(Tax loss) Harvest Season is Almost Here!

The kids are back in school, the leaves are changing colors, and pumpkin spice lattes – the age-old harbingers of harvest season – are everywhere. At Parsec, we are preparing for the harvest…of tax losses.

Every year, beginning in late October/early November, Parsec’s portfolio managers will scour clients’ taxable accounts for meaningful losses, which we can use to offset realized gains created from trading throughout the year. These tax-efficient trading strategies provide value to clients by minimizing their tax burden while keeping the portfolio aligned with their financial planning goals.

You might see trades from one security into another one that is similar, but not exactly the same – we do this so that you can recognize a loss while maintaining exposure to the same industry or sector, yet avoid incurring a wash sale. According to IRS publication 550, “a wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale, you buy substantially identical stock or securities,” either in the same account or in another household account, including IRAs and Roth IRAs. Stocks of different companies in the same industry are not considered “substantially identical,” nor are ETFs that track the same sector but are managed by different companies (like a Vanguard Emerging Markets ETF vs. an iShares Emerging Markets ETF).

Sometimes it makes sense to place a loss-harvesting trade and leave the proceeds in cash for 31 days, then repurchase the same security. We may do this for clients who have cash needs during the holiday season, with the intention of placing rebalancing trades in January when there is no more need for liquidity. When liquidity is not an issue, however, we prefer to keep the funds fully invested in another high-quality name. We may later choose to reverse the trade, once the wash sale period has expired, or we may leave the trade in place if we think it is appropriate and suits the clients’ needs.

Sarah DerGarabedian, CFA
Director of Portfolio Management

 

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What does a Weaker U.S. Dollar Mean for Companies & Consumers?

Earlier this year the U.S. dollar reached a 10-year high compared to the currencies of its major trading partners*.  However, the greenback has declined about 8% year-to-date through July.  In this email we’ll explore what drove the U.S. dollar to record levels, how dollar weakness or strength impacts corporations and consumers, and what may lie ahead for the world’s most widely-held currency.

Many factors affect a currency’s strength or weakness.  Some of these include interest rate levels, inflation, central bank policy, investor sentiment and the health of the economy.  The U.S. dollar is unique in that it is the largest foreign exchange reserve, accounting for over 60% of global reserves.  As a result, other countries’ need for reserves and investors’ fears or confidence also affect how much the dollar appreciates or depreciates.

Following the financial crisis, the U.S. dollar appreciated versus many other currencies due to its perceived safety and ultimately, a quicker U.S. economic recovery compared to its peers.  This happened despite the Federal Reserve’s ultra-accommodative monetary policy in which it pumped trillions of dollars into the economy – an action that might normally depreciate the dollar due to an increased currency supply.  Instead, the Fed’s actions helped lead the U.S. economy out of the financial crisis which helped support corporate earnings and sales growth.  This in turn led to increased foreign demand for U.S. stocks and bonds.  As U.S. dollars are required to purchase our stocks and bonds, growing foreign investment in U.S. securities led to greater demand for the greenback, and subsequent dollar appreciation.

During the last ten years of dollar appreciation, we’ve experienced both positive and negative effects.  On the positive side, a strong dollar makes traveling abroad more affordable for U.S. citizens and effectively lowers the prices consumers pay for imports.  As consumers account for roughly two-thirds of U.S. GDP growth, the savings gained on lower-cost imports due to a strong dollar can lead to significant gains in disposable income, all else being equal.

On the downside, a strong dollar may hinder tourism in the U.S. and could result in weakened demand for U.S. exports as those goods become relatively more expensive for foreigners.  Another drawback is negative foreign currency translation for U.S. multinational companies.  U.S.-based firms that earn revenues abroad will have to exchange foreign currencies back to U.S. dollars at a less favorable rate.  This acts as a headwind to sales and earnings growth, and contributed to the recent “earnings recession” we saw among companies in the S&P 500 Index in 2015 and 2016.

In contrast, recent U.S. dollar weakness has started to help boost corporate earnings growth and could be a support for stocks going forward.  While it’s impossible to know if the dollar’s strength will continue to moderate, a few factors suggest it might.  One is an improving global economic outlook relative to the U.S.  The U.S. economy was a bright spot in the early years following the last recession, but emerging market economic growth is gaining ground and European GDP growth recently outpaced U.S. GDP growth.  Another factor is that the Federal Reserve has shifted to a less accommodative monetary policy stance.  Ordinarily this would support further U.S. dollar appreciation (via a reduced supply of dollars and higher interest rates attracting foreign investors); however, investor concerns that restrictive monetary policy could slow down the current economic expansion are outweighing the shift in the Fed’s policy stance.

Considering the above factors and given several years of strong gains, recent U.S. dollar weakness could continue.  While there are pros and cons to a depreciating dollar, we would welcome the shift as this would help reduce import costs for consumers and businesses, while supporting sales and earnings growth for U.S. multi-national corporations.

*Powershares DB US Dollar Index Bullish Fund (UUP) – compares US dollar to euro, yen, pound, loonie, Swedish krona and Swiss franc

The Parsec Team

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QCD – A Bigger Tax Benefit

What, another financial acronym? Yes, in late 2015, Congress passed the PATH (Protecting Americans from Tax Hikes) Act, which made the QCD permanent in early 2016. QCD stands for Qualified Charitable Distribution. This type of charitable gift is made directly from an IRA and isn’t included in taxable income. The QCD was introduced in 2006, but fell into the on-again, off-again bucket of acceptable tax strategies until the end of 2015.

Any individual over the age of 70 ½, who receives an annual RMD (required minimum distribution) from his/her IRA, is eligible to take advantage of a QCD. Now that the strategy is permanent, it’s worth a discussion if you’re already gifting to charity each year, over 70 ½, and the owner of an IRA.

As everyone knows, a gift to charity is tax deductible. So how is the QCD different and potentially more tax beneficial?

The amount of the QCD is excluded from income, which effectively lowers AGI (adjusted gross income) by that same amount. AGI is the threshold by which most itemized deductions are measured to determine if allowable or not. For example, unreimbursed medical and dental expenses are only deductible to the extent that they exceed 10% of AGI. Therefore a lower AGI may translate into an allowable or larger medical/dental itemized deduction.

Another benefit of the QCD is the possibility to reduce Medicare Part B premiums. This year, the standard premium for Medicare Part B is $134/month if you’re a single filer and your 2015 AGI was below $85,000 or married filing jointly and your 2015 AGI was below $170,000. To the extent your AGI was higher that these amounts on your 2015 return, your Medicare Part B premiums this year also increased. Currently, four AGI brackets determine the Part B premium amount that’s deducted from an individual’s monthly Social Security check.

 

MAGI* Limits for Medicare Part B Premiums
Single Tax Filer: Married Filing Jointly:
2015 MAGI: 2017 monthly premium: 2015 MAGI: 2017 monthly premium:
Less than $85,000 $134.00 Less than $170,001 $134.00
$85,001 to $107,000 $187.50 $170,001 to $214,000 $187.50
$107,001 to $160,000 $267.90 $214,001 to $320,000 $267.90
$160,001 to $214,000 $348.30 $320,001 to $428,000 $348.30
Greater than $214,000 $428.60 Greater than $428,000 $428.60

*MAGI (modified adjusted gross income) = AGI + tax exempt interest

 

The maximum QCD amount is $100k per individual (or $200k per couple as long as $100k is given from each taxpayer’s IRA). So, in a year where one spouse gifts the maximum QCD, AGI will be reduced by $100k and the bracket which determines Medicare Part B premiums will also be lowered by $100k. For example, Billy and Betty’s 2015 AGI was $245,000 which translates to 2017 Part B premiums of $6,429.60/year. This year, Billy and Betty gifted $100k through a QCD to their alma mater to establish a named scholarship fund. The QCD lowered their AGI to $145k (assuming all other items remain constant), which reduced their bracket for determining Medicare Part B premiums. The new lower premium of $3,213/year (premium reduction of 50%) will take effect in 2019. Remember the premium change does not happen until the year after the tax return effecting the change is filed.

One further point to make – a QCD must be given to a public charity. A private foundation or donor advised fund does not qualify.
Parsec’s client service team processes QCDs on a regular basis for our clients. Here’s an outline of the simple steps to follow:

  1. Call your Financial Advisor
  2. Complete an IRA distribution form from your custodian – ensure that the gift is coded as a QCD.
  3. No tax withholding selected – the distribution is non-taxable.
  4. Check must be payable to the charity, not to the IRA owner. The check may be mailed directly to the charity or to the individual to hand to the charity.
  5. Make sure that your accountant is aware of the QCD.

Please contact your advisor with any questions.

Thank you,

Betsy Cunagin, CFP®
Senior Financial Advisor

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Update on I Bonds and Other Interest Rates

With interest rates remaining at very low levels, there are few options for earning any sort of a return on cash balances.

Current yields:

Charles Schwab Bank High Yield Savings 0.35%
Bank Money Market 1.30% (same as in my 2011 article)
3 Month U.S. Treasury Bill 1.12%
6 Month U.S. Treasury Bill 1.14%
1 Year CD, National Average 1.42%
5 Year Treasury Note 1.85% (same as in my 2011 article)
10 Year Treasury Note 2.26%
5 Year Treasury Inflation Protected Securities 0.02% (plus inflation)
10 Year Treasury Inflation Protected Securities 0.45% (plus inflation)
Series I Savings Bonds 1.96% (for the next 6 months, then 0% plus the inflation adjustment)

One thing to consider for smaller balances is Series I Savings Bonds (“I Bonds”) issued by the U.S. Government.  The new rates came out May 1, and I Bonds are currently earning an annual rate of 1.96% for the next 6 months.  You can visit www.treasurydirect.gov for a more detailed description of I Bond features.

The earnings rate for I Bonds is a combination of a fixed rate, which applies for the life of the bond, and an inflation rate that changes semi-annually (think “I” as in “inflation”). The 1.96% earnings rate for I Bonds purchased through October 31, 2017 will apply for their first six months after issuance. I Bonds cannot be redeemed for 12 months after issuance, and there is a penalty of 3 months’ interest if they are redeemed before 5 years.  Purchases are limited to $10,000 per Social Security Number annually, so a couple could purchase up to $20,000 per year.

What if there is an emergency and you need the money?  Since you cannot redeem the bonds for 12 months, you need to leave some liquid cash on hand.  After 12 months, a penalty of 3 months’ interest is deducted from the redemption value.  But even after paying the penalty you would still be ahead of a bank CD, and considerably ahead if the change in inflation continues at its current level. In addition, I Bond interest is exempt from state income taxes and is tax-deferred until you redeem the bond.  Also, if you buy the bonds on the last day of the month, you still get interest for the full month (I like to call this the “Mendelsohn Option”, in memory of the man who first pointed this anomaly out to me many years ago).

All I Bonds have the same inflation component.  The only difference is in the fixed rate that each bond offers.  If the fixed rate increases significantly in the future, just redeem some bonds and pay the penalty.  Then buy some new bonds with the higher fixed rate (but remember the $10,000 annual limit on purchases for each Social Security Number).  After 5 years, there is no penalty on redemption.

Another possibility for liquidity needs is a short-term, high quality bond fund.  However, you should be aware that these do carry some interest rate risk.  For example, a popular short-term bond fund has a current yield of 1.96% and an effective duration of 2.60 years.  This means that if interest rates were to suddenly move up by 1%, the value of the fund would be expected to fall by about 2.6%.  This would wipe out over a year’s worth of interest, making it a less attractive alternative for cash balances. I Bonds cannot go down in value (unless the Government fails, in which case we all will have much bigger problems to contend with).  The worst that can realistically happen is if the inflation adjustment was to be negative for a period of time.  In that case, there would be no interest paid on the I Bonds until the inflation adjustment turned positive.  However, we believe that the probability of negative inflation over the next several years is minimal.

An examination of interest rates reveals current market expectations about inflation. We look at this by calculating break-even inflation rates over the next 5-10 years using current yields on Treasury securities.  The break-even inflation rate is simply the difference between the yield on a Treasury Note of a particular maturity and the corresponding TIPS, or Treasury Inflation Protected Security.

For example, using the yields listed previously, the current 5 year break-even inflation rate is 1.83%. This is the difference between the 1.85% yield on 5 the 5-year U.S. Treasury Note and the -0.02% yield on 5 year TIPS). If you believe inflation is going to be lower than the break-even value for a particular investment horizon, you are better off in a Treasury Note. If you believe inflation is going to be higher than the calculated break-even rate, then you should purchase TIPS or I Bonds.

 

Bill Hansen, CFA

 

 

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Value Stocks May be Poised to Outperform

Since Parsec’s founding in 1980, we’ve touted the benefits of long-only equity investing.  This includes owning individual stocks, mutual funds, and exchange traded funds (ETFs).  We’ve also maintained the same investment style over the last thirty-seven years.  Regarding funds, Parsec’s investment policy committee (IPC) focuses on low fees, higher-quality holdings, and managers with long track records of outperformance.  When researching individual stocks, we take a value approach, favoring higher-quality companies that trade at a discount to history or peers.

While history shows that value stocks have outperformed growth stocks over most market periods, in recent years growth stocks have delivered higher returns.  In this email we’ll discuss what we mean by value versus growth investing and why we believe value stocks are poised to outperform going forward.

Different stock investors define “value investing” differently.  However, most agree on a few basic principles.  In general, value investors prefer stocks that trade at discounts to their intrinsic values.  Often this happens when a stock’s valuation falls below its long-term historical average or that of its peers.  Another tenet of value investing is margin of safety.  This means selecting stocks that can deliver healthy total returns even if current growth assumptions fall short of expectations.  While we consider ourselves value investors, we will add select growth stocks to the Parsec buy list when expectations look reasonable and a company has a competitive advantage.  In other words, when we think a stock has a reasonable margin of safety.

In addition to a value-based stock selection approach, Parsec’s investment philosophy also has a quality bias.  This means we prefer companies with strong cash flows, consistent earnings growth, a long history of dividends, and above average returns on invested capital.  We also favor companies with strong balance sheets that can withstand different market environments and even gain market share during difficult economic periods.

Looking back over the market’s history, value stocks have outperformed growth stocks by an average of 4.4% annually from 1926 to 2016 (Bank of America/Merrill Lynch).  More recently from 1990 to 2015, value stocks outperformed growth stocks by just 0.43% annually.  The spread has since reversed and in the last ten years value stocks have lagged growth stocks by 3% annually through the second quarter of 2017*.

The shift in leadership from value to growth stocks coincided with the start and continuation of the Federal Reserve’s massive monetary accommodation programs known collectively as quantitative easing (QE I, II, and III).  Those programs put additional downward pressure on interest rates.  In the face of low or no yields and the slowest economic expansion after a deep recession in over 120 years, investors demonstrated a preference for growth stocks over value stocks.  They were willing to pay up for companies delivering higher growth in a world where growth had become scarce.  Throughout the last ten years value stocks have occasionally outperformed, but usually in tandem with a steepening Treasury yield curve and thus improving growth expectations.

Because asset prices and interest rates are inversely correlated, very low interest rates over the last decade have led to above-average asset valuation levels.  This has been even more pronounced among growth stocks as investors have been willing to pay a premium to own them in a slow growth environment.  As a result, typically higher-priced growth stocks are even more expensive today.

Sticking to our value- and quality-biased investment approach has admittedly been a headwind in recent years.  However, we believe higher-quality stocks trading at a discount are poised to outperform.  Growth stocks currently trading at premium valuation levels will have further to fall in the event of a market downturn.  As well, low interest rates have prompted corporations to take out record debt levels.  As rates begin to rise, higher-quality companies or those with strong balance sheets and robust cash flows will be better able to service their debt levels, even during an economic downturn.  While maintaining our investment approach through the current environment has been challenging, we feel confident that investing in higher-quality companies trading at discounted valuations will reward clients over the long-term.

*References the Russell 3000 Growth Index and the Russell 3000 Value Index

The Parsec Team

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Medicare: The Basics

Medicare is a complex topic but also an important tool for financial planning during your retirement. You will no doubt be inundated with flyers, pamphlets, and marketing materials from multiple companies and organizations—as you approach your 65th birthday. It can become very overwhelming, so here are five quick things that will help you get a basic understanding of Medicare and what you need to do now to prepare for the big 6-5!

1.) Medicare is health insurance for people 65 or older and people under 65 with certain disabilities. Original Medicare (Parts A & B) pays for about 80% of your health care costs. There are (4) main ‘Parts’ you will hear when talking about Medicare.

Part A– Hospital Coverage- part of Original Medicare
Free to most people

Part B– Doctor Coverage- part of Original Medicare
Has a monthly premium (based on income*) and a yearly deductible (the 2017 deductible amount is $183

Part C– Medicare Advantage- offered by private insurance companies
Takes the place of Original Medicare and usually combines Rx coverage

Part D– Rx Drug Coverage- offered by private insurance companies
Separate monthly premium

Original Medicare pays approximately 80% of qualified expenses, which leaves a gap of 20% that would be out-of-pocket for you.

There is currently no cap on the amount that the 20% could reach.

2.) It is important to know what qualified expenses are. Your ‘Medicare & You’ guide will have detailed information on this but here are a few examples of things Medicare does not cover: long-term care, eye exams for glasses, most dental care, dentures, hearing aids or exams, prescription glasses or exams, cosmetic surgery, routine foot care and acupuncture.

3.) You have options! You can choose Original Medicare (Parts A & B) or you can choose a Medicare Advantage Plan instead.You can also choose to add Supplemental coverage (for an additional monthly premium) to Original Medicare that would cover the approximate 20% gap in out-of-pocket expenses.

4.) There are penalties and fees for failing to enroll into Parts A, B, and D within a specified time frame. There is a 7-month window around your 65th birthday in which you can sign-up for Medicare and have guaranteed approval for any Rx drug, Advantage, or Supplement Plan you choose. You need to enroll in Medicare during this 7-month window to avoid late enrollment penalties/fees.

The 7 months covers 3 months prior to, the month of, and 3 months after your 65th birthday month.

You can enroll in Medicare online (www.medicare.gov) or at your local Social Security office.

5.) Use your resources! Medicare’s website (www.medicare.gov) is a wonderful tool to research, compare and shop for plans, companies, etc.If you are currently employed or covered by an employer health plan, talk to someone in your HR or benefits department as soon as you turn 64; the timing for signing up and your coverages may vary from the normal Medicare process.

As the time approaches, make sure that you complete the necessary steps to take advantage of the Medicare benefits which you have earned. For more detailed information, click here for our upcoming Parsec Newsletter  for an article called “Medicare: What you need to know before you turn 65.”

 

Lori King, RP®, Client Service Specialist

 

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Mid-Year Market Update

Now that we’re half-way through 2017, it’s time to take a look at market and economic trends year-to-date. The big picture view is that asset classes across the board have delivered strong returns through June. This is despite interest rate hikes by the Federal Reserve’s Federal Open Market Committee (FOMC). In fact, Treasury yields have actually fallen in the face of two interest rate increases this year, pushing bond prices higher. International stocks and bonds have also risen in 2017, boosted by stabilizing global growth rates, depressed yields world-wide, and improving corporate earnings.

Looking a little more closely at the U.S., stocks continued their upward trajectory early in the year following the post-Presidential election results in November. While the new administration has not made much traction in passing new legislation, relatively healthy economic data – including good jobs growth, higher wages, and a strong housing market – have supported stocks. At the time of this writing (June 15, 2017), the S&P 500 Index is up 8.5% on a price-basis and up 9.7% on a total return basis (which includes dividends).

Technology stocks have led U.S. equity markets this year. Within the S&P 500 Index, the sector is up over 17% year-to-date given healthy earnings growth expectations for the group. The more tech-heavy NASDAQ Index is up a whopping 14% this year, almost 6% ahead of the S&P 500 Index. However, we’ve started to see some signs of weakness among tech stalwarts recently and are watching the group closely. On the flip side, energy and telecom stocks have lagged the index, with price declines of 13% and 9%, respectively. Of note, energy and telecom stocks were two of the three best-performing sectors in the S&P 500 Index last year, with prices returns of +24% and +18%, respectively. This marked turnaround in performance provides a cautionary tale on the pitfalls of market timing: last year’s leaders may well become this year’s laggards. In general we’ve found that it’s difficult, if not impossible to predict which sectors or industries will outperform in any given year. As a result, we recommend maintaining a diversified portfolio through all market cycles and rebalancing regularly.

Another wide disparity arose among growth and value stocks. Year-to-date, growth stocks (as measured by the Russell 3000 Growth Index) are up almost 14% on a price return basis versus a 3% return for value stocks (as measured by the Russell 3000 Value Index). Much of the outperformance by growth stocks stems from strong returns among technology stocks – many of which are growth-oriented and trade at higher valuation levels.

After years of underperforming U.S. stocks, international equities have outperformed year-to-date. In aggregate, developed stocks from Japan, Europe, and Australia are up 14% on a price return basis through June. While this group has lagged U.S. stocks over the past four consecutive years, improving economies in most of these regions, positive consumer sentiment, and accommodative central banks are starting to turn the tide. Likewise, Emerging Markets stocks are up over 17% on a price return basis so far this year. The marked turnaround comes as corporate earnings growth for many of these countries is starting to improve and global growth is stabilizing.

Other interesting observations for 2017 include record-low stock volatility levels, lower yields despite higher interest rates by the FOMC, and an eventful (if unproductive) six-months in Washington.

Looking forward, we see risks and opportunities. The Federal Reserve is set to reduce its bloated balance sheet later this year which could pose a risk to above-average stock valuation levels. Despite the potential for unintended consequences, we view the move as a vote of confidence in the U.S. economy and as a much needed step towards more normalized monetary policy. While a more restrictive Federal Reserve is a headwind to asset prices, interest rates remain very low (with no signs of rising) and the U.S. economy remains on stable footing. These factors, along with improving U.S. corporate earnings growth, bode well for continued stock gains over the long-term.

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Congratulations Parsec Prize Recipients!

One of the fundamental values at Parsec Financial is giving back to our community. We founded the Parsec Prize in 2005. Since that time, we have given over $1,000,000 in prizes to 66 local non-profit organizations serving Western North Carolina and Charlotte. The Parsec Prize represents approximately one-half of our annual charitable giving.

For the first time, we are expanding the Parsec Prize to a multi-year donation to one of the recipients. OnTrack Financial Education & Counseling will be the inaugural organization to receive this multiyear donation of $100,000 in total over the next four years. This is the largest commitment that Parsec Financial has ever made to one organization. We are giving an additional four Parsec Prizes of $25,000 each to four other worthy organizations. 

The 2017 Parsec Prize recipients are:

  • Guardian ad Litem of Buncombe County – $25,000
  • OnTrack Financial Education & Counseling – $100,000 (4-year commitment)
  • Our VOICE – $25,000
  • United Way of Asheville and Buncombe County, Middle School Success Program – $25,000
  • Western Carolina Rescue Ministries – $25,000

We thank these organizations for the value they provide to our community.

We encourage non-profit organizations to visit our website for information on applying for a Parsec Prize in 2018. The Prize will be considered for non-profits in any region where Parsec has a physical office.

Thank you,

The Parsec Team

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The Fiduciary Rule and You

If you keep up with current events and what is happening in Washington, it is likely that you have heard about the Department of Labor’s Fiduciary Rule. Some of you may be curious about what exactly it is and how it could possibly affect you. Before we talk about that, let’s take a quick look at the spectrum of financial advice, and where Parsec lands on that spectrum.

RIAs and B/Ds

These two acronyms stand for Registered Investment Advisors and Broker Dealers. These are two different types of providers of financial advice. In 1940, Registered Investment Advisors were separated from Broker Dealers under the Investment Advisors Act of 1940. Consider that the United States had just emerged from one of the biggest stock market crashes on record a year or two prior. The goal of this new legislation was to eliminate potential conflicts of interest, when a financial professional might consciously or unconsciously provide advice not in the best interest of the client. However, these new rules did not apply to everyone! They only applied to a group of advisors that were Registered Investment Advisors or RIAs. To make things even more complicated, someone could be a Registered Investment Advisor at the same time they were associated with a B/D! Now, if an advisor is associated with a B/D, they are essentially an agent for that company. Very simply, think about your local home or auto insurance agent. They work for the insurance company, and you know their job is to sell you an insurance product. This is the relationship that all advisors who work for large banks and brokerage firms maintain. Their first priority is to sell the products of their employer.

Cue the Independent Broker Dealer

As mentioned previously, there are some advisors who are associated with both an RIA and a B/D. These advisory firms typically associate with an Independent Broker Dealer, which means that they are still able to sell products and receive a commission, or they can provide advice through the RIA and receive a fee. At the end of the day, these advisors are stuck with a decision, whether to sell the client a product, or to provide objective advice. Doesn’t it seem like it would be very difficult for an advisor to provide advice, then sell them a product based on that advice? It is like asking your barber whether or not you need a haircut. This is why it is extremely difficult, if not impossible, for an advisor to be a fiduciary if they maintain an association with a B/D.

So what is Parsec?

Since our founding in 1980, Parsec has only been a Registered Investment Advisor. We have never been associated with a B/D, nor have we ever received any commissions or revenue sharing from our recommendations to our clients. One of our core beliefs is that our clients should have complete transparency on our fees, and that there is never any question of what the total cost to work with us is. This means that we are a fee-only fiduciary that always seeks to serve our clients’ best interests as well as eliminate any conflicts of interest that could arise.

How does the DOL’s Fiduciary Rule affect RIAs and B/Ds?

The current fiduciary rule proposal affects retirement accounts, including 401(k)s and IRAs. If the rule is adopted, it will require anyone working with these types of accounts to show that their advice is in the best interest of the client, not just a “suitable” recommendation, which is the current requirement for B/Ds. We believe this is a step in the right direction for consumers, but must point out that if an advisor is a representative of a B/D they still are still considered an “agent” of their firm, and this rule only requires they act in the clients’ best interest with IRAs and 401(k)s. We believe the best outcomes occur when an advisor is able to guide a client in a fee-only advisory relationship. The proposed regulation (if it eventually goes through) will require very small changes to some of our processes for documentation purposes, but no changes to how we work with our clients. We hope this post leaves you more informed about why being a fiduciary is so important to us.

Thank you,

The Parsec Team

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March Update – Trading

Trading is an important, albeit often underappreciated part of investment management.  In this email, we’ll share with you our investment philosophy and how it drives our trading approach.  While Parsec uses both funds and individual securities across client accounts, this blog applies more to those portfolios with individual stock holdings.  In general, we use funds for smaller-sized accounts because of the immediate diversity it provides, at a relatively low cost.  We generally use individual securities for larger client portfolios as these portfolios offer economies of scale that can overcome trading costs.  Over the years, we have fine-tuned our trading approach with an eye towards minimizing costs and maximizing efficiency.

As you’ve heard us say time-and-again, Parsec does not engage in market timing.  Instead of trying to determine when one asset class will underperform and another outperform, we select our securities using a bottom-up fundamental research approach.   Using individual equities as an example, this means that we first screen any new stock ideas for attractive financial characteristics and then perform additional due diligence to determine its total return potential over the next several years.  Once a stock is added to a Parsec portfolio, we monitor the company regularly for changes in its competitive environment, its growth drivers, and valuation levels.  However, we do all of this in light of our long-term thesis on the stock, as opposed to the market’s near-term noise.

Taking a long-term investment approach in which we focus on a security’s total return potential often allows us to buy and hold securities for many years.  This keeps our portfolio turnover – a measure of how frequently assets are bought and sold – low, and in turn keeps our trading costs low.  When we do trade we use block trades whenever possible.  By aggregating all of our trades into one large transaction we can better assure that clients receive the same price when a given security is bought or sold.

In addition, our focus on a security’s long-term potential largely circumvents the need for specialized trade orders.  Typically short-term traders, and not long-term investors, utilize limit orders, stop orders, or other types of non-market orders.  These specialized trades often come with additional costs, including higher transaction fees for retail investors and various opportunity costs.

One such opportunity cost can arise when setting short-term price targets.  For example, using a limit order to purchase a security requires an investor to set a price target.  However, without thoroughly researching a security using fundamental analysis, price targets are often based on “a gut feel” or are knee-jerk reactions to an investor’s past experience with an asset.  In effect, unconscious emotions can drive the trading decision and lead to even higher costs.  These can come in the form of missed opportunities, as when a stock declines but doesn’t quite reach an investor’s price target to buy.  In this case if the stock then continues higher an investor may have missed-out on significant upside potential.

Another opportunity cost is possible when a security pays a dividend, but because an investor was waiting for a slightly lower price before buying, he or she inadvertently forfeited the added income.  In some cases the dividend payout might have amounted to more than the savings associated with buying at a lower price.

While there are many types of trades, and some that do add value, in general we’ve found that specialized trade orders often come with more costs than benefits.  This is why Parsec identifies assets using fundamental research and takes the long-term view on a security’s total return potential.  Doing so inherently reduces security turnover in a portfolio and thus trading costs.  It also avoids incurring hidden opportunity costs and, we believe, increases the likelihood of reaching your longer-term financial goals.

Thank you,

The Parsec Team

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