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Tag: Stock Market

Inflation 101: Understanding the ‘Why’ Behind Today’s Inflation

Posted on by Scott M. Peterson, ChFC®

The Bureau of Labor Statistics just reported a whopping 9.1% year-over-year increase in the inflation rate. This is the highest in forty years and many economists suggest that inflation will get worse before it starts to get better. To put a 9.1% inflation rate in perspective, one million dollars today has only $909,000 worth of purchasing power compared to just one year ago.

Americans are facing higher prices for food, fuel, and housing and are grasping for answers about what is causing inflation. How long it will last, and what they should personally be doing to combat its effects.

There are no easy answers or painless solutions when it comes to the inflation problem. Before we jump into how long it will last and what can be done to resolve it, we need to define how inflation is caused.

Inflation 101: What is Inflation?

Stated in its simplest terms, “inflation happens when too many dollars are chasing after too few goods and services”. So, inflation is really a supply and demand problem. When there is an equilibrium between the supply of goods and services and demand (money available to spend), inflation is in check. When the demand outpaces the supply of goods and services, inflation accelerates. Once this concept is understood, we can dissect what is limiting the supply of goods and services and what is driving demand.

What are the Issues that Impact Inflation?

What are some of the most hard-hitting issues that impact inflation? Read below to learn more about supply issues and demand issues.

The Supply Issues Impacting Inflation

A couple of events have contributed to the limited supply of goods and services:

First, the COVID pandemic in early 2020 led to lockdowns and numerous restrictive measures by governments around the globe to stop the spread of the virus. These government-imposed lockdowns disrupted the global supply chain as factories were shut down and maritime ports were closed. Currently, COVID continues to affect worldwide supplies as China, the world’s largest manufacturer, is still troubled by shutdowns as they try to get on top of the COVID pandemic still plaguing their nation.

Second, the United States went from being energy independent just a couple of years ago to once again being forced to purchase oil in the world markets.  U.S. production has decreased while our consumption has increased. The inevitable result of this supply/demand imbalance is inflated oil prices. Higher oil prices serve as a catalyst to higher prices in all other parts of the economy as higher energy prices increase the cost to produce and ship goods.

The Demand Issues Impacting Inflation

Consumers are spending big. When the pandemic started, the personal saving rate in the United States was sitting at an all-time high. With large amounts of savings on hand, the federal government sending out relief checks to individuals and businesses, and employees sitting at home with shopping at their fingertips, the U.S. consumer spent a lot of money. And the spending spree isn’t over, with unemployment numbers sitting at all-time lows, employees are either finding better paying jobs or are requiring higher wages from existing employers. These higher wages continue to encourage high demand for the limited goods and services available.

Additionally, with the pandemic mostly behind us, there is a pent-up demand from people looking to travel and vacation once again. If you have traveled recently, you would have noticed the inflated prices of airline tickets, rental cars, hotel rooms, restaurants, and more.

How Long Will High Inflation Last?

There are thousands of economists attempting to answer this question, all with different opinions. So, how long this recent inflation acceleration might last is anybody’s guess. However, there is a consensus on how the inflation supply/demand equilibrium will be brought into balance. The inflation rate will decrease as consumer spending slows down, or in other words, when the demand for goods and services is reduced.

How is Demand Reduced?

Two of the main ways demand is reduced is either by raising interest rates, by the economy suffering a recession, or both.

Raising Interest Rates

The Federal Reserve has the responsibility to monitor the economy and implement policy to maintain the equilibrium between supply and demand, in other words, keep inflation in check. The Federal Reserve is raising interest rates to slow consumer demand and subsequent price growth. This policy response means that the economy will surely head for a slowdown. We have already seen how higher interest rates and higher borrowing costs have begun to cool off the housing market. The question — and big uncertainty — is just how much federal action will be needed to bring inflation under control.

Having A Recession

A recession is when the economy shrinks. This is a more painful and less desirable way to slow consumer demand, but it can work towards taming inflation. During a recession, the overall economy struggles, corporations make fewer sales and become less profitable. Workers are laid off and unemployment surges.

The hope is that the Federal Reserve can raise interest rates just enough to slow consumer demand without throwing the country into a recession. This optimistic scenario, often called a soft landing, is difficult to orchestrate and despite the best efforts by the Federal Reserve board, can still end up throwing the economy into a recession.

In our current environment, the so-called soft landing is especially challenging. As the Federal Reserve tries to reign in demand with higher interest rates, they have zero control on the supply side of the equilibrium. If supply chain shortages persist, the Federal Reserve will be required to raise interest rates more drastically. This will slow the demand enough to bring higher prices under control. It’s an economic tightrope, we will see if the Federal Reserve can walk it.

What will not help inflation?

Currently, there is talk on Capitol Hill of sending out additional stimulus checks to help the U.S. consumers pay for high gas prices and other goods. This is indeed a noble thought, but terribly misguided. The demand side of the equilibrium is already out of balance. In other words, there is already too much money chasing too few goods and services. Going into more debt, to throw more money at a problem caused by too much money pursuing too few goods and services is not the answer. We cannot spend our way out of inflation and any attempt to do so, will only result in higher inflation.

Conclusion

We have addressed the causes of inflation and talked about how inflation rates will be reduced. In our next blog we want to get personal. We will be going over the personal dos and don’ts of managing higher interest rates and making good decisions concerning your investments during recessionary times.

If you have questions, concerns, or would like to review your personal retirement situation, please click here to schedule a complimentary consultation.

Preparing for, and Dealing with, Market Turbulence

Posted on by Scott M. Peterson, ChFC®

At Peterson Wealth Advisors, we manage the retirements of several retired commercial pilots. As I have discussed these pilots’ careers with them, one of the retired pilots explained that being a pilot can be described as, “hours and hours of boredom punctuated by moments of sheer terror.” Although these moments of sheer terror are rare, pilots will spend countless hours of training throughout their careers. They are preparing for that moment when their flight plan might not go according to plan.

Just as pilots have a plan, investors also need to have a plan to follow when their investments are not going according to plan. The last couple of years have provided investors ample unplanned and unforeseen market turbulence. A pandemic, a supply chain crisis, the highest inflation rate in our lifetimes, and the prospects of another world war in Europe have certainly rocked the investment world. It’s even caused the best-made investment plans to not go according to plan.

Investors should always be asking, “what is my plan when things temporarily aren’t going according to plan?” Let me share with you the Peterson Wealth Advisors’ perspective and what we are doing for our clients. Especially when it appears that things aren’t going according to plan due to ‘investment turbulence’.

Embrace the Volatility

First, temporary downturns are not a deviation from the plan. Rather, they are an expected part of the plan. Stock and bond market downturns are always temporary. Historically the duration of almost every major decline is measured in months, not years. The media would have you think that market corrections, “are unexpected events that are shocking in both their occurrence as well as their impact.” As investors with longer-term perspectives, we understand that the price you pay for inflation-beating investment returns consist of enduring occasional periods of market volatility. Few of us would pass up a Hawaiian vacation because there will surely be some turbulence in our flight to and from Hawaii. We likewise need to keep temporary market downturns in perspective and remember that turbulence is a planned for event.

Even though the exact timing of a correction is difficult, we should expect and even embrace market volatility. Investors should seize the opportunity to make wise tax moves during declining markets by doing Roth conversions, rebalancing portfolios, and tax-loss harvesting. They should also be opportunistic by purchasing depreciated equities while they are being sold on discount.

Protect Gains

We believe that investors should never be in a position where they need to liquidate depleted investments due to a temporary market downturn. This is difficult to do if an investor is not preparing for the downturns before they happen. With the Perennial Income Model™, we proactively attempt to protect our clients from selling investments at a loss. This is done by following a rigid, goal-centric, approach to harvesting investment gains once the goal of an investment has been reached. Harvesting is the process of transferring aggressive investments to more conservative investments as goals are achieved.

Navigating retirement with a plan that establishes investment goals and appropriately harvests gains can bring order, discipline, peace of mind, and added security to the retiree.

Maintain Flexibility

If you have the flexibility, you can wait out market downturns and wait for good investment opportunities. The best way to add flexibility, and tip the investment odds in your favor, is by increasing your time horizon. The longer you are invested, the better opportunity you have to endure a range of market turbulence. This endurance flexibility lets you stick around long enough to let the odds of benefiting from a positive outcome fall in your favor.

Additionally, flexibility within an investment portfolio allows Peterson Wealth Advisors to select only positive-performing investments within a portfolio to be drawn upon for income. This allows investments within that same portfolio, that may have temporarily dropped in value, to rebound.

Flexibility gives you room for error. Giving yourself a margin of error is the only way to safely navigate the world of investing. The world of investing is governed by probabilities, not certainties.

Create a Plan that has Conservative Projections

In other words,  plan for the worst and hope for the best. As the creators of the Perennial Income Model™ we project retirement income streams over decades. This process is unique to our firm. We have concluded that it is in everybody’s best interest to project low. We assume future investment returns 30% less than historical averages in all of our planning and projections. If an acceptable retirement income stream can be created from the conservative assumptions that we use, an actual income stream that spins off more income than originally projected will certainly be welcomed.

Conclusion

Market turbulence has and will continue to afflict investors with regularity. This is why we choose to create retirement income streams. We follow the goal-based, time-segmented processes of the Perennial Income Model.

A retirement income plan is only successful if it can survive reality. A future filled with unknowns is everybody’s reality. That is why we feel it is important that retirees understand and embrace volatility, follow a goal-based plan to protect investment gains, maintain investment flexibility, and use conservative estimates as retirement income streams are projected. If retirees understand and embrace these points, they will be prepared to answer the question, “what is my plan when things temporarily aren’t going according to plan?”

Schedule a free introductory meeting with an advisor.

The Perennial Income Model™ – Retirement Income “bad luck insurance policy”

Posted on by Scott M. Peterson, ChFC®

The Perennial Income Model™ was created and launched in 2007. Through all the ups and downs of the stock market, it has withstood the test of time. The initial goal of the model was to provide a logical format for investing and for generating inflation-adjusted income from investments during retirement. In the beginning, we did not fully anticipate all the accompanying benefits that would result from projecting a retiree’s income over such a long timeframe. However, our eyes have been opened to a number of benefits, one of them being how the Perennial Income Model acts as a ‘bad luck insurance policy’.

The Perennial Income Model can help protect your retirement income during a bad market

The Perennial Income Model can protect you if you are unlucky and happen to retire about the same time as a stock market crash. Every stock market correction is temporary, but that knowledge isn’t helpful if you are ill-prepared and are having to liquidate equities in down markets to support yourself.

Let me share with you an example, Mike had been carefully planning for his retirement for years and it was finally his turn. He wanted to be conservative as he selected investments for his retirement years, but he knew enough about investing to realize that a good part of his investment portfolio had to be invested into equities if he was going to keep ahead of inflation.

So, he reluctantly invested more than half of his portfolio in stock-related investments. Mike retired, and almost immediately his worst fears were realized, as the stock market dropped by 50%. His money was invested in a balanced mutual fund that was composed of 60% stock and 40% bonds. Unlike the working years, Mike couldn’t just wait for the stock market to recover, he had to withdraw a portion of his money every month from his mutual fund just to pay the bills. As Mike withdrew his monthly stipend, he realized that he was liquidating a proportional amount of stocks and bonds each month from his balanced mutual fund. This meant, he was systematically selling stocks at a loss every month that the stock market was down, and it could take months, or even a couple of years before the stock market recovered.

Mike was frustrated, and even a little angry. He thought to himself, “why did this happen to me? I anticipated, and planned for, every contingency of my retirement in detail, then the one thing that I have no control over trips me up. I must be the unluckiest person on the planet!”

Mike is not alone; this exact scenario happens and will continue to happen to millions of new retirees every time there is a market correction. It’s true when we are no longer contributing and we begin taking withdrawals from our accounts, the temporary ups and downs of the market can have a much bigger impact on our investments than when we were working and had time to wait out market corrections.

To be clear, Mike’s mistake wasn’t in being too aggressively invested because a 60% stock, 40% bond portfolio is a very reasonable allocation for a new retiree. His mistake was failing to have a plan that allowed him to only liquidate the least impacted, non-stock portion of his portfolio to provide immediate income during a market downturn.

To illustrate this point, let’s take the example of two investors, Mr. Green and Mr. Red. Both have decided to retire at age 65 and both have saved up a $1,000,000 nest egg. Each of them plan to withdraw 5% of their initial balance each year to have an annual income of $50,000. As you can see from the table, both average the same 6% return during their 25-year retirements, but Mr. Green ends up with more than $2,500,000 to pass on to his heirs at death, while Mr. Red runs out of money halfway through his retirement. How can this be?

Every aspect of their retirement experience is identical except for one thing: the sequence of their investment returns.

retirement income planning chart comparing two possible outcomes

As you can see from the chart, Mr. Green experiences overall positive returns at the beginning of his retirement and a string of negative returns towards the end. Mr. Red experiences the same returns only in reverse. He goes through a series of negative returns at the beginning of retirement and the more positive returns come at the end. Again, both investors average the same 6% return over their 25 years of retirement. The sequence of those returns is the only difference. We can see from the table just how much of a difference the order of returns makes.

Set yourself up for retirement success

The good news is that it’s possible to set ourselves up to be successful no matter what the markets happen to do year by year. The Perennial Income Model is the bad luck insurance policy that can protect you from the pitfalls that Mr. Red experienced.

I’m not suggesting that following the Perennial Income Model will guarantee that your account balance will never go down, or suffer temporarily because it will. What I am saying is, that by following the Perennial Income Model, you shouldn’t find yourself having to sell stocks at a loss during a stock market correction.

Mr. Red’s losses are realized as he liquidates equities in down years at a loss to cover his expenses. If Mr. Red were to have his portfolio organized according to the investment regimen provided by the Perennial Income Model, he would not be in a position where he would have to liquidate stocks in down years to provide income. He would have a buffer of conservative investments to draw income from while giving the more aggressive part of his portfolio a chance to rebound when the stock market temporarily experiences periods of turbulence.

The Perennial Income Model’s design is intended to give immediate income from safe, low-volatility types of investments. At the same time, it furnishes you with long-term, inflation-fighting equities in your portfolio, equities that won’t be called upon to provide income for years down the road. Market corrections typically last for months, not years. So, even if you are the unluckiest person on the planet and your retirement coincides with a market crash, your long-term retirement plans won’t be derailed as long as you are following the investment guidelines found within the Perennial Income Model.

Ready to talk? Schedule your complimentary consultation here.

It’s Not as Bad as You Might Think

Posted on by Jeffrey Lindsay, CFP®, CRPC

The stock market recently went through another correction. During the last quarter of 2018, media outlets were happily giving bad news day in and day out. At its worst, the market fell almost 3% on Christmas Eve alone. From all-time highs in September to the Christmas Day low, the market had taken a nearly 20% tumble. As usual, many investors agreed that it was finally a good time to panic. During Christmas break, I heard a nationally syndicated talk show host giving advice to his listeners. He warned them he had pulled out of the market altogether and they would be wise to do the same. He should have read Scott’s book before making such a rash decision.

S & P 500 2018-19

Since Christmas, the market has rebounded and is already flirting with the all-time highs that are so common in a normal market. It doesn’t always happen exactly this way (if you blinked this time, you might have missed it), but the pattern is usually similar. I wonder if our talk show host friend will wait until the market is about to plunge again before putting his money confidently back into the market just in time to see another drop in the value of his portfolio.

Whenever we get into another one of these temporary downturns there is a tendency to question the stability of the market that we are dealing with. Why would we put our money into this “house of cards”? It feels like there is no end to the bad news and we’ve already missed out on the opportunity to get out while the getting was good.

The reality is the stock market is just a group of companies making goods or services people need and want. If they can make a profit on what they do, the value of their stock will rise over time. The price of a stock follows the profits of the company it represents. Not every day, not every quarter, but over time.

Since the bottom of the 2008-2009 recession, the stock market has returned nearly 300% to those who were patient. That’s just over 14% per year. With all the bad news that we’ve had over the past 10 years, how is it possible that companies could have been so profitable?

Let me start with the most obvious reason. In 2007, Apple came out with a new technology – the iPhone. Since then, smartphones have been adopted at such a rate that even our preteens can’t survive without them. The efficiencies that nearly every worker, from the CEO to the delivery person have gained with their smartphones are incredible. Reports are created, shared, edited, and presented all via a mobile device.

A CEO can manage the many aspects of his business at the touch of a screen. When he has a meeting across the country it takes him minutes to book his flight and travel arrangements – a task that took much longer in the past. When he lands, he can request an Uber on his phone and knows the second it pulls up to get him to the next meeting. While on route, he can have video/phone calls with those who need a face to face meeting, but not a handshake.

The FedEx driver gets time-saving data on the most recent crash or traffic jam, and the best secondary route all updated in real-time. He uses his phone to scan each item for a more efficient drop. He also takes a picture of the package when he delivers it. The photo is automatically sent to the customer to secure the package before it can be stolen. This saves money for customer support hunting down or replacing lost items. It also creates a better customer experience.

A farmer can monitor his crops using mobile technology and drones. He can pinpoint the need for fertilizer or herbicide and deploy them using the drone. With the right equipment, he can even run his tractors and irrigation from the comfort of his home office or wherever else he might be working that day.

Many companies have expanded on this mobile technology to make the consumer’s (and the company’s) life easier. Processes that used to require many manual steps have become, in many cases, an app allowing the customer to interact with the company almost completely digitally. We rent movies using an app, or just stream them directly from the company’s website. We use an app to refill prescriptions and drive up to pick up the filled prescription, or even have it delivered directly with the rest of our mail. We also do much of our shopping using apps. This way of doing business is potentially so much more profitable since a company can thrive without a large and well-lit store front in a prime (expensive) location.

Imagine an inventor or engineer with a revolutionary idea. The technology and systems exist now that enable the inventor to create their invention on their computer and send the schematic to a company that can custom build their idea. Or even better, the inventor can use their own 3-D printer to build the idea then they can test and refine on the spot. What took years of trials, testing and manufacturing expenses can be done in a matter of hours at a fraction of the cost.

A doctor can have a live video conference with a patient from hundreds of miles away with the ability to diagnose and treat the patient in much the same way they could in person. Using robotic technology, they can even operate on a patient remotely. This gives the doctor the ability to be so much more efficient with their time and see the patients that they can best help.

There are so many more examples of time and money-saving technologies and processes that have been created or refined in just the past 10 years. The US energy industry has had a complete revolution. Health care is making strides on many fronts creating a healthier and longer-lasting workforce. When you think about it, it’s no wonder companies across industries are seeing profits increase over time.

Of course, there are many places that still need improvement and obstacles that need to be surmounted. We see negative headlines every single day outlining the next challenge to overcome. If you read or watch everything out there, you’re likely to be overwhelmed. But those are the interesting (if morbid) tidbits that sell news time each day. They don’t represent the seemingly ordinary but real increase in productivity and standard of living that we see evolving around us at ever increasing rates. Don’t get bogged down by each new negative piece of news you hear. It’s not nearly as bad as you might think.

If you are getting close to retirement and will have at least $1,000,000 saved at retirement, click here to request a complimentary copy of Scott’s new book: Plan on Living!

Past performance does not guarantee future results – Grand Illusion #3

Posted on by Scott M. Peterson, ChFC®

“If past history is all there was to the (investment) game, the richest people in the world would be librarians.” -Warren Buffett

If you have ever bought shares of stock, a bond, or shares in a mutual fund, you were presented with the following disclaimer: “Past performance does not guarantee future results.” The U.S. Securities and Exchange Commission requires it and the SEC is right, there truly is no correlation between an individual investment’s past performance and its future. Past performance has no predictive power whatsoever.

Of course, that doesn’t mean your investment advisor sat you down, rested a hand on your shoulder, and with a kind but concerned look in their eye, uttered these words. No, it was in the fine print somewhere that most of us never bothered to read. Or worse, when we came across this disclaimer, we ignored it, because frankly, we did not want to accept it. We like guarantees. When we buy an investment, we simply want the assurance that it will perform as it has done in the past. Unfortunately, that promise can’t honestly be given.

The “grand illusion” of persistence of performance is hard to diffuse because so much of our life experience is based on the reliability of past performance. We believe the sun will come up tomorrow morning at the appropriate time, because it always has. We therefore assume that it always will. Your summer vacation at the beach, or next winter’s ski getaway, can be planned months in advance because of the persistence of performance of the weather, and the reliability of the change of the seasons. If you have a car that has averaged seventeen miles per gallon since you purchased it four years ago, it would be crazy to assume it will average anything but seventeen miles per gallon next month.

The persistence of performance surrounds us, and it seems quite natural to want to use past performance as a criterion to select our investments. Unfortunately, there is no evidence that the past performance of a specific investment has any predictive power of that investment’s future.

S&P Persistence Scorecard

S&P Global, an independent research company that monitors the mutual fund industry, produces a biannual report they call the “S&P Persistence Scorecard.” These annual reports, always come to the same conclusion: that over a five-year period, less than 1% of the mutual funds in the top quartile at the beginning of a five-year period have been able to maintain their top quartile status at the end of five years.

Many investors waste an inordinate amount of time and energy studying past investment returns, attempting to discover next year’s investment champions. It is an exercise of futility, but it is easy to get caught up in, because we really want this illusion to be true. Founder of Peterson Wealth Advisors, Scott Peterson recounts an experience of when he was first beginning in the investment business:

“I cut my teeth in the investment business in the late eighties and early nineties, back in the day when double-digit investment returns were the investment norm. It seemed as if the whole world was consumed with finding the hottest-performing mutual fund. As a young and inexperienced advisor, I spent countless hours identifying all the top-performing funds so I could direct my clients to them. I now recognize that perfecting my golf swing or cleaning my garage would have yielded equally productive investment results.”

So, who profits from promoting the idea of persistence of performance?

Any entity that touts their ability to direct you to a superior investment, based on that investment’s past performance, perpetrates this grand illusion. The Morningstar, Inc. star-rating system for investments is based on past performance, rendering their system meaningless. That is right: buying a five-star fund versus a one-star fund does not increase your chance of success! Countless newsletters and magazines are sold as they flaunt their recommended lists of the hottest stock or best mutual funds to buy. All their recommendations are based on historical performances which has no predictive power.

Just as the road in front of us is different from the road behind us, it is important to recognize that drivers as well as investors who navigate solely by what they can see in their rear-view mirror are not well equipped to manage the inevitable twists and turns of the road that lies ahead.

If you are getting close to retirement and will have at least $1,000,000 saved at retirement, click here to request a complimentary copy of Scott’s new book!

 

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Grand Illusion #4: Equities are Risky and Should be Avoided

The myth of “Timing the Market” – Grand Illusion #1

Posted on by Scott M. Peterson, ChFC®

The first “grand illusion” of investments is market timing. Market timing presupposes that those who are smart enough, or follow the markets closely enough, can figure out both when to get into the stock market and when to get out. The goal is to miss the pain and experience the gain.

Of course, we would all love to own equities and enjoy the profits while avoiding downturns, but unfortunately, it cannot be done. The difficulty in market timing is that you not only have to know when to get out, but also when to get back in. Therefore, you must guess correctly not only once, but twice for market timing to actually work.

What we have found is that there are a lot of people and products willing to take money from the public who attempt to time the market, but none have a proven track record to substantiate their claims. Of course, there is the occasional “investment guru” that may guess the temporary movement of the market. When that happens, they have their face on the cover of the financial magazines and show up on the financial radio and television shows, but they are soon forgotten. Why? Because successful market timers must guess correctly twice: when to get out, and when to get back in. That cannot reliably be done.

We often run into individual investors that report to us they saw the financial crisis of 2008-09 coming, and they were able to avoid the big downturn in the stock market. As we investigate their claim in more detail we find that these investors, that take such pride in their investment prowess, usually still have their money sitting in the bank account that they moved their money to during the great recession.  Therefore, even if they did miss the 56% downturn of 2008-09 they also missed out on more than 300% upturn since 2008-09. Again, you must guess correctly twice.

Can you really outperform the stock market average?

The S&P 500 is a representative basket of the 500 largest corporations in the United States: Apple, ExxonMobil, Proctor & Gamble, etc.

An index is a tool that gives us a way to measure how the overall stock market is faring. There is no management of the portfolio of stocks that make up the S&P 500, and you can’t buy into the S&P 500 itself. You can, however, purchase exchange-traded funds (ETFs) and mutual funds that mimic the holdings of the S&P 500. When you buy an investment product that mimics the S&P 500, you become a partial owner of all 500 corporations that compose the S&P 500. You are buying a piece of the entire basket of stocks.

Actively managed portfolios

The alternative to passively investing into an index fund is to attempt to make money by investing into actively managed portfolios. Actively managed investment portfolios are those that attempt to outperform an index, such as the S&P 500, through market timing and superior investment selection. It is interesting to note that in a given year roughly 15% of actively managed mutual funds that invest into large U.S. stocks can outperform the S&P 500.

You may be thinking that you only need to do the research and find the 15% of mutual funds that beat the S&P 500. That is a great idea, but it’s just not that simple. It’s never the same funds that beat the S&P 500 year after year. Every year there will be a different group of mutual funds that outperform. You would have to determine in advance which 15% of mutual funds would be next year’s winners. Therein lies the challenge. Good luck.

Over longer time periods, the percentage of actively managed mutual funds that can outperform the index diminishes dramatically. The obvious question that needs to be asked, therefore, is, “Why don’t I just buy the average?”

Well, why don’t you?

The good news is that you don’t need to “beat the market” to be a successful investor, you only need to get the market’s average and participate in its earnings. Because when it comes to investing, getting the average return of the entire market puts you near the top of the class.

The profiteers of market timing

So, who stands to profit from the illusion of market timing?

First, the mutual fund industry in general. The fees for actively managed mutual funds are more than ten times higher than buying a fund that mirrors an index. The average cost of actively managed large-cap stock funds is 2.33% when expense ratios and transaction costs are considered. The average cost to buy a fund that tracks the performance of the S&P 500 itself is .20% when transaction costs and expense ratios are considered. Even though index funds outperform actively manage mutual funds and are cheaper to buy, for the obvious financial benefits, mutual fund companies promote their more expensive, worse-performing funds instead.

The second group of profiteers of this particular grand illusion is any other person or entity that promotes the idea that they know what the market’s next move will be. The large brokerage firms and the small investment advisors, whose value propositions are their knowledge of the future, are co-conspirators of this illusion.

Magazines, newsletters, and cable news stations that predict the future of the markets, the price of oil, the next recession, or any other future price or event, likewise share in this “grand illusion”.

The following that some of these prognosticators have is amazing. On the air, these self-assured individuals are incredibly convincing. But being convincing doesn’t mean they are accurate. Few investors take time to investigate the track record of those that can “see into the future”. If you were to Google the accuracy rate of their past predictions, you would know better than to follow their forecasts.

Some of the most entertaining promoters of the illusion are the authors of books that have figured out when the “financial apocalypse” will begin. For $34.99, they will share this dark secret with us, and instruct us on how we can thrive while the entire economy collapses, dollars become worthless, and our neighbors starve to death in the streets.

The next time you are in the bookstore, check out the books on investing. You will find a book authored by Harry Dent in 1999. His book, ‘The Roaring 2000s’, predicted that the Dow Jones Industrial Average would surge to 35,000 by the end of the next decade. That never happened. Instead, the first ten years of this century ended up being the worst decade for investing since the Great Depression. The Dow Jones Industrial Average closed the decade lower than where it began, an entire decade with no growth.

Instead of taking a breather after this forecasting disaster, in 2009, Mr. Dent doubled down on his forecasting and wrote a new book, ‘The Great Crash Ahead’. Since this book hit the shelves, the S&P 500 has tripled in value.

It seems like this forecaster just can’t get things right. I wouldn’t be so disparaging about this author if it were not for the fact that he is one of the most quoted “experts” in the financial industry. Every year for the past several years, he has predicted that the Dow Jones Industrial Average will drop by 6,000 points. It hasn’t happened, but that’s not the point. The point is that every time he makes this dire prediction, he sells a lot of books.

The grand illusion of market timing is reminiscent of the California gold rush. In 1849, fortune seekers from across the globe flocked to California in hopes of striking it rich. Fortunes were made, but it was not the hard-working prospectors that become wealthy. Rather, it was the shop keepers, suppliers, and bankers who were the real profiteers. Similarly, fortunes are now being made by market timing. Unfortunately, it is not the investor that will be bringing home the profits. It is the mutual fund industry, brokerage firms, and the financial media that are the real winners.

With the illusion of market timing, everybody makes money but the investor.

If you are getting close to retirement and will have at least $1,000,000 saved at retirement, click here to request a complimentary copy of Scott’s new book!

 

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Grand Illusion #2: Superior Investment Selection
Grand Illusion #3: The Persistence of Performance
Grand Illusion #4: Equities are too Risky and Should be Avoided

This Time Really Isn’t Different: What to do When the Stock Market Crashes

Posted on by Scott M. Peterson, ChFC®

Anytime the blended price of America’s 500 largest companies (S&P 500) drops by 34%, you know that there is something significantly wrong going on. This is the fourth time we have experienced this magnitude of decline in my thirty-four year career and every time such an event comes around, we tend to surmise that, “this time it is different”. We conclude this because the details of each crisis are fundamentally different from anything we have before faced.

Thus, the COVID-19 pandemic, and the economic panic it has engendered, seems entirely unique in our history. Moreover, we are without historical precedent as the equity markets become unmoored from valuation fundamentals. We have no idea how the pandemic will affect the earnings of corporations nor how much future dividends will be cut. Furthermore, we don’t really have an idea how long it will take for the economy to stabilize and return to a sustainable path of growth. We are mired in a bog of uncertainty as to how the immediate future will play out.

During times of uncertainty and fear, human nature defaults to the conclusion that our current crisis is fundamentally, and even fatally, different from past bear market episodes. That has always been human nature’s rationale for not staying the course and selling out in a panic. This fear of uncertainty caused the epic selloff in February and March when the stock market dropped 34% in thirty three days.

As I think about the three analogous bear markets of this magnitude that I have experienced during my tenure, I recognize that even though each is radically different in its particulars, each was fleeting in its long term effects once we got through them. The three events I am referring to are the Global Financial Crisis of 2008-09, the terrorist attacks of September 11, 2001 and the stock market crash of 1987.

Global Financial Crisis of 2008-09

During the Global Crisis of 2008-09 the world’s financial system found itself over-leveraged and holding trillions of dollars of worthless mortgage derivatives. Under this burden, the credit system broke. Many of the nation’s largest banks, brokerage firms and insurance companies were teetering on the brink of bankruptcy. In response, the S&P 500 declined 57%, making it the worst equity wipeout since the Great Depression. Liquidity was gradually restored, bad loans were written off and from the market trough of March 2009 to the market’s peak in February of 2020 the S&P index delivered an annualized return of 16.7% and stood almost five times higher in 2020 than its 2009 level.

The Stock Market Crash Following 9/11

As the nation reeled from the events of 9/11, Americans feared that World War III had begun. We waited for the next surprise attack fearing that the next one might be nuclear. The stock market was closed for a week and America was convinced that life as we knew it would forever be changed. We will never forget what transpired on that infamous day yet, economically and financially, 9/11 ended up being just a temporary distraction.

Black Monday, October 1987

On a beautiful fall day in October of 1987, the stock market had its single worst day in recorded history. The S&P 500 plummeted on Black Monday by 23%. Nobody understood the drop and we all wondered if this was our generation’s crash of 1929 and the ushering in of our very own Great Depression. I remember a couple of investors shooting their stock brokers while other distraught investors jumped from buildings and bridges. As disturbing as the events of Black Monday were, the stock market quickly rebounded, ushering the unprecedented growth that was experienced from the date of that crisis until the year 2000.

Today it is difficult if not impossible to envision that the financial effects of the COVID-19 pandemic will soon be a distant memory, a mere paragraph in a history book that will be added with the other Black Swan events of our times. This will happen because there simply is no other option. There are 330 million hungry American consumers and almost 7 billion additional consumers worldwide that will keep the market’s permanently marching on to new heights. The human race is too adaptable, too motivated, and too ingenious to let terrorism, viruses, or come what may derail our progress. There will be other crisis, there always are, but history has proven that whenever the human race is faced with a challenge, we ultimately overcome the challenge and move on.

Thus, the lesson of this crisis, as well as every other crisis past and future, is that although the exact nature of every crisis is unique, the resulting economic and financial impact of these crisis are remarkably similar and remarkably negligible. Long term investors cannot allow themselves to buy into the most destructive and expensive phrase ever uttered….. this time is different. “This time is different” will forever be the anthem of the failed investor and we can’t allow that phrase to creep into our psyche. History has proven that it is a losing proposition to bet against the ingenuity and indomitable spirit of the human race to succeed. We will overcome COVID-19, and this soon will become just another blip on a chart.

Stay the course, and remember that this time really isn’t different!

Strategic Opportunities in a Market Decline

Posted on by Scott M. Peterson, ChFC®

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” – Winston Churchill

As I watch the emotional reaction of investors during market turbulence, I concur with Churchill as I see individual investors categorize themselves into two separate camps. They are either victims or they are opportunists.

Beyond reminding the self-prescribed investment victim of the overwhelming historical evidence of the resiliency of the stock market, there is little that can be done to save them from themselves as they panic and sell as markets decline. Therefore, let’s not waste our time discussing how to rescue the lemmings as they throw themselves off a cliff

Let us focus instead on the positive steps that can be taken by an investment opportunist when stock markets retreat. There is so much that can and should be done in every financial crisis. The prepared opportunist can turn today’s temporary stock market lemon into tomorrow’s lemonade.

An investment opportunist recognizes that every downturn is temporary, every bear market is eventually followed by a bull market, and that the stock market will eventually go on to reach new record highs. There has never been an exception to this pattern, only the timing and duration of the bear and bull markets is uncertain.

Six ways to take advantage of a temporary market downturn:

1. Roth IRA Conversion

A traditional IRA will someday be taxed while a Roth IRA grows tax-free. Therefore, Roth IRAs are more advantageous to own than traditional IRAs. You can convert a traditional IRA to a Roth IRA, but you must pay income tax on the entire amount of the traditional IRA that you convert. So, let’s say you own 10,000 shares of ABC stock that are priced at $10 per share. The value of your investment is therefore $100,000. If you were to convert these 10,000 shares at the $10 price you would need to pay income tax on the $100,000 converted to a Roth IRA.

In a down market, an opportunist would realize that his ABC stock is now only worth $7 per share. If he were to convert all 10,000 of his shares that are now worth only $70,000, he would only have to pay tax on the $70,000 Roth conversion, not the full $100,000. When the price of ABC stock rebounds to $10 per share our optimists would have $100,000 worth of Roth IRA value but they would have paid tax on $70,000 worth of Roth IRA conversions.

2. Refinance Your Mortgage

When the stock market recedes, it is common for the Federal Government to step in and attempt to jump-start the economy. They do this is by reducing interest rates. This move will often temporarily reduce mortgage interest rates. The opportunist would jump at the chance to refinance their mortgage because a thirty-year, $300,000 mortgage with a 3.5% interest rate costs $60,000 less over thirty years than the same mortgage with a 4.5% interest rate.

3. Fund IRA/Increase 401(k) Contributions

An easy way to take advantage of a temporary market downturn is to contribute additional funds to retirement accounts. We have all heard the maxim, “buy low, sell high”. Well, then buy when equities are selling at a discount.

Some of you will remember the years 2000-2009 which was the worst decade for investing since the great depression. Large stocks ended the decade at the same levels that they began the decade. That’s right, ten years with zero growth. The pessimist would say, “I am glad, or I wished, that I missed out on that disaster”. Meanwhile, for the opportunist, this decade was a wonderful investment opportunity! As markets went down the opportunist systematically purchased depleted equities in their 401(k)s and IRAs at a substantial discount. These once depleted shares are now worth 400% of their 2009 value and that’s taking into consideration the latest downturn.

Those who make annual contributions to retirement accounts should contribute when markets plummet. Those who systematically contribute to 401(k)s should consider reallocating conservative investments within their 401(k)s to equities and/or increasing their 401(k) contribution rates.

4. Rebalance Your Portfolio

There is proven value and additional security when investors diversify their investments. Few would argue that diversifying or creating the proper mix of investments to accomplish specific goals is important. The challenge is keeping portfolios diversified. As markets fluctuate, portfolios get out of alignment as top-performing investments become a bigger allocation and underperforming investments shrink to a lesser allocation of the original portfolio mix. Rebalancing brings the investments back to the original mix. The process of rebalancing requires buying and selling securities which ofttimes create unwanted taxable gains. Rebalancing can be accomplished during market downturns with greater tax efficiency because the capital gains incurred are less as depleted equities are sold.

If it so happens that your rebalancing requires purchasing equities to bring your portfolio back to its original composition, then rebalancing adds additional value as temporarily beaten up equities are purchased at discounts.

5. Tax Loss Harvesting

Let’s say that Clara bought a mutual fund three months ago for $100,000. Because of the recent slide in equities, this investment is now only worth $80,000. Clara could simply hold on to that investment and wait for it to rebound to $100,000. There would not be any tax benefits or consequences by waiting for the depleted shares to rebound.

However, Clara is an opportunist and hates paying income taxes. She decides to sell the diminished investment and create a $20,000 capital loss which would benefit her taxwise. She then invests the $80,000 into a very similar investment to that which she sold and when the market rebounds she would still have the $100,000 of value plus a $20,000 capital loss that could save her several thousand dollars in income taxes.

6. Invest Excess Cash

The most important criteria to consider when deciding how to invest is time horizon, or how long money can be invested until it is needed. Money that will be required in the next five years for a purchase or for income should not be invested in equities because of the short-term volatility that accompanies the stock market. Money needed between five to ten years should be moderately invested into a mix of equities and fixed-income investments. Money that will not be needed for ten years and beyond should be invested in equities to help fight inflation. Market corrections provide opportunities to reassess portfolios and put money that is on the sidelines to work.

A Concluding Thought

The richest men in the world, from every generation, did not get that way by betting against the ingenuity and indomitable spirit of the human race to create a better life for itself. Successful investors have always been richly rewarded for their willingness to invest in the future. This generation is no exception. Today’s optimists, or those willing to invest a better tomorrow, are thriving.