Brexits 1.0 and 2.0
First, a quick note on “Brexits”: unreal, right? Losing to Iceland to get knocked out of Euro 2016 in the Round of 16? Don’t think the bookies called that one...or the earlier one either, actually. You know, the one 3 days earlier where England voted to leave the European Union? If you looked at the headlines Friday morning and thought the world was going to end, we don’t blame you...but we’d like to point out that it has been a rather non-world-ending week since then.
Be prepared for more headlines to come as this plays out over the next two years. Yes, years. The now-oxymoronic UK needs a new Prime Minister in a couple months, someone who theoretically will actually trigger the clause (Article 50 of the Lisbon Treaty, for those keeping track) to start negotiations for exiting the EU (which, by law, can take up to two years, with the possibility of an extension). And the front-runner, one of the two people who basically engineered the "leave" vote, just dropped out of the race.
Meanwhile, you have seven or eight other countries that will try to get their own national referendum held about EU membership, not to mention Scotland and Northern Ireland trying to break away from the UK so that they can stay in the EU. Phew. That’s a lot of ink yet to be written.
As for how this will affect you personally...two things.
One, expect more volatility going forward. The US market dropped 5% over the Brexit vote weekend (Friday-Monday). Some European markets dropped more than 10% in a day! This doesn’t mean completely change your investment strategy, it just means make sure your strategy is one that you are comfortable sticking with long-term. And two, your vacation to England just got about 10% cheaper on exchange rates alone. Though at this point I can’t in good conscience recommend trying to catch a football match when over there...might as well just play a little footie yourself in the garden.
In the interest of transparency and full disclosure, it was not actually last week’s episode of Last Week Tonight that featured a discussion on retirement plans...it was three or four weeks ago now. But never let facts get in the way of a good title, as they say. Or as somebody has maybe said, once. Possibly inclusive of us, just now.
I’d recommend taking 20 minutes to watch the segment on YouTube or HBO GO or whatever your BitTorrent service du jour is - it is a pretty entertaining and informative look at what is generally a very dry (but important!) topic. We won’t rehash the whole thing for you here, but the segment closes with 5 pieces of advice and a massive domino crushing Kristin Chenoweth, so we will highlight those and share our thoughts.
1. Start saving now (or 10 years ago)
Two words: compound interest. We brought up the Einstein quote in a previous note, but here’s another illustration of just how important this is. Let’s say you save $5,000 a year, and you get a 7% annual return on that investment (that’s higher than we think you’ll actually get over the next decade, but it makes for a better illustration. Also, it’s the return assumption John Oliver uses in the segment.
If you save this $5,000 every year from 35-65, you will have saved $150,000 (30 years x $5,000), but you will actually have $472,304 in your portfolio, thanks to that 7% annual return.
But! If you can start at 25 and save $5,000 every year from 25-65, you will have saved $200,000 (40 years x $5,000), or 33% more than you would have starting 10 years later...but you will actually have $998,176 in your portfolio - that’s over 100% more!
Time definitely works in your favor. It’s a lot easier to start saving early on, even if it seems like just a little bit, than trying to play catch-up later.
2. Low cost index funds
Here at Alidade Wealth we are very conscious of fees - not only how much the funds we invest in cost (expense ratios), but also how much it costs to buy or sell those funds (trading costs). And yes, those are different layers of fees. Index funds cost less than actively managed funds, and that is why prefer to use them in our portfolios. That, and the fact that they also tend to perform better.
Standard and Poor’s (that’s the S&P in “S&P 500”) puts out a semiannual report that looks at actively managed funds’ performance vs. the index they track. Google “SPIVA report” if you want to take a look at the numbers yourself, we won’t bore you with them here. Suffice it to say, last year only three categories out of seventeen (and by “category” we mean large cap, large cap value, mid cap, small cap growth, etc.) had more than 50% of actively managed funds within that category beat the index. Look back five years, and only one category (out of seventeen) had even a 25% chance of any actively managed fund within that category outperforming the index. So...if most of the time your index fund will outperform active management...and you’re paying less to get that outperformance…That seems like close to a no-brainer for us.
But we’ll spin this one around a little bit, because not all retirement plans necessarily offer index funds. It’s important to note that cheapest doesn’t always mean best - after all, about 10-15% of actively managed funds have managed to outperform the index over the last decade. So rather than say “go low-cost”, we’ll say “avoid high-cost”. Research will tell you that the cheapest fund isn’t necessarily always the best choice, but the most expensive fund is almost always not the best choice.
If you have questions about the availability of index funds, or the investment choices in your retirement plan in general, let us know - we’d be happy to help walk you through it.
3. Use a fiduciary
As John Oliver says, the terms “financial analyst” and “financial advisor” don’t actually mean anything. They imply a lot, but there is no actual credentialing required to use those titles. The CERTIFIED FINANCIAL PLANNER™ certification, however, is so regulated that we are technically required to put it in all caps like that, with the ™ superscript, and there is even a list of approved nouns that can be used after it. We wish we were kidding.
As a CFP® practitioner (yes, the ® is mandated, yes “practitioner” is one of the approved nouns), we are bound by a Code of Ethics, Rules of Conduct, and Practice Standards. One of the Rules of Conduct mandates that in any planning engagement we “owe to the client the duty of care of a fiduciary”. Basically, your interests as the client have to come first and foremost.
For us, a big part of that is not receiving any commissions, trails, or any kind of compensation from the products or services that we might recommend. It also includes a component of education, so that you can understand why we are making the recommendations we are, and how that might compare to the other options available to you.
4. Shift investments from stocks to bonds as you age
We’re not entirely on board with this one. It has been investment canon to shift from stocks to bonds as you get older, because presumably bonds are a less risky investment and also presumably you are no longer needing a lot of growth from your investments and instead will be perfectly happy just living off the income stream from the bonds.
But here’s a fun fact: 20% of the global bond market has a negative interest rate right now. Bond prices in the US have been going up for 30 years. You can put your $1M retirement portfolio into 10-year US government bonds and get a grand total of…$14,600 per year in interest right now. How’s that for a budget killer.
There has even been some research recently that suggests a better way to go about things is drastically reduce stock investments when you retire, and then actually increase stock exposure as you age. We’re not on board with that one either (our response to that research is quoted in this article).
Our preferred approach is to shift between stock and bond investments as the markets dictate, and as appropriate given a client’s risk tolerance, coupled with an options-writing strategy to generate income within the portfolio. Not sure what options are or how they work? Ask us! We’d love to tell you about it. In fact, we wouldn't be surprised if they get their own note at some point in the future.
5. Keep fees under 1%
Back to the $5,000 a year example. At 2% fees (the number John Oliver uses), your $1M portfolio (that you got by saving $5,000 a year from age 25 to age 65), is now actually only $572,000.
How realistic are 2% fees? Well, pretty realistic, actually. 1.2% or so is a fairly average rate for financial advisors who are fee-based. And your average actively managed mutual fund fees are about another 1.2%. So that’s...call it 2.5%. Yikes.
We see management fees as the intersection of a Venn diagram incorporating three factors - lowest cost, value added, and services provided. For us, that number comes to 1%. It is below the industry average, which is important to us, yet still feels reasonable considering the active approach we provide (in asset allocation and rebalancing, options writing, and potential tax-loss harvesting).
Is that worth it? Well, that’s for you to decide. Some people will say no, some will say yes based solely on the peace of mind it provides. But what is important to us is that we are transparent about the fees we charge and mindful about keeping them as low as feasible (pun not actually intended for once...but appreciated).
And back to the chart at the beginning of this section briefly - that chart assumes a constant 7% return, and also that your advisor does nothing except buy the same stocks at the beginning of every year and then just skim 2% off the top. If we realistically expect markets to return 2% annually over the next 10 years (which we do), and through our allocation strategy and options writing we can actually deliver, say a 3% return over that same decade, then those 1% fees have paid for themselves!
We often get asked what people should do when starting out in their careers...how much to save for retirement, etc. Get the match from your employer if they offer one. That’s free money. If your company matches 3%, then make sure you’re getting all of that 3%. After that, we understand that it becomes a trade-off between putting money aside for retirement and having money available to invest in yourself and things you like in the nearer-term, such as going back to school or buying a house...or that UK vacation.
We probably wouldn’t recommend pinning your retirement dreams on a beanie babies collection, but we do feel your money should be a means to enjoyment. Canon says put 15% or so away for retirement every year. We say make sure you’re at least getting all of the free money on the table, then come talk to us. Despite all the math in this note, retirement is more than just a number in an account. And life should be more than just trying to get to retirement.
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