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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Time to Update your Estate Plan?

Now that we have started a new year, it’s a good time for many of us to stop putting off getting an estate plan created or updated.

Under current tax law, most people do not have a concern with estate tax.  The current Federal estate tax exemption is $5.49 million per person. If properly elected, any unused exemption is portable between spouses.  Therefore, a married couple with an estate of $10.98 million or below could pass their entire estate to heirs without any Federal estate tax liability.

While much attention is focused on the tax aspects, estate planning is more a matter of organizing and simplifying your affairs so that your heirs are not burdened with additional stress at the same time they are grieving for the loss of a loved one. We recommend that you engage the services of a qualified attorney to guide you and create the appropriate documents.

Your estate plan should include a will and possibly living or revocable trusts. Advanced directives and incapacity planning are other items that are typically addressed as part of your estate plan. This includes having documents prepared such as a durable power of attorney, health care power of attorney and living will.

As part of your estate plan, you should review your beneficiary designations. By filling out a beneficiary designation form, individuals can bypass the probate process and pass specific assets upon their death directly to their heirs. Many types of assets such as IRAs, qualified retirement plans, life insurance policies and commercial annuities pass via beneficiary designation rather than through your will. In addition, beneficiary designations can be added to taxable investment accounts (known as Transfer on Death or “TOD”) and bank accounts (known as Payable on Death or “POD”). Note that while the assets passing by beneficiary designation bypass the probate process, they are still included as part of the decedent’s estate for calculating any potential estate tax liability.

There is talk that the estate tax may be changed or even eliminated this year. For most people that shouldn’t be a deterrent to getting their estate plan done, since few are affected by the estate tax in the first place. Having an updated estate plan gives you peace of mind and helps prevent additional stress on your heirs. Once you have a plan in place, it can always be modified as tax laws and your personal circumstances change.

William S. Hansen, CFA
President
Chief Investment Officer

bill

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What’s Ahead for Fixed Income?

After more than thirty years of falling interest rates and thus rising bond prices, yields may be moving higher.  While trends are often short-lived, this new trajectory could persist into 2017 and beyond given recent changes in the political landscape as well as a less accommodative Federal Reserve (Fed).  We’ll take a look at what this new monetary and political environment may mean for bonds and how to best-position your fixed income portfolio for the long-term.

A proxy for the bond market, the 10-year Treasury note yield hit an historical low of 1.36% in July 2016 only to jump 100 basis points (or 1%) by the end of November.  The move came as investors responded favorably to the surprise U.S. Presidential and Congressional election results, in anticipation of higher growth levels in the years to come.

Part of the optimism stemmed from the new administration’s promise to cut consumer and corporate taxes and spend on infrastructure projects.  This picture presents a mixed bag for bonds, however.  Increased fiscal spending and lower taxes are positive for economic growth and a healthy economy is generally good for lending and credit activity.  But stronger economic growth would push yields higher and thus bond prices lower.  On the other hand, higher yields would provide investors with higher current income, acting as a partial offset to lower bond prices.  Rising interest rates or yields would also allow investors to reinvest into higher-yielding bonds.

Duration is an important characteristic to consider when reinvesting at higher yields.  A bond’s duration is the length of time it takes an investor to recoup his or her investment.  It also determines how much a bond’s price will fall when yields rise.  Longer duration bonds such as Treasury or corporate bonds with long maturities experience sharper price declines when yields rise.  Likewise, shorter duration bonds are less volatile and will exhibit smaller price declines, all else being equal.  Because we can’t predict the exact direction or speed of interest rate changes, it’s important to have exposure to bonds with a mix of durations.  In this way an investor is able to respond to any given environment.  For example, when yields are rising, an investor can sell her shorter-duration bonds, which are less susceptible to prices changes, and reinvest into longer-duration bonds with higher rates.

Another factor that affects bond prices is inflation.  Inflation expectations have started to heat up in light of low unemployment, wage growth, and expectations for increased government stimulus.  Higher inflation could also put upward pressure on interest rates and thus downward pressure on bond prices.  While inflation can erode the real returns of many bonds, some bonds, such as Treasury Inflation-Protected Securities (TIPS), stand to benefit.  TIPS are indexed to inflation and backed by the U.S. government.  Whenever inflation rises, the principal amount of TIPS gets adjusted higher.  This in turn leads to a higher interest payment because a TIPS coupon is calculated based on the principal amount.

Finally, the Federal Reserve’s shift away from accommodative monetary policy will have an impact on bond prices.  Although higher interest rates from the Fed will likely pressure fixed income prices, overall we view this change favorably.  This is because a return to more normal interest rate levels is critical to the functioning of large institutions like insurance companies and banks, which play a key role in our society.  Likewise, higher interest rates will provide more income to the millions of Baby Boomers starting to retire and would help stabilize struggling pension plans at many companies.

Taken altogether and in light of an uncertain environment, we believe a diversified bond portfolio targeted to meet your specific fixed income needs is the best way to weather this changing yield environment.  In addition to considering your specific income objectives, our Investment Policy Committee meets regularly to assess the current economic, fiscal, and monetary environment.  We adjust our asset allocation targets in order to take advantage of attractive opportunities or reduce exposure to higher-risk (over-valued) areas.  While we may over-weight some areas or under-weight others, in the long-run we continue to believe that a well-diversified portfolio is the best way to weather any market environment.

Thank you,

The Parsec Team

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2016 IRA Contribution Rules

The deadline to make IRA contributions for tax year 2016 is April, 18 2017. The maximum contribution is $5,500 per individual ($6,500 if age 50 or over) or 100 percent of earned income, whichever is less.

There are income limits which determine whether you can deduct your Traditional IRA contribution or if you qualify to make a Roth contribution. The following table gives the phase-out range for the most common circumstances.

Do you qualify to deduct your Traditional IRA contribution?
If your income is less than the beginning of the phase-out range, you qualify. If your income is over the phase-out range, you do not. If your income falls inside the range, you partially qualify.

Modified Adjusted Gross Income Phase-Out Range
Tax Filing Status For 2016 Contributions For 2017 Contributions
Single, participates in an employer-sponsored retirement plan: $61,000 – $71,000 $62,000 – $72,000
Married filing jointly, participates in an employer-sponsored retirement plan: $98,000 – $118,000 $99,000 – $119,000
Married filing jointly, your spouse participates in an employer-sponsored retirement plan, but you do not: $184,000 – $194,000 $186,000 – $196,000

Do you qualify to contribute to a Roth IRA?

Modified Adjusted Gross Income Phase-Out Range – Roth
Tax Filing Status For 2016 Contributions For 2017 Contributions
Single: $117,000-$132,000 $118,000-$132,999
Married, filing jointly: $184,000-$194,000 $186,000-$195,999

If your filing status differs from those listed above, please contact your advisor and he or she can help you determine whether you qualify.

Harli Palme, CFA, CFP®
Partner

Harli Palme

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2016: Year in Review

While the year hasn’t officially wrapped up as of this writing, we’re close enough to be able to form some opinions and offer some perspective on 2016.  If nothing else, this year could be characterized as unexpected.  Despite a steep stock sell-off in January, which weighed on investors’ outlooks early in 2016, U.S. stock returns are poised to close up over 10 percent through December.  On the other hand, bond returns, while on target to gain about 2 percent for the year, are finally starting to come under pressure after a bull market of over 30 years.

Looking back, the S&P 500 Index fell over 6 percent in January after U.S. GDP growth came in below expectations, corporate earnings continued to fall, and recession fears spiked.  Despite investor concerns, most economic data at home were relatively healthy, driven primarily by steady gains in employment and disposable personal income.  Additionally, many investors were concerned that slowing global growth would ultimately weigh on a resilient U.S. economy.  Specifically, the International Monetary Fund (IMF) lowered its global growth rate predictions several times, China delivered GDP growth below expectations, and commodity prices remained depressed.

Stocks turned a corner in March, however, surging almost 7 percent at home and over 13 percent in developing countries.  The state-side rally came amid falling U.S. corporate earnings that were driven by lower energy prices, depressed commodity prices, and a strong dollar.  Although declining earnings growth usually leads to lower stock prices, the Federal Open Market Committee’s (FOMC) announcement that it would reduce the number of interest rate hikes for the year buoyed stock valuations.  As a result, stock price-to-earnings multiples (a common valuation metric) expanded while underlying fundamentals remained weak.

After several years of underperformance, emerging markets stocks and bonds reversed course in 2016 as depressed commodity prices started to recover.  The FOMC’s plan for fewer interest rate hikes was also a boost for emerging markets countries, many of which owe significant amounts of U.S. dollar-denominated debt.  Likewise, economic data out of China were better than expected, although growing debt levels and excessive government stimulus there could prove to be longer-term risks.

In another unexpected development, low-growth telecom and utilities sectors led U.S. stocks in the first half of the year.  Utilities and telecom stocks typically carry higher debt levels and the FOMC’s move to keep interest rates lower for longer was viewed favorably by the markets.  Both sectors were up over 20 percent through June, although they have since given back almost half of those gains.

In between tragic terrorist attacks, the U.K. shocked the world in June when it voted to exit the European Union, a development known as “BREXIT.”  Markets tumbled on the news but quickly bounced back and reached new highs.  While shocking headlines dominated the popular press, global economic growth was quietly stabilizing around the globe and accelerating at home.

The summer brought a much-needed reprieve from the barrage of grim headlines earlier in the year.  It also ushered in new confidence in the U.S. expansion as jobs growth continued, wage growth perked up, and housing data improved.  As the Presidential election drew near, corporate spending started to pick up, oil prices rallied, and company earnings improved.

Following a relatively calm summer, the U.S. surprised the world in November with the election of Donald Trump to the presidency, while Republicans maintained their majorities in the House and Senate.  Despite concerns of a global shift towards populism, markets soared on hopes of tax cuts and better growth at home.  After the election and following months of healthy economic data – – including a meaningful pick-up in 3rd quarter U.S. GDP growth and signs that inflation was heating up – – the FOMC raised rates in December, as expected.

Clearly, 2016 was an eventful year for markets, governments, and citizens alike.  While several unknowns have become known, many of this year’s developments have sowed the seeds for more uncertainty ahead.  In terms of markets, although a divide still exists between stock valuation levels and underlying fundamentals, we’re encouraged by improving corporate earnings growth.  On the other hand, bonds have benefited from over thirty years of falling yields (and thus rising prices).  A steeper FOMC rate hike trajectory is clearly a headwind for fixed income, but the central bank’s stance is supported by strong economic growth and signs of inflation.  The end result may mean stagnant fixed income returns, but a healthy economy – a trade-off we’re willing to take.

Overall, we view stocks as most likely to outpace growing inflation expectations over the long term.  While equity prices may be due for a pullback in the near term, evidence suggests that the longer-term secular bull market remains intact.

Thank you,

The Parsec Team

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The Perfect Gift? Ideas…From a Planning Perspective

December is here and 2016 is drawing to a close.  As we enter the holiday season, we scramble to pick the perfect gift for our family members, our friends, teachers… the list goes on.

At Parsec, we work with clients to create gifting strategies that fit into their overall financial plan.

This December we encourage you to think about giving and its potential longer term impact on both your family (children and grandchildren) and your taxes.  Let’s first review a powerful gifting strategy to younger family members: the custodial Roth IRA.

As long as there is earned income, which can come from mowing lawns, housework, babysitting etc., contributions to a custodial Roth IRA can be made up to the amount of the earned income but not over $5,500*.  For example, your 9 year old grandchild earned $1,000 over the summer through his lawn mowing business.  You can open a custodial Roth IRA for him and deposit a matching gift of $1,000. Let’s say he continues to mow lawns each summer for the next 10 years and you continue to match his earnings with a $1,000 holiday gift.  Assuming a 7% return each year, your gifts will grow to over $15,000 at the end of 10 years.  Remember this is only the beginning, the approximate $5,000 earnings in this example will continue to compound over time and ALL earnings are tax free upon withdrawal later in life.  Rewarding your grandchild’s hard work through Roth contributions is a holiday gift that offers valuable lessons on many levels.

Let’s switch gears to philanthropy.  Each year Parsec’s client service team processes hundreds of charitable gift requests from our clients.  These gifts of course offer tax advantages in various forms.  For many of our clients, the qualified charitable distribution or QCD brings the most formidable tax savings.  How does it work?  If you are over 70 1/2, up to $100,000 of your required minimum distribution (RMD) can be given directly to charity through a QCD.  The result: your AGI will be reduced dollar for dollar by the amount of the QCD.  A simple, yet impactful strategy:  on not only your charity of choice but also on your tax dollar.

As we enter this holiday season we hope that you reach out to your financial advisor to talk about gifting strategies that may be appropriate for you and your family.  Happy Holidays!

Betsy Cunagin, CFP®

Senior Financial Advisor

*$5,500 is the IRA contribution limit for 2016 and 2017.  

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Infrastructure Spending

The next driver of economic growth and company fundamentals?

Now that the U.S. presidential election is behind us and a big unknown has become known, stocks are responding favorably.  While equities are basking in a bit of short-term certainty following the November 8th election results, key questions remain.  One of the most significant relates to future government spending, and specifically, infrastructure.  After years of unprecedented monetary accommodation that may have artificially inflated equity prices, increased investments in our nation’s roads, bridges, and airports could provide a significant (and real) boost to corporate earnings and the economy.

Regardless of your presidential preference, both Clinton and Trump promised to increase infrastructure spending on the campaign trail.  Hillary planned to spend about $275 billion over five years while Donald claimed he would double her target.  Overall U.S. infrastructure recently received a grade of D+ from the American Society of Civil Engineers (ASCE), suggesting this is one instance in which competitive campaign rhetoric may work in our favor.

Most experts agree that the U.S. has underinvested in infrastructure for nearly three decades.  As a result, many of our bridges, roads, public buildings, and ports have not had significant upgrades in 50 to 100 years.  Government officials are well aware of the problem, but lack of bipartisanship has been a hurdle to distributing needed funds to critical projects.  While historically divided government has been more favorable for stocks, in this case, an all-Republican government may enable the passage of much needed infrastructure spending bills.

Research suggests that over the long-term, every $1 spent on infrastructure has the potential to boost economic activity by $3.  This is because updated roads, bridges, and buildings improve productivity and drive efficiencies.  Increased spending on these projects would also provide new jobs, further benefiting GDP growth.

While most focus on the economic gains, modernizing key infrastructure facilities may have the added benefit of reducing the harmful greenhouse gases that contribute to climate change.  According to a report by the Global Commission on the Economy and Climate, more than 60% of the world’s greenhouse gases are associated with old and ailing power plants, roads, buildings, and sanitation facilities, among others.

Finally, increased infrastructure spending may be the balm we need to escape from years of easy monetary policy that has inflated equity prices.  Stock valuations are trading above their long-term historical averages despite multiple quarters of weak sales and earnings growth.  Now with record-low interest rates poised to go higher and few tools left in the Federal Reserve’s tool box, a shift towards new fiscal policies that increase productivity and encourage corporations to invest – such as infrastructure spending – would provide companies with real sales and earnings drivers.  This in turn would help bridge the gap between currently lackluster fundamentals and elevated security prices.

To be sure, there are potential negatives associated with increased fiscal spending, including currently large labor shortages in the construction industry, dependence on prudent government spending, and regulatory red tape.  Likewise, increased infrastructure spending could add to an already elevated federal budget deficit.  However, taken altogether the positives appear to outweigh the negatives.  And new fiscal spending could be just what we need to keep the economy on track while supporting stock prices.

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Parsec’s Holiday Schedule


The holiday season is quickly approaching! While we plan to be here for all your year-end needs, we also look forward to spending a little extra time with friends and family. So that we can enjoy time with loved ones, our office will be closed for certain holidays. Please review our schedule below so that you can plan office visits and gifting request accordingly.

  • Thanksgiving: Our office will be closed on Thursday, November 24 and Friday, November 25, 2016.
  • Christmas: Our office will close at 1:00 p.m. on Friday, December 23 and all day on Monday, December 26 in observance of the Christmas holiday.
  • New Year’s Day: Our office will be closed on Monday, January 2, 2017.

The closures apply to all offices located in Asheville, Charlotte, Southern Pines, and Tryon.  Some employees may be planning to take a little extra time off around the holidays, but someone from your advisory team will always be here to help you!

For a little fun reading this season, make sure to check out our new holiday edition newsletter. The cranberry sauce looks tasty! We hope you enjoy time with your loved ones and have a safe, happy holiday season.

Happy Holidays!

ashley_woodringb

Ashley Gragtmans, CFP®

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The Benefits of Focusing on Your Long-Term Financial Goals

As your advisor, our main focus is helping you reach your long-term financial goals.  We say this a lot, but it bears repeating.  It’s worth revisiting because near-term portfolio returns and market noise can distract even the best investor from remembering why he or she invests in the first place.  For most of us, investing is about creating the life we want, giving back to family, friends, and community, and leaving a legacy.  At Parsec, our job is to lead you through difficult market periods, including times when your portfolio may lag the major market indexes.  Every portfolio will experience underperformance from time-to-time.  However, getting caught-up in weak near-term performance can actually hinder progress towards your long-term goals.

This happens when we lose sight of the big picture.  Asset class leadership naturally ebbs and flows over the course of any economic cycle, and so too will portfolio returns.  Financial behavioral scientists suggest that if we’re caught-up in near-term underperformance we’re more likely to act reactively instead of proactively.  Reacting to current portfolio performance increases the odds that we sell low, buy high, trade excessively, or even sit-out the next market run.  In other words, focusing on near-term market moves increases the odds that we hinder our long-term performance results.

In contrast, measuring your progress versus your long-term goals is more likely to increase proactive behaviors and thus improve the odds of realizing your objectives.  For example, framing portfolio returns in the context of your retirement savings target several years from now is more apt to help you keep calm during periods of market turbulence.  “Keeping your eye on the prize”, as they say, can cultivate resiliency and has the added benefit of lowering your anxiety levels.  When you’re less stressed, you’re more likely to engage in proactive behaviors like maintaining an appropriate asset allocation mix, rebalancing back to your target regularly, and staying invested during market downturns.

While we acknowledge that portfolio declines or underperformance is never fun, it’s important to recognize that difficult performance periods are par for the course.  Over time some assets and sectors will outperform while others will lag.  Rather than trying to time the market or catch the latest trend – which is extremely difficult to do – sticking with a diversified asset allocation and rebalancing regularly is a tried-and-true method for achieving your financial goals.

With that in mind, our job is to help you stay focused on the big picture.  Doing so lowers the odds of engaging in detrimental behaviors and increases your chances of success.  When you succeed, we succeed!

Thank you,

The Parsec Team

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