Quarterly Update

In stark contrast to December’s losses and Q4 2018 in general, the first quarter of this year saw a sharp rally for stocks during January and February. This was largely a snapback from oversold conditions that carried stocks through several economic concerns, severe weather around the country, and the longest government shutdown in history. Stocks started to taper off a bit during the latter half of March before finishing the quarter strong.

The S&P 500 ended up almost 14% year-to-date in a rally that began the day after Christmas. Foreign stocks also staged a comeback following poor performance for all of 2018, with Developed and Emerging markets each ending the quarter higher by about 10%.

Here’s a summary of how major market indexes ended the quarter:

  • S&P 500: up 13.7%
  • Dow Jones: up 11.8%
  • Russell 2000 (small company stocks): up 14.6%
  • MSCI EAFE (foreign stocks): up 10.1%
  • MSCI EM (emerging markets): up 10%
  • U.S. Aggregate Bonds: up 2.9%
  • Municipal Bonds: up 3.2%

Top sectors during the Q1 rally included those that had been hit hardest during the Q4 rout, such as Technology and Energy, up about 20% and 16%, respectively. The worst performing sector was Healthcare, up almost 7%, which was relatively low but understandable after having held up well during Q4. Oil was up big during Q1, with West Texas Intermediate (the U.S. crude benchmark) rising about 30% to $60 per barrel.

In foreign markets, Chinese stocks were up about 31% after a dismal 2018. Trade headlines and concerns about slowing economic growth had caused China’s local stock markets to decline precipitously last year. This reversed course during Q1 as trade tensions eased somewhat.

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Final Two Terms

Before we begin, if you’re reading this in your email and see “Anonymous” as the author, that’s due to a system issue I’m still working to resolve. Or, maybe it’s just a cool pseudonym and I’ll keep it…

This week we’re closing out our review of financial terms with savings account and credit union, two terms that just about everybody should understand. But interestingly, about a quarter of those Americans polled by YouGov are unsure of what a credit union is and 12% say they’re unfamiliar or “not confident” about what savings accounts are. I wonder if these folks really don’t know about savings accounts, or if they’re just uncomfortable about what they have saved. Could be both, I guess.

Hopefully you know what a savings account is, so I’m going to “define” the term a little differently.

Savings Account – We have the Europeans to thank for coming up with the concept of savings banks back in the 1700’s, in countries such as France, Britain and Germany. According to Wikipedia, the first chartered savings bank in the US was in Boston, right at the turn of the 19th century. These banks were intended to bring the concept of saving money to the masses. One could deposit money into an account and the bank was responsible for keeping that money safe and would pay a small amount of interest on the deposits while doing so. This basic idea hasn’t changed.

But there are still many for whom this concept is foreign. Bankrate publishes a monthly survey of consumers and about 1 in 5 Americans say they’re not saving any money for retirement or for general purposes either. The main reason, apparently, is that their expenses are too high. Many also say they just haven’t gotten around to it yet. Bankrate determined that the average American spends almost $3,000 per year on stuff like takeout food, lattes and lottery tickets. This same consumer is probably spending close to half of their pay on housing, so that soaks up cash as well. But couldn’t some of that money be saved instead? I guess if someone is pinning their hopes on the lottery, a blasé savings account makes it tough to get interested.

Whatever one’s reasons for not saving, the bottom line is that there is no good excuse for not depositing at least something into some sort of savings account on a regular basis. You want to create muscle memory for saving, so the amount matters less than the repetition. And it should start young. Research shows that our relationship with money is often formed at a young age so getting used to saving early can only lead to good things down the road.

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401(k)'s, Principal and APR

Before we begin, if you’re reading this in your email and see “Anonymous” as the author, that’s due to a system issue I’m working to resolve. Until then, please understand that it’s still just me…

We’re getting close to the end of the list of finance terms Americans were recently polled about by YouGov. We started with terms like “index fund” and “amortization”, which relatively few folks were comfortable with. Now we’re into terms like 401(k), principal, and APR. Each is approaching the point where almost 2/3rds of us are familiar with the terms. How well do you know them? Read on for a brief explainer for each, from the perspective of your humble financial planner.

401(k) – Beware of unintended consequences. Back in 1978 Congress inadvertently created the 401(k) plan that we know today. Interestingly, the obscure section of the tax code was never intended to become the primary retirement savings vehicle for American workers. But it did and the rest, as they say, is history.

Before ‘78, a good chunk of workers had a traditional “defined benefit” pension plan. You’d work for a company for many years and each year the company would make contributions on your behalf to a general pension fund. This was (and still is) regulated by the government and the company would have to show, based on accepted criteria, how close the plan was to being “fully funded”. The company then had the responsibility of managing the fund’s investments so that it could meet its current and future pension obligations to retirees. While this was great for workers who could rely on a stable retirement without having to do much more than cash checks, it was incredibly expensive and risky for the employer.

This fundamental tension ultimately led to the small provision in the tax code being leveraged into the retirement-savings juggernaut we know today. Also known as a “defined contribution plan” because workers decide to make their own contributions, 401(k) plan balances currently amount to roughly $5 trillion. But this isn’t a replacement for traditional pensions, not by a long shot. Only about 53% of workers have a 401(k) available and a third have no plan at all. For those workers with a 401(k), the typical balance at Fidelity, for example, the largest company in this space, is about $25,000.

For all the perceived benefits for workers (pre-tax savings, funding flexibility, making personal investment decisions, etc), many experts, including those who started the 401(k)-ball rolling, regret what their creation has become. Why? Because the 401(k) structure transfers the risk and funding burdens from the employer to the employee, who is generally unprepared to take it on. This benefits employers but leaves many Americans woefully unprepared for retirement, even if they don’t currently realize it.

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Exits and Inversions

The last few weeks have seen uncertainty rearing its ugly head yet again in geopolitics and the financial markets. In Britain it was heightened disfunction related to looming Brexit deadlines. Here at home it was the yield curve and recession fears. Since the past few days have seem some notable headlines on both issues, let’s take a few minutes to review and discuss potential investment implications.

Brexit – Britain’s exit from the EU, as you’ll recall, was the result of a 2016 referendum in the U.K. asking a simple question: “Should the United Kingdom remain a member of the European Union or leave the European Union?” A political melee ensued and led to the so-called “Leavers” beating out the “Remainers”, largely on geographic and socio-economic lines. For the better part of three years now, the Prime Minister and parliament have been scrambling to figure out how to accommodate the will of the people without torpedoing their economy in the process.

The original deadline to leave the EU was this coming Thursday. With no deal in sight late last week an extension was granted by the EU, but only for two weeks until April 12th. The primary concerns about the whole process center on a seeming lack of political will and ability on the part of the prime minister and members of parliament to build consensus.

As I write this, members of parliament are actively trying to work around the prime minister to come up with their own exit deal. If they can, the EU has said it would lengthen the extension to May 22nd. Will that be enough time, given they’ve had over 1,000 days to get a deal done?

According to various analysts, the three most likely outcomes at this point are that 1) the U.K. hammers out a deal that few people are happy with but is acceptable to the EU, or 2) can’t come up with a deal and enters a so-called “Hard Brexit” by leaving without a plan, or 3) decides to put the kibosh on the whole Brexit process, perhaps sending the issue back to voters who, presumably, would vote to “Remain” simply to stop the political merry-go-round.

Whatever ultimately happens is unlikely to have much direct impact on the U.S. but is bound to roil financial markets. Does this mean we should sell investments now and run for cover? No. It means being mentally prepared for an uncertainty-induced short-term spike in volatility that markets would likely quickly recover from. Also, and all kidding aside, it’s a good time to remind ourselves that for all our political issues here at home, at least we’re not in the U.K.

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The Net Worth Trio

Before we begin, if you’re reading this in your email and see “Anonymous” as the author, that’s due to a system issue I’m working to resolve. Until then, please understand that it’s still just me…

Here are three more finance terms from the YouGov poll we’ve been reviewing in recent weeks: Assets, Liabilities, and Net Worth. These terms are so fundamental that they can be easily overlooked. But as with most financial jargon, ignorance is not bliss and misunderstanding these terms can cause you all sorts of problems.

Here are my brief definitions for each, understanding that the actual definitions go well beyond what I make room for in these posts. For example, we can think of our personal relationships or education as “assets”, but let’s stick to definitions from the realm of personal finance.

Assets – Think about assets as the physical stuff we own that could be sold for cash reasonably fast. But while you could sell literally everything you own and walk away with cash and the shirt on your back, how likely is that? Not very, so we tend to think about the value of more specific assets, such as the home we own, our car, investment accounts, maybe collectibles like artwork, jewelry, guitars, or even Beanie Babies (hey, they’re worth a lot these days…).

Where do the values come from? The internet makes it easy to value most assets. While it’s an imperfect tool, I like to use the “Zestimate” from Zillow for home values. Bank and investment account values can come from each company’s website, so that’s straightforward. But how to value the antique Hummel figurines left to you by your great-aunt? The internet can probably assist there too. Remember, we’re trying to value what our assets would likely sell for now, so go with the best number available.

List your assets and the current or expected rate of return for each. If the rate of return is too hard to quantify, instead list whether the asset is expected to appreciate or depreciate. Then total up the values and make note of the amount on a piece of paper.

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Fixed-Rate Mortgages, Recession and Stocks

This week let’s get back to defining common financial terms. As in prior weeks, we’re working our way up the list of terms YouGov polled Americans about. You may know about these terms already, but hopefully this post can add a little extra to your body of knowledge.  

Fixed-Rate Mortgage – There are different schools of thought regarding mortgages, but I’ll come right out and state my bias toward the fixed-rate variety. To me, having a fixed interest rate, a fixed term, and a fixed monthly principal and interest payment is the best way to borrow.

Yes, you could leverage an adjustable rate if you thought rates would go down as this would lower your borrowing costs. Perhaps you’re planning to live in your home for only a few years. You could opt for a fixed rate for a that timeframe, say three or five years, and then the mortgage starts adjusting right about the time you’re planning to sell.

Adjustable-rate mortgages can also offer a cheaper entry point, but nothing is free. Again, when I think about a huge purchase such as a house, I want the sense of security that comes from a straightforward fixed-rate loan. I don’t want to gamble.

Another aspect of why I favor fixed-rate mortgages is that we’ve been in a period of declining interest rates for over 30 years. Back in 1981, for example, the average 30yr loan cost over 18%! Currently we’re at about 4.4%. And rates this low will seem oh-so-cheap if (or when?) we move back toward the longer-term average of about 8%. In other words, long-term money is still cheap to borrow so I don’t think there’s much benefit in getting overly creative.

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