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May 2019 Newsletter (cont.)

Well, the markets finally moved on news not related to interest rates or the Federal Reserve for the first time in a while.  Last week it was trade negotiations with China which surfaced as the subject of investor attention.  However, last week also included a few favorable earnings announcements, which helped the markets recover a bit.  

The Trump administration has taken a hard stance with China, and the result has been a tit-for-tat between the two sides.  Needless to say, no one wants a full-blown trade war, but leaders from both countries must play to their respective bases, and this has seemed to exacerbate emotions.   As renowned “Bond King” Jeffrey Gundlach characterized the recent trade talks: “You have one immeasurable force meeting an immovable object.”  Clearly, for any successful deal, both parties will have to make concessions; however, both Trump and President Xi cannot afford to lose face with their constituents, adding to the already high stakes.

It seems that we are in an environment where on any given “tweet,” the market is now apt to move a few percent in either direction.  [A cynic might conclude that any time the markets sell off, a positive tweet or comment on trade mysteriously appears to stem the slide!] 

But, as mentioned, recent corporate earnings—which are really the most important factor to the markets—have been OK; and, as important, company outlooks have been good enough, making it easier for investors to look past the China situation.

To us, volatile markets are times to consider rebalancing portfolios and present opportunities to “upgrade the quality of a portfolio.” What this means is that when markets sell off sharply, usually everything sells off hard and therein lies the opportunity---better prices to buy higher quality securities during volatile markets. 

Buffett/Berkshire Underperformed? How Dare He!

In a show of the times, there was a recent Wall Street article that highlighted the fact that the performance of Warren Buffet’s company, Berkshire Hathaway, has lagged the S&P 500.  In fact, the author illustrates that Buffet’s performance has trailed, not only this year, but over the last decade.  Admittedly, 10 years is not an insignificant period of time and taken out of context, this fact might have people questioning Buffet’s strategy and his success.

For a second, let’s put aside the fact that Berkshire Hathaway has actually outperformed the S&P 500 when looked at over a much longer period and by a huge margin (over 10% per year).   And never mind that the cash flow or income generated by Berkshire is massive, often generating hundreds of millions of free cash flow per year which allows him to be patient and find good bargains.  [To be fair, both facts were listed in the article.]

Instead, we should focus on the quality of his returns over the last decade and what that should represent to any rational investor.  And we should call it what it was:  a tremendously solid investment.  

Today, rather than concentrate on a strategy that will meet their financial goals, too many investors are intent on thinking they can beat or match the S&P 500 or some other random index.  At best, this can lead an investor to be perpetually unhappy, and at worst, it can lead them to making big mistakes that will derail a successful retirement plan.

Most likely, any investor who measures success or failure by benchmarking against any arbitrary index, such as the S&P 500, will end up being severely disappointed AND experience a flawed retirement plan. Again, it’s easy to want to benchmark against the S&P during a decade when the S&P has been the clear winner (Remember hindsight is always 20/20!).

But how many investors-- especially retirees!!-- want to benchmark to the S&P during a bear market? Would a retiree with $2 million (benchmarked to the S&P) calmly watch their portfolio decline to $1 million or less---as it would have in either of the last two bear markets? Probably not.

So instead of comparing the Berkshire investment to the S&P 500, the better or more important question should be: “Would an investment in Berkshire have helped an investors’ chances in achieving their financial goals?”  The answer is:  absolutely.

Investors need to design a plan that will afford them the adequate returns to meet their objectives.   The portfolio should be a means to an end, not the other way around. The mere fact that Buffett had to actually defend his performance at his annual meeting is actually just startling.

Mutual Fund Share Classes in 401k Plans Can Be Elusive

If you’ve ever compared the expense ratio for funds in a 401k versus an outside brokerage account, you might be surprised to see a wider variance than you would expect.  Virtually every investment (passive or active) has its own operational fees which it will pass through to investors (i.e. expense ratio).   While the expense ratios for actively-managed funds depend on the size of the fund and the share class, it is not uncommon to see these fees over 1% to even in excess of 2%.  While we have come to expect this from actively-managed mutual funds, private funds, hedge funds, etc., we do not expect to see it with index funds.

The massive shift by investors to passive funds from actively managed ones revolved largely around fees.   It has become clear to most investors that holding a mutual fund that has a low expense ratio, for example an index fund or an ETF, is more advantageous than one being directed by a fund manager.  And often the performance in these low-cost index funds is actually BETTER than their actively-managed counterparts.

However, investors need to be aware that not all index funds share the same low fees.  For instance, index funds in a retirement plan may be much higher than ones you can purchase in a typical retail account.  The difference in expenses may not seem to be significant, but the difference in return outcomes will be.

The bottom line, investors need to conscious of the underlying fees in any investment.  And for those who participate in 401k plans, it is important to assess the expense ratios of the funds being used in the plan options.  Certain costs, such as advisor fees and record-keeping costs, may be covered by how much each fund charges, but often it may be more efficient to have those fees separated and your investment costs made as low as possible.

And if your plan does not allow for lower expense ratio funds, then it may be prudent to allocate away from those funds in the 401k, concentrate on the those that do have lower expenses and, if possible, invest outside funds, such as those in an IRA, where you can access less expensive options.

ROTH 401K’s

Currently, fewer than 15% of workers who have access to a ROTH 401k are contributing to it! This is disappointing news; investors may be missing out on an excellent savings vehicle. ROTH 401k’s are different from ROTH IRA’s though, and it is of course important to understand the difference between them and how they may fit into your financial plan.  Personal financial planning is done on a case by case basis, but for the most part we have usually recommended for our clients to take advantage of either a ROTH 401k or ROTH IRA, or both.  In a perfect world, we strive to have every one of our clients approach retirement with at least one of these accounts. Let us know if we can help in this area…

With the school year now over and our older children starting summer jobs, don’t forget about thinking about ROTH IRA’s for them. This is just another fantastic planning tip that not enough investors take advantage of! I had my 19-year old son fund his first ROTH; he has no idea how much this will benefit him years down the road. We are also helping another client’s daughter who is just starting out fund her first ROTH IRA. It’s such a powerful planning technique and yet so simple.

Validation For The RIA Business? 

We have long thought the Registered Investment Advisor Business is best positioned to serve investors. RIA’s, like NCM Capital, can be independent, fee-only, fiduciary advisors held to a higher standard than traditional brokers.  Well, it turns out that one of Wall Street’s most storied firms, Goldman Sachs, also likes this business.

Goldman just announced that they are buying United Capital Partners for $750 million. United is an “aggregator” in the RIA space, which simply means they have rolled up 220 advisory firms with $25 billion in assets into their firm. Now Goldman owns them all.

It will be interesting to see how this deal plays out in the industry and how it forces others to act. Will there be a culture clash with a traditional Wall Street broker pared with independent advisors? Practically speaking, this can be a difficult, if not challenging, match.  For example, what will be the reaction of the end clients? Those individuals who decide to work with an independent firm usually do so for the transparency, fee-only nature and fiduciary obligations of that advisor. How will they feel about Goldman now being the parent owner? It is possible that these firms may lose some of their true independence over time now that Goldman is involved.  The financial services industry is very quickly changing…

A wonderful Memorial Day Weekend to you all.

All the best,