Archive for Investments

RESETTING YOUR INVESTMENT STRATEGIES by Paul Ferraresi

John Maynard Keynes had a great quotation: “A speculator is one who runs risks of which he is aware, and an investor is one who runs risks of which he is unaware.”

So which are you?

Americans for more than 200 years have participated in the stock market as “passive investors”. A more common term used is a “buy and hold” investor. Over a long period of time this has proven to be a good way to accumulate wealth. Mind you, not an optimal way, but rather, a good way. Just set it, leave it alone, add to the account on a consistent basis and deal with the inevitable ups and downs.

Wall Street pundits continue to sing this happy tune of buy and hold as the only way to invest (you see if you took another approach then they would have to “resell” you each time in order to get you back into the market after each correction). Many people do not have the knowledge or time to produce better results, hence, they stay passive investors.

Things began to change for passive investors in the 1970’s as computers came onto the scene of investment management. Many people today do online investing with discount brokers or with their retirement accounts thinking they are being active. Yet, they are still passive investors, in that they go through the ups and downs of the markets. Funny these same investors get out of the market after it corrects. Conversely, as the markets reach new highs they start buying.

These activities confirm academic research which shows the small passive investor has obtained about a 2% return while the markets have averaged 10% – 12%. The results: passive investors, trading or trying to time the market does not work.

Today, worldwide trading is being done 24 hours per day. So while you are sleeping, markets, and your wealth, can be crumbling. Thus, the challenges for the passive investor will continue to increase in an exponential way.

Many passive investors who hold accounts at, say, Vanguard, Fidelity or others have their monies invested in good mutual funds and think they are safe. Unfortunately, as listed in the fund’s prospectus (you have read every page), it states that the manager can never move to more than a 10% – 12% cash position. Consequently, when the market corrects the small investor panics and sells their mutual funds. With only 10% – 12% of assets in cash, this forces the fund manager to sell more shares in a declining market which creates an even larger debacle in share prices.

An alternative to passive money management is known as Tactical Money Management (TMM). Here, selected professional money managers, using computer algorithms, not timing, move client’s money into and out of the market. This is not done on a daily, weekly or monthly basis. Rather, the moves are done when changes in money flow or activities in the market change (their “secret sauce” algorithms).

A Tactical Money Manager’s objective is to capture 70% – 80% of the market upside while eliminating 70% – 80% of the downside. They never pick the exact top nor the exact bottom. At anytime they can move your money into 100% cash or 100% in the market or some combination. The results compared to “passive investing” have been remarkable on the investors behalf.

So, if you think the market will continue to go up and up and never drop then stick with passive investing. If you feel there will be a correction, and a pretty severe correction then you may want to investigate Tactical Money Management.

I believe passive investment strategies will come under severe selling pressure in the coming years. Many investors have their core (and retirement) portfolios in these passive strategies. If you are prepared to ride out another 2001 – 2002 or 2008 – 2009 and then go through what I think will be and even longer and weaker recovery (until our debt issue is fixed), then stick with your passive strategies.

If you are looking for another option let me offer you one.

Contact us at (713) 871-5919 or at Jamie@fgmci.com and we will be pleased to educate you on the time tested successful Tactical Money Management strategies.

Here is to your safe wealth building strategies.

MASTERING ROLLOVER DECISIONS

Unfortunately, there is no one-size-fits all template that can be used to determine which option is best for a person. Each persons retirement plan must be evaluated individually, based on its own merit and the persons specific situation.

There are numerous variables to consider. These include fees, available investments, services provided, the 10% early distribution penalty, creditor protection, convenience, required minimum distributions and estate planning.

The ability to roll over is not limited to participants in the company plan.

A spouse who is a beneficiary can roll over inherited company plan funds to his or her own traditional or Roth IRA. Non spouse beneficiaries can directly roll over inherited plan assets to an inherited IRA (or directly convert the inherited plan to an inherited Roth IRA).

Probably the strongest argument for an IRA rollover is the ability of a beneficiary to stretch the money for years, keeping it growing in either a tax-deferred traditional IRA or tax-free in a Roth IRA. A non spouse beneficiary can stretch distributions on an inherited IRA over his or her life expectancy.

But many company plans do not allow the stretch option.

Another advantage to a rollover is that IRAs are more flexible than company plans in terms of estate planning and investment choices. IRAs offer the option of splitting accounts and naming several primary and contingent beneficiaries. Individuals can name anyone they wish as their IRA beneficiary.

In many company plans, a participant must name his or her spouse as beneficiary unless the spouse signs a waiver.

In an IRA, individuals can customize investment choices. In addition, investment changes can be made faster in an IRA because there is usually not as much bureaucracy as in a company plan.

Another attraction of a rollover is that it is much easier to access funds in an IRA than in company plans.

Another potential appeal is that an IRA can be a convenient place for a person to consolidate all retirement funds.

IRAs can be aggregated for calculating RMDs. The employee usually has to take his RMD from each company plan separately.

STAY WITH A COMPANY PLAN

If a person is interested in delaying RMDs as long as possible, continuing with the company plan may be a good idea because of the “still-working” exception that may apply. The individual may be able to delay the required beginning date until April 1 of the year after he or she retires. This rule does not apply to IRAs.

At the other end of the time spectrum, individuals who may need their retirement funds early should also give serious consideration to sticking with the company plan. If a person is at least 55 years old when he/she leaves their job, and he/she needs to tap retirement funds, distributions from the company plan will be subject to tax but no 10% penalty. But, if the funds are rolled to an IRA, withdrawals before age 59 ½ will be subject to the 10% early withdrawal penalty. The age 55 exception does not apply to IRA distributions.

For some people, creditor protection may be a concern. Company plans have an advantage here, as they receive federal creditor protection. State laws protect IRAs, and they can vary significantly.

An IRA cannot be invested in life insurance, but life policies can be held in a company plan. For some people, the life insurance offered through their company plan may be the only such coverage a person can qualify or pay for.

If a lump-sum distribution from a company plan includes highly appreciated company stock or bonds, a person may roll it over to an IRA, but he/she may not want to. Under a special rule, the participant can withdraw the stock from the plan and pay regular income tax on it, but only on the original cost to the plan and not on what the shares are worth on the date of the distribution.

The difference is called the net unrealized appreciation (NUA). A person can elect to defer the tax on the NUA until he/she sells the stock. When he/she does sell, he/she will pay tax only at his/her current long-term capital gains rate. The ability to use the NUA tax break is lost if the stock is rolled to an IRA.

2016 Election and the Stock Market

People have been calling me and cornering me at social events asking:

“What will happen to the stock market after the election”? In the short run of a day or a week there may be a bit of an adjustment. The real issue is the next four years.

Avoiding any political statements I address this strictly from an economic stand point and as a business owner. Unfortunately, I find most Americans cannot connect the dots when economic policies are presented.

Let’s examine things in light of Economics 101. What moves stock prices? Answer: Earnings (or some call it profits). As a simple example lets say we want to buy a “pizza shop.” The present owner has been earning (making a profit) of $100,000 per year. Lets say the profit equates to “cash profit.” Assume there are 100,000 shares outstanding so the pizza shop’s earnings per share are $1 each ($100,000 profit divided by 100,000 shares). A general rule of thumb is that one would pay about 4 – 5 times earnings (or profits) for a small business like the pizza shop. This is known as the PE ratio or the price earnings ratio. In our case that would equate to a selling price of $400,000 – $500,000. Thus, without changing anything and earning the same $100,000 per year, we, as the next owners, could get a return on investment in 4 – 5 years, or, in other words we are demanding a 20% – 25% annual return (simply divide the selling price $400,000 – $500,000 by the $100,000 profit to get the return number). The present owner would be selling each of the 100,000 shares to us at $4 – $5 per share ($400,000 – $500,000 sale price divided by 100,000 shares).

Now let’s assume after we buy the pizza shop we institute some changes, i.e., getting discounts for buying in larger quantities, teaching employees to be more productive or adding technology so we are able to now earn $200,000 in profit after tax in the next year.

What are some of the outcomes of our changes and hard work: (1) With higher profits more in taxes now go to the government. We see the need to begin advertising since we can now handle more business so the advertising company hires more people (who pay income taxes) to handle our account. We also hire more people to handle the anticipated new business (and the new employees pay income taxes). We ask for more products from our vendors they do the same and so forth and so on. This is known as the multiplier effect. By the way I am not advocating a love of taxes but rather showing the outcome of a growing business and economy. So, with Adam Smith’s “Invisible Hand” principal more people are working, which means they are off the Government dole, more taxes are flowing into the Treasury and more of our new customers are happy.

As a side bar, since our business is now making $200,000 per year (or $2 per share on 100,000 shares) the next buyer would be willing to pay us between $800,000 and $1 million or $8 – $10 per share under the classic 4 – 5 times price earnings multiplier. If we decide to sell the business we would owe taxes on the difference between the selling price of $1 million and what we paid originally of $500,000. So, it is the INCREASE IN EARNINGS that push up the stock prices. By the way the P/E ratio for the S&P 500 has averaged around 12 – 13 times since large companies are more stable and you would demand lower rates of return. I am using a small business example to explain the concepts. Keep in mind the companies that make up the stock market act similarly in concept to this small pizza shop.

Here is a major input to help you understand companies and the stock market. If you took all the companies in the U.S. from the small pizza shops, to grocery stores to Apple computer and added up their profits, the average profit for all the companies in the U.S. comes out around 4.8% (before tax). Yes, it is not the gigantic number people think exists. Grocery stores work on 1% profit while the “sin” companies like alcohol, tobacco etc. have much higher profit margins.

As any business owner, just like any employee, I want to maintain my income (earnings) and lifestyle. Let’s say we are able to maintain the earnings or income of $200,000 per year (or $2 per share) as noted above.

Next, let’s say my expenses skyrocket overnight because the government imposes higher income taxes on our profits, imposes costly new regulations and forces me to buy expensive health care insurance for employees. So, without any change in sales, expenses have gone up and my profits drop back down to the original $100,000. Please keep in mind it is not just our pizza shop that is hit this way. The advertising agency and all of our vendors are hit the same way plus all the other companies in the U.S.

So to maintain our lifestyles we have 3 options: (1) Raise prices, which will make us uncompetitive and is purely inflationary. (2) Cut costs by laying off employees which will restore our profits and lifestyle and make our employees miserable, or, (3) shut down the business. In all 3 options the Government will lose tax revenue and many people lose their jobs who now become a burden on society again by going back on the Government dole. How about selling the business? Well at $100,000 in profits we might get our original money back of $400,000 to $500,000 but the new potential owner has looked at our books and seen profits dropping plus costs going up, so I doubt we can get our money back in a sale.

Who loses here: The Government, employees and entrepreneurs.

Remember small businesses produce 70% of all new jobs created in the U.S. In the past year, for the first time in U.S. history, more small business are shutting down each month than are opening. Tragic!!
Small businesses are just a reflection of large businesses that make up the stock market.

Are you connecting the dots yet?

I hope you have the answer after this long winded explanation of what will happen to your wealth in the stock market after the election.

One candidate wants to (1) lower taxes on business (we have the highest corporate tax rate in the world. That is why many companies are leaving the U.S. and we lose jobs). Every time the Government reduces tax rates more tax revenue is generated. (2) This same candidate wants to reduce costly regulations that stifle the ability to start and maintain a business. (3) This same candidate wants to revamp the out of control costs to business of Obamacare. If this candidate can do this, it will lead to an explosion upward in business growth, employment, tax revenue and the stock market going through the roof which means your wealth will skyrocket.

Who wins here: The Government, employees, entrepreneurs and society as a whole.

The other candidate wants to increase taxes, regulations and health care costs.

This simple article has only covered a few policies that are on the table that separate the candidates. My desire was to answer the question on what will happen to the stock market.

Well, I hope you now can calculate and understand where the stock market will be in the next 1 – 4 years based on who wins the election.

In the great words of Mayor Daly……

“Vote early and vote often.”

Everything Down

Over the past year everything seems to be dropping in value. About a year ago the major commodities started a free fall, and then followed by gold, oil started down from over $100/barrel, and, now of late we have seen the stock markets worldwide take a swoon.

All the TV talking heads come up with wild inaccurate notions of why this is happening. They range from a slow down in China’s economy, the dollar getting stronger and a slow down in economies around the world. Baloney! Those are the symptoms of the real cause, namely, the end to quantitative easing (QE).

The fiscal policies of the Obama administration were terrible. Consequently the Federal Reserve had to step in with QE 1- QE 4. They pumped $4 Trillion into the US economy to try to give it a steroid shot. Internally there was no real growth in the economy it was a fictious smokescreen (wizard of Oz) to create the “wealth effect”. Well, this mirror program worked for a while. In fact, the Feds convinced Europe, Japan and China to do the same money thing. Consequently, a huge amount of money was sloshing around the planet. Money has to find a home! Either in bank accounts (at ¼ of 1 %), or into stocks or into real estate. Guess what? It went into stocks and real estate (commodities, art, and baseball cards), and created a growth without any fundamentals behind the asset price increase (a paper tiger)

In October 2014 the “FED” ended QE. This is the exact time that commodities across the board took a nose dive.

The drop in oil prices has little to do with supply fundamentals. The drop in commodities has little to do with deflation and over capacity. No, it is basically caused by the experiment known as quantitative easing.

Commodities and gold are down. Stocks are starting their plunge and real estate will be next.

The metaphor I can create for you is that at the “Frat” party they are giving away free booze. It is a hot party and more and more people are piling in.
Once they cut off the booze (end of the QE) everyone leaves the party and it stops.

Watch out below.

The Dow may still rise

    Stock market history suggests the combination of a Republican-controlled U.S. House and a Democratic president is the most likely to see the largest annual gain in the Dow Jones Industrial Average. Interestingly, Democratic presidents outpace Republicans consistently, but Republican Houses beat their Democratic counterparts over time. In the table here, the quadrants show the Dow’s average annual growth in “dual-party” environments:

    Dow Avg Annual Gains, 1990-2014 In Four Political Environments

    Source: U.S. Election Commission; Bloomberg BMO Private Bank

    Source: U.S. Election Commission; Bloomberg BMO Private Bank

    Even though valuations are somewhat stretched, stock market returns from November through April have dominated May through October by a long shot since 1955. Add that seasonal effect to the political environment, and we could be setting up for a decent tail wind.