Deciding to Retire

Deciding to retire is a big deal. That’s probably obvious but people don’t always fully appreciate just how hard and complicated a decision it can be. Folks often plan on it for years, getting more excited as the “right time” gets closer only to find they can’t take the leap when they get there. There can be fear of loneliness and boredom, worry about relationships, or even fear of missing out on the goings-on at the office. Or simply a fear of the unknown. There are lots of reasons for retirement anxiety and they are not always financial.

Maybe it was easier when you worked for a company long enough to hit mandatory retirement. There wasn’t much personal choice involved. You attained the age and that was that. This kind of retirement is rare these days, so people usually have to make the decision themselves. And with most retirees not having a pension to draw from and with Social Security being relatively small, they have to rely on themselves too. That’s a burden but also an opportunity.

But how do you know you’re ready? Maybe your humble financial planner says you can afford to retire, but is it a good personal choice? Why do you want to back away from work? Are you somehow giving up by retiring? Will it be forever, or do you just need a nice long break? What do you plan to do? There are so many questions and we, as a culture, seem to lack a clear framework for addressing them.

Along these lines, here are portions of a recent article from a psychologist writing for The Wall Street Journal. She lays out eight questions to ask yourself if you’re thinking of retiring. Question #2 is firmly in my wheelhouse, but #8, regarding travel and where to live is something I’ll delve into in a future post.

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The Rise of SPACs

I am extremely risk averse when it comes to managing money for my clients. This might sound strange given that most of my clients have at least half of their retirement savings invested in stocks and others have at least some. Risk is necessary for growth (financial and personal) and I’m not shy about risks that I have some control over. It’s the unknown unknowns that bother me most and are why I have always avoided more speculative and illiquid types of investments.

Risk is a tool that can work wonders if used correctly but can also lead to disaster. Of all the different types of risk I think about, the one I try to avoid like the plague on behalf of clients is what I refer to as “blow up” risk. Call me old-fashioned, but I simply have an aversion to putting client money into anything that risks catastrophic failure, even if the potential return is huge.

This idea was drilled into me during an early-career training session led by a seasoned veteran who offered this simple advice to the newbie advisors in attendance: don’t blow anybody up. Some in the room laughed and others thought the concept too simple. For some the sage advice went through one ear and right out the other. But it stuck with me and I’ve been reflecting on the advice quite a bit during the last year or so with the rise of Special Purpose Acquisition Companies (SPACs).

You may never have heard of SPACs, or maybe only recently because they’ve been in the financial news lately. Also known as “blank check” companies because that’s essentially what investors are handing over when they buy shares, the structure has been around for years but really took off as the pandemic began to rage last Spring.

Celebrities like Shaquille O’Neal and A-Rod are in on the game, as are other big names like former Congressmen and VP candidate Paul Ryan. If they’re doing it, why shouldn’t you? SPACs are being touted in some circles as the “poor man’s private equity”, or another force “democratizing” investing much like brokerage firm Robinhood and the GameStop short sellers were said to be doing. This kind of hyperbole coupled with star power seems to have all the hallmarks of a bubble.

I’ve been getting questions about SPACs lately, so I thought I’d put together some resources for you if you’re interested in learning more. I would suggest treating this as an academic exercise and not something to jump into with your hard-earned savings. The reasons will likely become apparent as you investigate these things. But the bottom line is that, just like with other investment fads over time, blow up risk is high. Early entrants make money, often through private deals, and by the time they offer it to you it’s because they need to sell it to you to take their profits.

Here are some notes about SPACs and a few links for further reading, ordered by level of detail.

SPACs are formed with a relatively small amount of money and then sold to investors in an Initial Public Offering (IPO) so the fund can accumulate cash. Essentially, investors buy shares of a fund that has no value, just cash and a goal to merge with a private company so it can grow. Investors trust SPAC management to find a good company to merge with. It could ultimately be a good deal, but you won’t know much about it until it’s happened. There have been successes and notable failures.

Investors can buy the SPAC as an IPO, or afterward on a stock exchange before it announces a merger, or on an exchange after the merger announcement. These are the three stages of a SPAC and the latter stage might be most appropriate for a long-term investor, if at all.

SPACs have two years to merge with a company and, if they don’t, must allow early investors to sell their shares back to the fund. Apparently, lots of the early folks do this.

The SPAC allows a private company to “go public” faster than the typical IPO process and with less scrutiny. This gets a growing private company quick access to capital, but the process isn’t transparent to the end investor (you).

SPACs exploit a regulatory loophole that allows them to aggressively promote the fund on social media, podcasts, etc, in ways that wouldn’t be possible with a traditional IPO. Many suggest that this sucks a lot of unwitting retail investors into deals that help make initial investors rich but leaves the newbies with high costs and, often, losses.

Ultimately, once the SPAC merges with a private company, the new merged company begins trading in place of the SPAC. The new company is more transparent because it’s now public. This allows ordinary investors to see what the SPAC actually accomplished. If investors don’t like the new company they can sell in the open market, hopefully for a profit. Most of the original investors are already out at this point, profits in hand.

If you’d like to learn more consider checking out these links. It’s a reminder of how creative people can be when trying to make money off the backs of others.

Link 1 – A story yesterday from the WSJ about SPACs and their recent parabolic growth rate. There’s a soft paywall, so you may not be able to access the article. If so, let me know and I can email it to you through my subscription.

Link 2 – A bulletin from the SEC for retail investors to learn more about the structure and risks of SPACs.

Link 3 – An excellent but long paper covering all you ever wanted to know about SPACs. The authors also discuss some ways that the SPAC structure could be used to actually democratize part of the investing landscape.

Have questions? Ask me. I can help.

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Updates to COBRA

Health insurance is extremely expensive, no doubt about that. But the total cost for many workers is a mystery because most of the monthly premium is typically born by their employer. That is until they get laid off, of course. Then, unless their former employer is extremely altruistic, the newly laid off employee must pay the entire cost to keep their health insurance going plus a 2% administrative fee while they look for a new job.

This ability to continue typically higher quality workplace coverage after a layoff or large reduction in hours is due to the Consolidated Omnibus Budget Reconciliation Act (COBRA), passed by Congress in the mid-80’s.

As you can imagine, COBRA has been extremely helpful for workers who lose their job but it’s costly. The average monthly premium is a couple thousand bucks for a family. That large expense adds to the stress of trying to find a new job, and due to the complexity and cost lots of workers simply go without until they can hopefully restart coverage with a new employer. This lapse in coverage can have major ramifications. Lump that stress on top of job hunting during a pandemic and you’ve teed up a problem for a free-spending Congress to try and solve. While fully addressing the problem would be a major undertaking, Congress at least gave it a band aid within the nearly $2 trillion American Rescue Plan recently signed into law.

I had read about the plan’s COBRA-related provisions when it passed but wanted to share the following Wall Street Journal article with you. The big news is the federal government will foot the premium bill for a while, but an interesting twist is how coverage can be backdated. Typically the worker has a short window to decide to continue their old workplace plan under COBRA, but now they can go back to last March if necessary. A link to the story follows, but I’ve pasted most of it below.

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Quarterly Update

Market performance during the first quarter (Q1) of 2021 is probably best summed up as a transitional phase. We began anew after what was, on balance, a horrendous year for public health and much of our economy. Then increased vaccinations, more relief from Congress, and further reopening across the country helped signal a shift toward a more positive future. Stock investors reacted favorably to this while bond investors were cautious.

The stock market remained solid throughout the quarter as it threw aside performance trends from last year. Small company stocks and various market sectors had underperformed for much of 2020 but a rotation between them, which began late last year, continued into Q1. The result was that small company stocks enjoyed a big runup through about mid-March and handily outperformed their large-cap brethren. Not all returns were positive, however. The bond market struggled as investors digested a seeming disconnect between sanguine inflation guidance from the Federal Reserve and the massive amounts of relief and stimulus money coming from Congress.

Here’s a roundup of how major markets performed during the first quarter:

  • US Large Cap Stocks: up 6.4%
  • US Small Cap Stocks: up 12.9%
  • US Core Bonds: down 2.7%
  • Developed Foreign Markets: up 3.9%
  • Emerging Markets: up 2.4%

Style (e.g. small vs large company) and sector (e.g. energy vs technology) rotation was a main theme during Q1. Some analysts suggested the rotation may have been due to large scale portfolio rebalancing after such a lopsided year as 2020. Whatever the reason, and there were probably many, the performance difference during Q1 was stark when compared to last year. The smallest company stocks that had seen a horrible 2020 were up almost 24% and the largest that had performed so well last year were up a relatively small 6%. Within the various sectors, Energy was the clear outperformer during Q1, up 31%, while Technology, a market darling in 2020, was up only 2%. All told, the S&P 500, the typical measure of the US stock market, closed at an all-time high of 4,000 as the quarter ended.

The transition from a market focused on stay-at-home orders to a more optimistic reopening trend was clear throughout the quarter. This had a negative effect on the bond market, however. Bond investors saw one of their worst quarters since the Global Financial Crisis. The yield on the benchmark 10yr Treasury ended the quarter at about 1.7%, up from early-pandemic lows of half a percent and .9% as 2020 ended. Since bond prices move in the opposite direction of yields, this steep increase in yield led to steep price declines. And the longer the term, the worse the performance. 20+ year Treasuries were down 13%. Intermediate-term Treasurys, the kind more typical to investor portfolios, were down 3-4%.

This transition phase for bonds seemed almost entirely due to the inflation fears of investors here and abroad in countries like Japan. However, those controlling interest rate policy and government spending weren’t (and still aren’t) nearly as concerned. Even though the government seems poised to inject trillions into the economy from the start of the pandemic and over the next several years, Fed Chair Jerome Powell and Treasury Secretary Janet Yellen don’t expect inflation to be a problem. Both speak of the pandemic creating a huge economic hole that we’re still digging our way out of and how stimulus from Congress and work by the Fed are providing backfill. Some excess inflation will even be welcomed, they suggest, as the recovery is allowed time to reach more Americans.

We learned at the end of Q1 that our unemployment rate dropped to 6%, down from almost 15% a year ago. While this should be celebrated, there are still roughly 4 million more unemployed Americans than before Covid. And millions more are either working part-time because their hours have been cut and others are simply detached from the workforce. Additionally, the number of so-called long-term unemployed is stuck at over 4 million people, up substantially from before the pandemic. Powell and Yellen have said they won’t be concerned about inflation until most of these people are back to work. This is expected to take at least a couple years, so money should be cheap and plentiful until then.

Even with all the current challenges and those yet to come, the outlook is brightening (we’ll put our hopeful hats on for a moment). Consumer confidence is higher, housing prices are soaring, the vaccine rollout is moving forward, people seem ready to travel again, and the recently passed $2 trillion American Rescue Plan may be followed by a $2+ trillion infrastructure plan. All this spending will boost the economy for most Americans and should help keep the stock market elevated for a while.

Obviously, there’s lots of risk to this outlook. Nothing is free and no government can spend aggressively for long without creating imbalances (aka bubbles), having to raise taxes, fight inflation, or all three. The stock market will eventually correct because of this and who knows what else, and bond prices will remain in flux as investors sort all this out. But again, the overall situation is showing signs of meaningful improvement. Accordingly, we’ll want to remain focused on fundamentals like diversification and rebalancing as inevitable shifts occur within our portfolios.

Have questions? Ask me. I can help. 

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Shifting Sands

In the past year many of you asked how the stock market could perform so well even as so much seems to be going wrong in the world, how it can seem so detached from reality? The answer depends on one’s perspective since there are lots of ways to think about the question. One way is that there are times when the market is completely mad. The so-called madness of crowds kicks in and greed spurs some investors to willingly put their blinders on to everything other than rising share prices.

This isn’t everyone, of course. When we talk about all the ebbs and flows in the stock and bond markets we’re mostly thinking about active traders, those trying to beat the market, and for some of whom trading stocks is a game. Their collective mood drives much of the day-to-day volatility we see, so keeping tabs on what they’re doing and why is instructive.

As you can imagine, their mood can flip quickly and for no apparent reason. The abruptness of the change sometimes leads to dramatic selloffs when short-term investors sell with the same reckless abandon with which they bought. We saw this a year ago as the Covid shutdown orders caused some investors to literally sell everything, defying all logic and reason. Then many were so shellshocked that they couldn’t get back in and missed the quick recovery. In hindsight, this was a great example of what not to do.

At other times active traders seem to wake up and look around with much clearer eyes. Instead of being detached from reality they’re soberly focused on it. Not the broader reality but the financial and economic.

A good example of this is the shift that’s been taking place in the stock market beginning last Fall. Since the market lows one year ago today, the S&P 500 is up about 75%, a great return, especially given how bad things were back then. It’s been uneven, however. The largest stocks in the S&P were doing the best for about the first six months of the recovery and far outpaced the smallest stocks. The index got so top heavy that at one point five big tech stocks were driving most of the index’s performance.

Then traders started switching their focus from the stay-at-home stocks (such as in the technology sector) to those geared for the re-opening of the economy (like energy, banks, and commercial real estate) and this accelerated into the new year. High-flying “growth” sectors like tech had surged out of the pandemic lows but then gave way to beaten down “value” sectors as the shift accelerated in recent months. The smallest stocks are now up over 60% since early September while the biggest stocks are up only about 5%. This is a major shift, but that it’s occurring within a rising market is a good thing. It implies that investors are paying closer attention to reopening and that the big tech names had probably risen too far too fast.

The following chart from Schwab illustrates this. You’ll see the performance contribution of the top five names until early September when the shift begins and then their contribution wanes.

Something similar has been playing out in the bond market at the same time. Interest rates have been rising as some bond investors have been selling due to growing inflation concerns. The idea is that with so much money moving around the economy, and soon there will be more (and more again with a huge infrastructure package now being worked on), that this is bound to create damaging inflation, or even stagflation (rising prices amid a flagging economy). We haven’t had to deal with an inflation problem for a long time so it’s natural and even wise to be wary, even though these concerns may prove to be unwarranted.

The following chart from Bespoke Investment Group shows the shift in the bond market, beginning with the red dot in the first part of September. (As a reminder, as rates rose in the chart that means bond prices fell.)

That more active investors are processing these sorts of things is good for investors like us because our economy isn’t made up of only one or two sectors. In a healthy market eventually prices in outperforming sectors like Technology have to come back to earth a bit and some attention be paid to the rest of the economy. It makes sense that as more of the country reopens a more diverse range of companies will start being profitable again, not just the likes of Amazon and Apple. Much of these growth expectations are priced into the market currently, but an actual healthy reopening over the next year or two could still be a tailwind propelling growth and value stocks further. Interest rates could continue to rise but, if so, would only be approaching more normal levels.

The last year has taught us many lessons but one from the investing world is how diversification and not following the crowd helps the long-term investor.

Investors like us have been able to ride these shifts with relative ease. We’ve owned both large and small stocks in the growth and value categories and haven’t chased performance during all the volatility. We may lean a little one way or the other, but no big bets either way. We also haven’t made big bets on the direction of interest rates, so bond performance is better than it could have been. Lots of active traders have done the opposite and many, if not most, are probably no better off than we are after all their trading, and some are much worse.

Have questions? Ask me. I can help.

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Bonds Wobble on Inflation Fears

I don’t think it comes as a surprise to anyone to hear that major shifts are happening in our country and economy. People are on the move. Industries are changing. Long-term trends seem to be playing out all at once. These shifts create lots of questions that are hard to answer, and the uncertainty can be uncomfortable, to say the least.

This impacts everyone and even flows over into the normally staid world of bonds. Recent months have seen the stock market rise but prices for bond benchmarks like the 10yr Treasury have fallen. The 10yr Treasury is important to follow because it serves as the benchmark for mortgages and is a good proxy for bond returns in your investment portfolio.

The yield on the 10yr is currently about 1.6%, up almost 1% from the lows of last Spring (as a reminder, yields rise when prices fall). The 10yr yield remained low until late-Summer when it began to rise again before falling prices accelerated in the last month or so. The result is that the average 30yr fixed rate mortgage is now over 3%, following many months below that, and typical bonds within your investment portfolio are probably down around 3% year-to-date. Longer-term Treasurys are down more, almost 12%, and short-term bonds are down too, maybe less than half a percent. This volatility follows strong returns for bonds over the past two years.

So why is this happening to the bond market now? In short, bond investors are struggling with big questions just like the rest of us. How quickly will our economy get back to normal? What will that even look like? How helpful will government stimulus programs be, and will they become problematic by causing inflation?

Bond investors have been reacting to these questions in recent weeks primarily by selling bonds. That selling, as I mentioned, causes yields to rise, mortgage rates to go up, and so forth. The primary culprit is said to be inflation fears. These fears appear to be warranted, at least if you look at things through a short-term lens.

Manufacturing is roaring back to life even as companies deal with material shortages, shipping delays, and higher commodity prices. And Congress seems poised to pass massive amounts of economic stimulus this week that will inject hundreds of billions of additional cash into the economy. Many market prognosticators are assuming that the coming rush of consumer spending could hit supply-constrained manufacturers and lead to, you guessed it, inflation.

An interesting aspect to this, however, is how the government agencies that are supposed to stay up nights worrying about inflation, simply aren’t. Or at least not in the way you might think.

In the past week or so we’ve heard Jerome Powell, the Fed chair, and his predecessor and current Secretary of the Treasury Janet Yellen, express a distinct lack of concern about inflation. The issue, they say, is that our economy is still reeling from the pandemic and has lots of room to absorb all the stimulus money. If you just look at recent months, yes, the economy is growing quickly, and some prices seem inflationary. But that’s growing from the bottom of a deep hole. Instead, if you broaden your comparison to pre-pandemic levels certain sectors of the economy are still struggling, and overall inflation is quite low, currently less than 2%.

Reasons for this come from many places but primarily we see it playing out in our country’s unemployment rate, which is 6% or so. According to Secretary Yellen, however, real unemployment is more like 12% if you define the term more broadly. The bigger picture unemployment rate was about 7% before Covid-19 hit our shores and rose to around 22% last Spring. Yes, 12% is much better than 22% but we still have a way to go before “full employment” is reached. And recent reports indicate that about 40% of the unemployed have been so for over half a year, the so-called long-term unemployed. That’s a lot of people who are losing touch with their respective industries, skillsets, and so forth. Essentially, both Powell and Yellen are staying up nights concerned about those people, not inflation.

Regarding current moves in the bond market, Powell and Yellen seem equally sanguine. The yield on the 10yr Treasury was about 3.2% a lifetime ago in late-2019, so they likely see the recent yield uptick to 1.6% as a step toward normal for bonds.

A takeaway from all this, I think, is that even though we had strong returns last year from stocks and bonds, this year, like we’ve discussed in other posts, is likely to be volatile. This is nothing new for the stock market, but you might be less used to it coming from the typically stable world of bonds. Modestly higher interest rates will take a little pain to reach but will be healthier for the economy in the long run. So, try to take recent bond market volatility in stride as part of an adjustment phase for bonds. Just one more aspect of our lives and economy searching for normal.

Have questions? Ask me. I can help.

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