately, Andrea spoke with an advisor who shared that her total combined fee (advisory fee + fund expenses) was 1.4% of assets under management. This advisor has yet to provide any documents to her that show these fees in writing.

 

Does a 1.4% fee sound high? It should. With many “financial advisory” firms, the scope of their work is limited to investments or insurance (i.e. the products they sell!). A 2016 white paper from Personal Capital concluded that average fees for these “financial advisory” firms ranged from 1.07% to 1.98%. This then begs the questions: Are the investment and insurance products that these firms sell superior to other options out there? The answer: Absolutely not. Simply put, the employees of these firms are highly paid salespeople that rely on the ignorance of the general public.

 

How do you know if your advisor is taking advantage of you? Request the he or she agree, in writing, to disclose all conflicts of interest and to always act solely in your best interest. If they can’t agree to this, consider shopping around for a fee-only advisor that can.