This news article, Dealers See Higher ’11 Yields, from about a year ago is a painful reminder that the brightest minds in the world cannot predict how the year will turn out, and instructs us to consider ways of hedging our portfolio against unnecessary risk. The actual year played out with the 10 year Treasury at yields below 2%, after having hit all time lows, and bond investors once again making high single to big double digit returns. In comparison the S&P 500 total return number was a paltry 2%, coupled with immense volatility and the mental anguish that goes with it. In addition, the “no brainer” emerging markets laid a huge egg down about -18%.

The US bond market is in a 30 year rally mode, yet the bubble is due to be popped in a massive way.   However, who really knows when that event may occur, so the risk of betting it all on one side and being wrong is too great.   Recollect Alan Greenspan in 1996 calling the Stock market gains “irrational exuberance.” If you would have listened to him completely, then you would have missed some of the best returns ever. It was not that his premise was wrong, but rather his timing, as it took 4 more years to pop that bubble. Besides when it did sell off in 2000 it bottomed at around 884, which is still 40% higher than when he first made that statement.  Even after the housing crisis in 2008 the S&P 500 bottomed at 666, and then moved back up to its present level of around 1300.

Yes, based on the historically low yields, super accommodative fed monetary policy, and increasing deficit spending, it seems only a matter of time before the bond bubble will burst.  The timing, way, and magnitude of the burst are unknown, so invest with expectation, but also be diversified.  Accept the fact you will not hit the home run, but that means striking out less as well.  Avoid being tempted by “the analyst experts”, to swing everything in one direction or the other, rather take their opinion with a measured approach.

In May the US bumped up against the $14.3 trillion debt ceiling limit, its maximum borrowing limit. In early August an agreement was reached to increase the debt ceiling, called “The Budget Control act of 2011.” The legislation put mechanisms in place to increase the debt at least $2.1 trillion, and potentially up to $2.4 trillion, while also providing spending cuts over the next 10 years. The new law does not cut spending today but aims to reduce future spending.1

This past quarter was highlighted by daily headlines on the debt situation in Europe, particularly Greece. The Eurozone has a highly interconnected economic system that has a stable common currency, the euro. Over the past decade, however, the Eurozone has experienced an explosion in consumer and government debt, especially in some of the weaker, peripheral economies.

Greece, in particular, has an extremely large debt-to-GDP ratio, and is struggling to finance its debt. The Greek economic system is fundamentally uncompetitive, and the government has been spending much more than it has been taking in. Some may wonder why the Greeks don’t just exit the euro. The reason is that doing so would likely cause the Greek banking system to implode instantaneously. The negatives of leaving the Eurozone are still far greater than staying and dealing with a very difficult adjustment process and austerity program. Similar challenges are potentially facing the Irish, Portuguese, Spanish, and Italian economies.2

“What we think”

Boring as it may seem, a diversified basket of poorly correlated investments is still the best foundation of an efficient, highly predictable investment portfolio. However in the short term this “Asset Allocation” approach can often do little to alleviate market volatility, and the emotions that go with it. You can and should however trust this process, as it is time tested, and proven to work in all periods of recordable time. Often times in the investment world when things seem the darkest, they are actually closest to breaking out into the light. The “investments light” we see near term are US stocks and going farther out the Emerging Markets. A quick word of caution, it is best not to judge the wisdom of an investment decision purely on its short term experience. Rather like everything, look at the fundamentals, buy cheaply when everyone else is afraid, and then wait and trust the process that good fundamentals will always payoff over time.

Here are some general reasons for our bullish equity views.

Good cash flows, Good relative values:

Average broad market dividend yields pay over 2%, about the same as the 10 year treasury. However, those dividend yields are only taxed at a 15% dividend rate and can rise with inflation. Additionally, the S&P 500 is trading around 11x future earnings, which is way below the historical average of 16x. The companies that comprise the S&P 500 hold trillions of dollars of cash on their books, so if you are buying stocks you are buying companies with a lot of cash flow. By the way, emerging markets are even cheaper. Companies have the ability to navigate away from troubling economies, and find profits in other lands no matter where they are domiciled. Even though companies are affected by the US’s anemic growth, 9% unemployment, and massive debt, they have their own balance sheets, and agendas to create shareholder wealth. Apple and Nike are examples of companies that benefit from this type of flexibility.

Limited choices for long term investors:

Where else can you really go? There are few alternatives in the bond market and money market rates are close to 0%? Why does this matter? Because the cost of gas is not going backward, neither is food, water, medicine, etc. Our money has to eventually be positioned to keep up with inflation and preferably grow ahead of it, even though we must also consider risk and short term cash needs.

The trend is your ultimate bullish friend:

It is really the long term global demographics, which we believe will power well run companies upward in growth, no matter what country they are domiciled within. There are still a lot more people without food, water, clothing, electricity, and healthcare in the world than there those that have them. As the world becomes more globally connected those people who live without will finally have access to these and many other goods and services. The stocks of the well run companies making and selling all these products will help create great shareholder wealth over time. The 1 billion new people expected to be added to the Earth over the next 20 years will only help drive demand…

Sources

1 Authors Multiple. “Budget Control Act Summary.” Fidelity Market Commentary (2011): pages 1-2. Web. 2 August 2011.

2 Eisinger, Nick, Tom Nolan, and Jamie Stuttard. “Eurozone Debt: Policy Scenarios and Investment Strategies.” Market Perspectives (2011): pages 1-10. Web. 23 Aug. 2011

In addition to wanting to provide the best and most cost-effective 401k plan for your employees, the stakes are being raised with the new fee-disclosure legislation that will be rolling out by year’s end. We all know the children’s story about the wolf in sheep’s clothing, well, the companies that are in the business of selling or brokering 401k plans are all-too-often masquerading as independent advisors. The truth is that the number of 401k advisors that act as a written, legal fiduciary as defined by ERISA are few.   And contrary to popular belief, the 401k plans that use these fiduciary-level advisors actually cost significantly less than the bloated plans with hidden costs and revenue sharing.

To ensure you are receiving the best, unbiased, advice from a fiduciary, here are a few questions you should be asking your current advisor/broker/insurance guy:

- Do you have access to all provider options?
- Do you have access to all fund options?
- Do you receive compensation from any fund company, provider, or other third party?
- Do you act as an ERISA section 3(21)a or 338 fiduciary on the plans you manage?

These questions should be the baseline to even consider an advisor for your plan.

“Projected long-run program costs for both Medicare and Social Security are not sustainable under currently scheduled financing and will require legislative corrections if disruptive consequences for beneficiaries and taxpayers are to be avoided.”

This is a fancy way of saying that the government needs to fix our retirement and insurance problem. But is that really the answer, or should we evaluate our retirement futures from a broader perspective? I suggest we should and can begin by considering the following:

•      The programs are not going broke, but rather facing a projected shortfall and thus a reduction of benefits. My generation (gen X) and those behind me will more than likely see a reduced benefit, but none the less a benefit. It will still be a piece of the pie, just smaller.
•      We have tools available that allow us to see Social Security as just one piece to the overall retirement pie. We need to continue to utilize the various retirement plan’s available (401k, IRA, Roths, etc.) to the best of our abilities. These plans can’t do it all, but need to be part of your overall solution.
•      We have the chance to begin preparing mentally for when our economy is fully out of this recession. I say this because I believe we can learn from our most recent economic valley and possibly be better stewards with the resources we’re given in the next boom (this is my way of saying that when things improve we need to save, save, save). If we go into the next economic expansion with a financial plan we’re much more likely to see long term success.
•      And for us who have a number of years left to work. Begin to prepare now for possibly working longer. To the best of your ability stay physically fit, continue to learn, stretch your mind and look for ways to evolve your career so that retirement is not the ultimate goal.

So what does all this mean? It means we must commit to creating, monitoring and adapting a personal financial plan that’ll allow us to retire in a way that’s not dependent upon the trustee’s plan for social security, but rather upon our own plan.

Before I get too far into the investment stuff, please make sure to take care of your mother.  Whether she’s 40 or 80 when the Lord takes me home, please look out for her; she loves you so much and I love you too.  Also, in good and bad times, get on your hands and knees and ask that God would give you peace, wisdom, grace, and mercy.  Keep seeking the fullness of our faith.  Do not be conformed to the world but be transformed by the renewing of your mind.  There is a lot more but that’s in another letter…again, I love you guys so much!

On investing…

Investing is about many things; but importantly, it’s about common sense.  So, here is some common sense advice to think about when managing your own little nest-egg:

1)      No good investment idea works well all the time.  Be patient! Invest today as though you’ll own it forever. Deal with the fact that there will be times when it’s out of favor with the market.

2)      Although nothing works all the time, some things never work.  When you know you’ve made a mistake, don’t be afraid to take a small loss and move on.

3)      Don’t put all your eggs in one basket.  Asset allocation wins over time and good quality stocks that pay dividends will be worth their weight in gold.

4)      The more risk you take, the more return you should expect.  If you can’t expect more return if you take more risk, and less return for taking less risk, then it’s a scam.  It’s challenging at best to decouple risk from return.

5)      Who cares about what Sally and Sam are doing with their money; investing is about you and your situation.  Make decisions based on you and where you are at vs. taking someone else’s ideas and thinking they will be solutions for you.

6)      Ask for advice from a team you’ve put in place to help you make good, sound, financial decisions.  Included in the list is a trust-worthy CPA and a trust/estate/tax attorney.

7)      It’s not about what you earn on an investment it’s about what you keep from the investment- after taxes, inflation, cost of capital, and fees.

8)    Save more than you spend and once you’ve built up a rainy day fund, find a good investment to buy with your savings.  Repeat every year for the rest of your life.  Use the credit card solicitations you receive for starting camp fires or recycle only.

9)      Don’t look around for anyone to blame for making a bad investment decision; pick yourself up and don’t make the same mistake again.

10)  Be generous with your time, talents and treasure.

These are a few things I’ve learned in the last 20 years as an investor.  I hope this helps, even if it’s in a small way, to manage your precious financial resources wisely.

Love, dad.

This is a short letter from me (peter fisher) to my children (andrew, owen, grace and benjamin) .  They won’t know the letter exists until I’m gone but I thought I’d share it with some friends.  This letter was inspired in part by Arthur Zeikel.

But now that the responsibility had suddenly shifted to her shoulders, she wanted to understand for herself how things worked so she could make informed decisions for her family.  She came to me to get an outside opinion and an independent look at her accounts.

When I asked her about how she thought she was paying for her advice, she said that the advisor told her he wasn’t charging very much since their firm typically managed larger corporate accounts and so they didn’t need to make a lot of money on her personal accounts.  However, upon looking through her account statements, it was clear that she was paying large commissions anytime she bought a stock, bond, or mutual fund.  The commissions ranged from 2% to 5.75%.  After the initial commissions were paid, she then was paying annual expenses of close to 1% in fees.

After we uncovered how much she was paying, she said to me, “If you were me, what would you ask my advisor about making sense of this?”.  Here are the questions I would ask: 1) Mr. Advisor, how are you and your firm compensated for our relationship?  2) Is it through commissions from selling investments?  3) Is it from a set fee?  4) Is it a mix of both?  5) Do you have any financial incentives that would keep you from recommending me the “best” investments for my portfolio?  6) Is your compensation tied to my accounts’ performance and well-being?  Or is it tied to making a sale?

These are tough questions to ask an advisor, but they are crucial in gaining a full perspective of the relationship.   When your advisor is making a recommendation, you don’t want to have any doubts about his/her motivations.  The only way your advisor can have your best interest at heart is if he has no financial tie to any product or vendor.  When those ties are eliminated, the advisor can be free of conflict and will then be able to recommend only what he considers the “best” investment products for you, and that’s something you can trust.

For me, and our fearless investment team, the question of “what is risk” is popping up a lot lately.  If we just look at the numbers, investors are voting that stocks are risky and bonds are safe.  Last year, which was a nice up year for stocks; investors pulled nearly 75 billion from US stocks and added over 41 billion to taxable bonds.  So far this year, (through March month end) investors have liquidated an additional 1 billion from US stocks and allocated another 41 billion to taxable bonds.[1]

Clearly, if we use historical data, bonds are less “volatile” as measured by ups and downs in investor returns.  However, while reviewing average returns since 1926, along with performance, some would argue that the risky assets are bonds and cash.

Take for example the numbers below, while accounting for inflation, with the noted investment blend(s).

If we measure “risk” as volatility, then it’s obvious that the riskiest asset class is stocks with a drop of over 37% in a one year period.  If however, you measure loss in number of years where your investment mix went down (unrelated to how much it went down) then the answer to the question of ‘what is risk” takes a bit more time to debate.

Nobody is going to have a meaningful discussion about risk without addressing inflation.  Even more importantly is the question about family A’s inflation rate vs. family B’s inflation rate.  At 37 years old, I’m staring down 4 college educations (one for each child).  If I use traditional inflation numbers for my plan to fund college I’m going to have miscalculated the total sum needed significantly.  Looking at college tuition from 1989 to 2005, college inflation was nearly double the general inflation rate.[2]

The question of “what is risk” continues to be discussed with many different opinions sharing headlines.  In our view, addressing the risk question without consideration given to inflation is an error in planning…

This morning I was running with a group of people that I really enjoy.  Probably because the individuals represented might seems so similar on the outside but on the inside, have different (but not necessarily opposite) views of the world.  I like to say we all come to similar conclusions but take drastically different paths getting there…refreshing really.

On my drive back from the run, I realized how much diversity we really have in the group.  The diversity comes from how we are all going to retire and the financial mechanisms each of us are going to rely on for that retirement.  However we all get to retirement (whether it’s savings, inheritance, social security, retirement accounts or a pension) we’re all going to have money invested somewhere.

So, this is what excited me about sitting down to write this morning.  The rallying point for us all is that the precious capital we have needs to be attended to in a wise manner.  And, the people we charge with caretaking for those resources need to be accountable.  Regardless of whether a person is managing their retirement on their own, or trusting those resources with someone/something else, their needs to be a high degree of financial stewardship and an eye toward transparency.

I was mainly thinking about those in our group with Public Pensions, or, those involved in 401(k) plans where there is not a whole lot we as individuals can do to determine the management of the funds.  In other words, who our 401(k) plan is with or how our public pension is managed is not our decision (unless you yourself are the decision maker).  However, just because the 401(k) plan manager or pension is not yours to manage does not mean you should just say “those who are managing this thing have got my back (although many times they do.)”

What I’d encourage all of us to do on this Opening Day is scrutinize how these retirement resources are being managed.  If they are not being managed in a way that has your best interests at heart, speak up.  If costs are out of whack, information on the investment can’t be found with a few key strokes in Google, or it’s just a black box in general, there needs to be more questions asked and discoveries made.  If you need help assessing the situation and a little more light should be shined into a rather opaque circumstance, call somebody who can give you a fair assessment…Human Investing comes to mind but there might be others.

(503) 905-3100

In a less emotional manner than I might have, our ITM comes into my office to rationally explain the relationship between the broker, the advisor, and the mutual funds on the account statement in question.  It seems that the brokerage firm, the advisor, and the mutual funds were all somehow connected; surprise, surprise.

The obvious connections which took no research came in the form of XYZ brokerage firm with XYZ advisor, who was selling XYZ mutual funds.  The more sneaky display which required some research came when XYZ advisor was selling BDQ mutual funds which are a mutual fund series managed by an XYZ brokerage affiliate.  Either way, whether the conflicts of interest were clear to our prospective client on some investments, and not so clear on others, is NOT the point.

What is the point is that MILLIONS of investors, YOU and ME, are being flogged about the head with marketing campaigns set to gain our trust so that we might invest our precious capital with these brokerage firms and their advisors.  These campaigns tout “free” this and “no fee” that or “discount trades,” and we don’t stop to think how they might pay for the endless barrage of advertising because we never get an invoice from them.

The money for these campaigns, the giant buildings, and the oversized paydays is coming out of the accounts investors host with them.  We don’t tend to pay attention to the small transaction costs or the below market advisor fee because when compared to other investment related costs, they seem reasonable; even low.  In the end, the brokerage firms and their “advisors” are receiving massive paydays for both touting proprietary mutual funds AND funds from other companies because of back office revenue sharing.

In the case we were recently made aware of, the brokerage firm was gaining over 50% of the advisor fee in the form of non-disclosed revenue sharing (also know as KICKBACKS) from the mutual funds that were prescribed to our prospective client.  Again, this was a national discount broker, just think of what the “full service firms” are doing to investors.

We address fees a lot in our writing and if there was a positive effect for paying more we’d likely advocate people find the highest charging firm and go with them.  In other words, “you get what you pay for.”  However, what were finding, is that these non disclosed relationships and fees are hurting client trust and ultimately performance.  It’s limiting the playing field of choices and leaving investors with poor performance and few choices.

We know these types of relationships exist in many walks of life from food producers to drug manufacturers.  But when lack of disclosure has the ability to negatively impact the lives of so many investors in such a financially significant way, shouldn’t more investors chose a more independent and fee transparent firm the first time?  Or, once they are made aware of the issues, enacts change as soon as possible?  We think so.

(503) 905-3100

Our reply is that if your thesis is correct about the USA’s crash course to financial meltdown, then owning US currency( cash ), or any bond issued by the US government is one of  the last things you want to own, and would be one of  the riskiest places to put your investment(s).

So what is safe in this scenario?  Well, anything that has pricing power and/or, the ability to navigate the global economic and currency markets separate from the USA.  Of course assets like commodities and real estate count, but for this discussion, we wanted to focus on one of the “risky assets” called equities or, stocks. Stocks are a living, breathing, and dynamic financial organisms which must constantly change and adapt in order to grow and survive. A public company has one primary objective; grow shareholder value and return that value via growing its price or distributing the value via dividends.

The company CEO cannot use the excuse that the US isn’t a fun place to do business anymore- they need to find other ways to drive revenue. The corporate leadership must direct their corporate capital to other markets outside the US in order to grow. They must say that “if the US dollar decline is hurting us, we will hedge that risk using foreign currencies.”  Leadership must act on their belief that if the domestic regulatory environment is too difficult, then they must move and domicile their business in another part of the world.  For a publicly traded company there are no excuses; only growth or death.

Conversely, the US government has only a few levers to pull when trying to manage their stock price; which is really called the US dollar.  They have adjusted the monetary, fiscal, tax, and regulatory policies of the US to increase growth prospect, but not without cost.   The results of these “adjustments” are massive and increasing debt burdens that if not handled properly, could be very painful to the US dollar. If the US ever did go through a type of bankruptcy, through devaluing the currency, then those holding a lot of cash will be hurt the most.

So, if your opinion is that the US economy is in real trouble, then owning US$ denominated instruments conflicts with that thesis.  A more fitting strategy would be to own stocks, which include the Google’s, Apple’s, GE’s, and Pfizer’s of the world.  These types of companies will be busy making and selling products, and receiving just valuations for the vast profits they will earn, and then distributing those profits to shareholders.