Could Black Friday Spark a Rally?

Black Friday sales may be the harbinger of a significant surge in consumer confidence that could fuel our economic recovery. According to the National Retail Federation (NRF), Black Friday retail sales were up 16% over last year. The NRF notes that 226 million shoppers hit the stores and online sales over Thanksgiving weekend and spent $52.4 billion.

In more good news, an NRF pre-holiday poll found that shoppers are more optimistic this year than they were last year. Based on that survey, the NRF forecasted that total holiday sales would be up 2.8% to $465.6 billion. However, the wildly successful Black Friday may result in sales beating that estimate. Interestingly, over the last ten years, we’ve seen a 2.6% annual average increase in holiday spending. However, over the course of the previous decade, the average annual increase was 3.4%.

Retailers have a huge incentive to get you to shop until you drop this season. As the NRF notes, about 20% of their sales occur in the less than 30 days between Black Friday and Christmas. For some retailers, such as jewelers, that percentage could be as high as 40%. To resist the holiday message to spend, spend, spend, think of other economies that stress the merits of saving. Over the past three decades, Germany, France, Austria, Belgium, and Sweden have maintained household saving rates between 10 and 13 percent. Conversely, saving rates in the United States dropped to nearly zero in 2005 before inching up to 5% during the credit crisis of 2008. Most recently, our savings rate has fallen to less than 4%, far less than half of what many Europeans save. Think about that as you head to the mall….

Think Twice About an Indexed Annuity

We all enjoy playing a game we can’t lose, but investing in the stock market is not one of them. However, the promise of “guaranteed returns” led shell-shocked investors to pour nearly $30 billion into index annuities in 2009, even as they pulled $9 billion out of U.S. stock funds.

Index annuities are a close cousin of a traditional deferred fixed annuity, an investment vehicle in which an insurance company invests your money in bonds during an "accumulation period" of seven years and then converts your account into a steady stream of guaranteed income payments. An index annuity has the additional twist of tying those guaranteed payments to the performance of a stock market index, such as the S&P 500.

Guarantees are tempting in the wake of the Great Recession and continued market turbulence, but dangers lurk in the indexed annuity’s structure and fine print. In my view, the top three stumbling blocks are:

• High commissions, up to 9 percent in some cases, that can tempt the selling agents to act against your best interests.
• Steep surrender fees, as high as 20 percent, that can be imposed if you cash out before 10 years.
• Product complexity that makes it tough to know what you are buying.

Beyond those concerns, according to William Reichenstein, an investment management professor at Baylor University, over the long term a very conservative portfolio easily beats an index annuity. Why do indexed annuities almost always underperform? The issuing insurance company caps your return and can adjust the cap each year. A common cap for an annuity tied to the S&P 500 is 4.5 percent. And, according to the research firm Advantage Compendium, for the five years ended in September, the average index annuity paid an annualized 3.89 percent, just slightly better than the 3.81% you would have earned in a five-year CD and less than the 5.1 percent from taxable bond funds.

Finally, please be aware that fixed annuities are often marketed at “informational lunches” that are really over aggressive, high pressure sales pitches. Remember, the old adage “There is no such thing as a free lunch” applies to the market as well.

In Praise of Rebalancing

If buying low and selling high is the secret to investing success, should you buy every time the market drops significantly? Jason Zweig argues convincingly in a Wall Street Journal article that investing during the market’s equivalent of retails’ Black Friday is not a simple path to increased returns. Sure, buying low helps, but how low does the market have to go before you buy? Also, you have to correctly identify how high is high enough to sell.

Zweig correctly identifies rebalancing—selling one asset that has gone up in price to buy another that has gone down—as the key to improving returns over time. Rebalancing works as your portfolio’s GPS. That is, you set your course with your initial asset allocation, but when you encounter roadblocks or the unexpected along your route, the GPS re-calculates your driving directions, or rebalances, to keep you on course to reach your destination.

Zweig quotes research from Francis Kinniry Jr., an investment-strategy analyst at Vanguard Group, that found that, over the past decade, regular rebalancing between stocks and bonds would have added about 0.3 percent in average annual return to a strategy of buying on dips of 2 percent or more. Further, he shares the finding that an investor with 40 percent in U.S. stocks, 20 percent in international stocks and 40 percent in U.S. bonds who rebalanced at year end over the last decade would have earned 5.6 percent annually —versus 4.9 percent for someone who merely bought and held.

Here’s another analogy to underscore the value of rebalancing. It feels great to buy a new car far below the sticker price, but you need to regularly maintain your vehicle for it to serve you well over the long-term. Rebalancing is required maintenance for your portfolio. As I look back on the technology bubble that burst, 9/11 and the financial crisis/Great Recession, our disciplined rebalancing is one of the major reasons our clients have had a better investment experience.

Don't Let Fear Thwart Your Investment Strategies

With Paranormal Activity 3 setting records at the box office, it’s a good time to talk about how fear can impede sound investment decisions. Certainly, the acute market volatility we’ve experienced over the last few years has sparked a growing fear among investors of incurring additional losses. How does this attitude impact your portfolio? Interestingly, a Fidelity survey of participants in workplace retirement plans during the turbulent 18-month period from October 2008 to March 2010 quantifies just how much letting yourself fall into fear’s grips can hurt.

Fidelity found retirement investors who kept contributing to their plan and who maintained some exposure to equities throughout the period were better off throughout the market’s roller coaster ride than those who moved in and out of the market in an attempt to avoid losses. Specifically, the 81,400 who sold all stocks in 2008 had an average return of -6.8 percent over the period. On the other hand, the 7,332,000 who sat tight and kept investing in equities earned an average 21.8 percent over the 18 months.

We tend to retreat during market turbulence because, as behavioral finance pioneers Daniel Kahneman and Amos Tversky have shown, human beings have a stronger preference for avoiding losses than for registering gains.

Recognizing and adjusting for this innate bias may help prevent you from making fear-driven decisions during dark days in the market. Think about your own behavior during past downturns. Did you make any fearful decisions that you now regret? With volatility looking like it’s here to stay, has your risk tolerance changed? If so, it may be necessary to make adjustments to your portfolio. Otherwise, the best advice to keep short-term volatility from prompting emotional fear-based decisions that can negatively impact your portfolio is to stay focused on your long-term goals.

As Benjamin Graham, a pioneer in security analysis said, “Individuals who cannot master their emotions are ill-suited to profit from the investment process.” As our clients' trusted advisor, it’s our job to help minimize the impact of inescapable emotional swings and maintain disciplined investing.

Stick with Stocks

Many investors believe step one in dialing down their portfolio’s risk should be reducing equity exposure. Yes, stocks are riskier than bonds, but that’s an oversimplification that can result in some misguided moves. First, stocks provide a greater return than bonds over the long term According to Standard & Poor’s, the S&P 500 Index has had an average annual return of 9.9 percent annually from 1926 to 2010. Over the past 50 years, it’s returned 9.8 percent, and over the past 25 years, the return has been 9.9 percent. According to Ibbotson Associates, long-term government bonds have averaged 5.5 percent, 7.1 percent, and 8.9 percent during these same three time periods.

Stocks are also a better hedge against inflation. On an inflation-adjusted basis, the S&P 500 Index has provided average annual returns of 6.7 percent from 1926 to 2010, 5.4 percent over the past 50 years, and 6.9 percent over the past 25 years. There were a total of 10 rolling-year periods when the S&P 500 Index did not keep up with inflation. While long-term government bonds provided inflation-adjusted returns of 2.4 percent, 2.9 percent, and 5.9 percent over those same three periods, there were 33 rolling-year periods when long-term government bonds did not keep up with inflation. One factor influencing the gap between stocks and bonds is that, even in difficult markets, companies can increase their prices to remain competitive.

If you want another reason to invest in equities, consider this prediction by Professor Sylla, a financial historian at New York University's Stern School of Business who has studied market behavior all the way back to 1790. A recent Wall Street Journal article--A Long-Term Case for Stocks--reported his view that if the market sticks to its long-term pattern, the Dow Jones Industrial Average could climb to 20250 by the end of 2020, up 84% from its recent 10992. Additionally, he says the Standard & Poor's 500-stock index might hit 2300, up 99% from its recent close of 1154.23.

Using 10-year averages of annual market returns, including dividends and adjusting for inflation, Prof. Sylla found when 10-year-average annual returns drop below 5% as they did in 2008 and 2009, markets tend to transition to recovery.

Of course, we all know that past results cannot be used to guarantee future returns…

The real lesson in this research is that investors are best served when they take a long-term view of the market and think in terms of decades and years, not quarters.

BofA's Move Increases Brokers' Conflict of Interest

When Bank of America management decided to relieve Sallie Krawcheck of her duties as head of Bank of America’s wealth management division, they put more than 16,000 Merrill Lynch brokers in the hands of a new boss who presumably has a different corporate agenda. It’s expected that David Darnell, who hails from the banking side of B of America, will likely spearhead a renewed effort on the part of the nation's largest bank to further integrate Merrill Lynch and encourage its brokers to cross-sell more bank products.

This initiative for brokers at Bank of America Merrill Lynch clearly illustrates the conflicts of interest that brokers operate under. However, remember that anyone who is a registered representative of a broker/dealer also has a conflict of interest. Also, an advisor who is dually registered with a broker/dealer and RIA still is not a full-time fiduciary.

Bernhardt Wealth Management is a registered investment advisor and a fiduciary. That means we always put our clients’ interests ahead of our own -- in all cases. To fully appreciate the role and responsibilities of a fiduciary, we return to its Latin roots: fides, meaning faith, and fiducia, meaning trust or confidence. Traced back to English Common Law, fiduciary describes a person who holds a position of great trust. Most often, a fiduciary would administer trusts or handle the conveyance of property. Particularly in today’s complex and challenging market, you deserve nothing less than a fiduciary.

To determine if the advisor you work with is a fiduciary, consult the National Assocation of Personal Financial Advisor's “Fiduciary Questionnaire.”

Is Social Security a Ponzi Scheme?

Governor Perry generated quite a stir during a recent Republican debate when he referred to Social Security as a Ponzi scheme. According to Governor Perry, Social Security is a “monstrous lie…a Ponzi scheme to tell our kids that are 25 or 30 years old today you're paying into a program that's going to be there."

We can debate how long Social Security can remain solvent, but it is not a Ponzi scheme. In fact, this article in the New York Times offers details on just how Social Security differs from a Ponzi scheme.

That said, we all know there’s plenty about Social Security that needs fixing. Simply, last year Social Security began paying out more in benefits than it received in taxes. And as more Boomers retire, that shortfall is expected to grow, especially given high unemployment rates. The New York Times article points to the nonpartisan Congressional Budget Office’s estimate that the combined Social Security trust funds would be exhausted in 2038. However, a number of steps could keep the program afloat. Washington could choose to increase taxes, reduce benefits by raising the retirement age, or reduce cost-of-living increases. Of course, none of these options will be popular with voters, so it remains to see what our elected officials who often are more concerned with keeping their jobs than with attacking our nation’s most serious problems will do. If the debt ceiling debates are any indication, we could be in for a rough ride on the way to Social Security reform.

Celebrating the Spirit of Volunteerism

After my niece, Dorothy, graduated from high school this year, she spent the summer with me. She did some work in my office, and we spent very enjoyable weekends sightseeing in the D.C. area. After a tour of Mount Vernon one Saturday, we had the pleasure of having a conversation over lunch with a couple--Don and Virginia--who had recently retired.  They sold their home in Texas and travel the country in their trailer.

However, the most unique element to their new lives is that they spend three months at a time in different parts of the country volunteering at various U.S. Fish & Wildlife Service locations. When they take a break from these rewarding volunteer commitments, they may take a cruise; schedule a visit with their kids and grandkids, or see another part of the country. They love their new lifestyle. They use Volunteer.gov to apply to various locations from Alaska to Florida and from California to Maine.

We’ve all heard the expression, “Put your money where your mouth is,” and American’s certainly do that. According to the recently released Giving USA 2011: The Annual Report, Americans donated 2 percent of their disposable personal income to charitable causes in 2010, amounting to $290.89 billion. This was an increase over 2009 and two years of declines during the Great Recession. However, it must be especially gratifying in retirement to so actively contribute to the causes you have long supported financially like Don and Virginia--our new friends from Mount Vernon.  You can see a photo of Don, Virginia and Dorothy below.

Debating Tax Reform

“Warren Buffett’s secretary shouldn’t pay a higher tax rate than Warren Buffett. There is no justification for it,” declared President Obama when he announced his deficit-reduction plan. “It is wrong that in the United States of America, a teacher or a nurse or a construction worker who earns $50,000 should pay higher tax rates than somebody pulling in $50 million.”

The President’s reference to the Oracle of Omaha was a response to Buffett’s recent editorial in the New York Times where he noted that the tax rate he paid last year was lower than that paid by any of the other 20 people in his office – and suggested that the rich should pay more in taxes.

In an interview with ABC’s Christiane Amanpour, Buffett clarified his views further when responding to her question on whether the wealthy need tax cuts to increase business activity and further economic growth. Said Buffett, “The rich are always going to say that, you know, 'Just give us more money, and we'll go out and spend more, and then it will all trickle down to the rest of you. But that has not worked the last 10 years, and I hope the American public is catching on.”

Is the middle class paying more in taxes than millionaires? Remember, election season is heating up, so it’s worth doing some fact checking. According to data from the IRS quoted by the New York Times, in 2009, 1,470 households filed tax returns with incomes above $1 million yet paid no federal income tax. However, that's less than 1 percent of the nearly 237,000 returns with incomes above $1 million. This year, those millionaires are expected to pay an average of 29.1 percent of their income in federal taxes, according to the Tax Policy Center. Households making between $50,000 and $75,000 will pay an average of 15 percent of their income in federal taxes.

Yet, projections are just that. Taxes are determined based on where income comes from. Wages are taxed higher than capital gains, for example. Additionally, the tax code is riddled with deductions, exemptions and credits.

As the quest for the White House continues, I’m sure we’ll see tax figures spun a dozen different ways. Certainly, the debate over the “Buffett rule”--that suggests that people making more than $1 million a year should pay a larger percentage of their income in taxes than middle-class families pay--will continue. But it seems to me true tax reform will be a little more complicated than that.

Diversification, Diversification, Diversification

In their well-known and oft-quoted 1986 study of 91 large pension plans, “Determinants of Portfolio Performance,” published in the Financial Analysts Journal, Gary P. Brinson, L. Randolph Hood and Gilbert L. Beebower found 94% of portfolio returns were determined by the asset allocation plan and just 6% attributable to market timing and security selection. Interestingly, however, most individual investors spend little time constructing an appropriate asset allocation plan. Rather than determining the ideal percentage to invest in stocks, bonds, and cash and spreading assets among various sub asset classes, most investors look for the hot stock. This return chasing results in portfolios that are overly concentrated in specific stocks or funds, which increases overall risk.

In Are stocks a loser's bet? another industry influential, William J. Bernstein, quotes research from Dimensional Fund Advisors that found that from 1980 to 2008, the top-performing 25% of stocks were responsible for all the gains in the broad market, as represented by the University of Chicago's Center for Research in Security Prices (CRSP) database of the U.S. total stock market.  So why not invest in only those carefully chosen "superstocks?"  Bernstein’s answer, “Simple: Because a portfolio of 'carefully chosen' equities could easily wind up with none of the best-performing stocks in the market - and thus produce flat or negative returns over many years. Missing out on even a handful of superstocks can leave you short of your target.”

Bernstein notes further that if you missed out entirely on the top 10% performers from 1980 to 2008, you would have cut your annual returns to 6.6% from 10.4%. How does translate into dollars? Bernstein says, “A $100,000 investment in 1980 would have grown to $1.8 million by 2008 at 10.4%. That same amount, at 6.6%, would have grown to only $640,000.” That’s quite a difference.

Here’s the bottom line: It is not worth risking your family’s financial security by speculating on a few stocks, no matter how carefully chose or how much inside insight you think you have. Think of your mother’s advice. “Don’t put all your eggs in one basket.” Spreading your money between stocks, bonds, and cash--asset classes that historically have responded differently to market conditions--is your best defense against being hurt by poor performance in any one asset class. As you see from the Callan Periodic Table of Investment Returns, one asset class never stays at the top or bottom forever. History teaches us that, like a seesaw, as some investments decline, others rise to offset those losses.

Our clients don’t expect us to help them outperform the stock market. Rather, they want our help to develop a plan pay for college, or maintain their lifestyle in retirement, or achieve other important goals. The best way to do this is to invest each client's money in a globally diversified portfolio based upon their goals and risk tolerance.  This does not mean they will never have losses but it is the best way to ensure they get the market return rather than hoping someone can identify the year’s top stocks for their portfolios.