Reflections From the Trail

Many of you know that I like to run and that my event of choice is the ultramarathon. Whether it’s in the Sierras or our local hills and valleys, I’ve been running ultras for five years or so and have seen some beautiful scenery and had lots of time for reflection along the way. This past weekend was no exception.

On Saturday I ran the Napa Valley 50k, a 31-mile race beginning in Calistoga. The course wound its way up through the wild flowers and rock spires of the Palisades Trail before eventually turning around at the top of Mount St Helena and heading back to town. The race exemplified the rugged beauty and difficult terrain I’ve come to associate with ultras.

This was my third time running the race. I keep coming back for several reasons, but primarily it’s a time to appreciate my surroundings, be grateful for the good health that carried me through, and the periods of solitude. While the race is run with hundreds of other people, the nature of the terrain often means long stretches by yourself. It’s a good time to think.

It may seem strange, but I often think about my clients during these times. I think about their plans, the markets and the economy. I also reflect on how similar ultrarunning is to planning for retirement.

We’ve all heard about the importance of pacing ourselves. Maybe it’s working too hard for too long or eating and drinking too much. We tend to know intuitively how much we can handle, but it can be difficult to reset and slow down before we run into trouble. This week I thought I’d expand on this a bit with some reflections on the art of pacing, both in a long race and when planning for, and living in, retirement.

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The Good, the Bad and the Ugly

Even though we’re surrounded by debt in our day-to-day lives, it’s not all created equal. We can leverage debt to our benefit, but it can also get away from us if we’re not careful. And the more debt we carry the less likely we are to be financially successful over the long-term. So, it pays to understand that there are three kinds of debt: The Good, the Bad and the Ugly.

The Good - Yes, there is such a thing as good debt. To be considered “good”, the debt should have been used to purchase something of long-term value (like a home, perhaps a car), have a fixed interest rate and a straightforward repayment plan.

A 30yr mortgage on your primary residence is a perfect example. If your credit score is good and you have a decent job you should be able to borrow at a reasonable interest rate. Your property taxes and home insurance would likely rise over time, but your monthly principal and interest payments would be fixed, based on a set schedule. This creates certainty in an often otherwise uncertain financial world.

Since what you’re buying is a tangible item that could be reclaimed by the lender if you default, interest rates are comparatively low. The average 30yr mortgage rate is 4.2% currently. If we think about the longer-term inflation rate being 2+% and interest rates rising in the future, the cost of your loan today could become cheaper purely from the passage of time. This is the opposite of an adjustable-rate loan in a rising rate environment, but we’ll get to that next.

Refinanced student loans can also fall into this “good debt” category if they have fixed terms and helped you to get into your current career. As a bonus, interest on good debts like home mortgages and student loans can be tax deductible, which helps with affordability.

The Bad - Debt is considered “bad” when it didn’t help you buy something of lasting value and if it doesn’t come with a fixed rate and straightforward repayment schedule. This means anything “adjustable”, such as interest rates that can change (we’re mostly concerned with them going up from current low levels) over time.

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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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Is Indexing Bad for Markets?

Index funds have been making the news lately but for the wrong reasons. Some commentators speculate that the rise of “indexing” as an investment approach might be casting too wide a net and is harmful to markets. The idea is that index investors “blindly” buy the performance of markets without paying attention to underlying fundamentals. This can lead investors to overpay for poorly performing companies that happen to be in the index and also to drive up prices for the “big” stocks like Apple, Amazon and Microsoft.

While this makes sense in theory, rest assured that we’re not blindly doing anything and that markets are healthy, even with the rise of indexing. This is confirmed in the following essay from Dimensional Funds. I’ve pared down the original to get to the core ideas. The language is a bit wonky but it’s worth a quick read. If you have any questions about how we use index funds and ETFs in your portfolio, please don’t hesitate to ask. Now on to the article…

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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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