Why Stock Buybacks are Significant and What to Make of Recent Trends

Company stock buybacks recently surpassed 2007’s prior record of $172 billion. As of the first quarter 2018, buybacks from the S&P 500 Index constituents reached $178 billion, up about 34% year-over-year. This compares with $24 billion in stock buybacks at the market bottom in 2009.

As the name implies, stock buybacks (also known as share repurchase programs) happen when companies buy back their own shares. A firm uses its cash position to repurchase company stock either in the open market or directly from select shareholders. These programs reduce the number of shares outstanding for the company in question and thus increase the ownership stakes of its remaining shareholders. The end result is more profits or earnings per share (EPS) per shareholder.

In general, stock buyback programs are viewed favorably by Wall Street. These programs help neutralize shareholder dilution that comes from excessive stock option issuance. Many management teams go further and announce buyback programs that more than offsets dilution from stock options.  In these cases, existing shareholders see their ownership stakes grow, and with it, their portion of earnings per share.

Another positive attribute of share buybacks is their affect on key company financial metrics such as earnings per share (EPS), return on equity (ROE), and earnings growth rates. These ratios are used by professional investors to determine the health of a company and are usually part of their investment decision process. Because share buybacks often boost a company’s financial profile, these programs can lead to more interest among institutional investors and thus increased demand for the stock. Higher demand from large investors typically translates into a higher stock price. With higher ownership stakes and larger earnings per share accruing to remaining investors, stock buybacks offer shareholders a compelling, two-fold benefit.

Investor perception also plays a significant role in share buybacks. Many argue that because a company’s management team has inside information regarding a firm’s growth prospects, a share buyback announcement is a signal that a stock may be undervalued – otherwise management would choose to spend the company’s cash on more profitable investments. This positive signal alone can cause a stock’s price to rise.

There is a downside to share buybacks, however. In recent years, record-low interest rates have prompted many companies to issue large amounts of debt to fund their share buyback programs. While this has had the effect of boosting near-term earnings growth and increasing existing shareholders’ ownership stakes, it could come at the cost of longer-term returns. Although interest rates remain low, as yields increase- debt servicing costs are likely to rise. These higher debt burdens – taken on to buyback company shares – could crimp a company’s ability to invest in value-enhancing initiatives such as technology investments or new manufacturing facilities, and ultimately reduce long-term earnings and cash flow growth.

Likewise, stock buybacks are a more flexible alternative than issuing a dividend. Many contend that management teams prefer share repurchase programs to dividend payments because they can easily suspend buyback activity with limited negative ramifications. In contrast, dividend cuts are viewed quite unfavorably by investors and are likely to significantly pressure a stock price. When a company issues a new dividend it suggests confidence in the firm’s market position, growth prospects, and cash flows. Thus, when dividends are cut or eliminated it signals deteriorating company fundamentals ahead.

Given the short-term benefits and minimal near-term risks associated with share buybacks, more companies are engaging in these programs than ever. Similar to individual investments, repurchase programs are most beneficial when a management team buys its firm’s stock at low levels and watches it appreciate in value over time. Although the investing principle of buy low and sell high is well understood, many corporate directors fail to follow this basic rule of thumb. The historical record indicates that seasoned company management teams are just as likely to buy at peak valuation levels and refrain from share buyback programs at market bottoms.

Although company management teams have a poor track record when it comes to timing share buyback programs, many are excellent stewards of their firm’s growth prospects and market positions. This suggests that as individual investors we would do best to focus on high-quality investments with long-term track records of delivering value and leave the market timing to speculators.

Carrie Tallman, CFP®, CFA™
Guest Contributor 
Share this:

Bear Market Anniversary Reflections

March 9th marked the 9 year anniversary of the most recent bear market bottom. It passed quietly with no bands playing and no flags flying. For those who endured the decline, it was a stressful experience that tested the mettle of all of us as investors. The market peaked in October 2007, and then the S & P 500 index of large-company US stocks fell 37% in 2008. Stocks continued to fall in early 2009, until the market finally bottomed on March 9th.  Overall, there was about a 57% decline in the S & P 500 from peak to trough, the magnitude of which no one had seen since the Great Depression. Although the length of the decline was in line with the post-World War II average for a bear market at 17 months, it seemed like it would never end. After hitting the bottom on March 9, 2009, the market recovered sharply and closed up 26.5% for the year. It is interesting to note that despite these declines, the calendar years 2007 and 2009 were both positive for stocks. All declines, while distressing at the time, have proven temporary.

2017 marked the 9th positive year in a row for stocks. While we remain optimistic about the economy, we recognize that eventually there will be another negative year or years. There’s just no way to predict exactly when these will occur. Fortunately, all the major declines in modern history have been short-lived, typically lasting 2-3 years. In the past 92 years, 1929-32 was the only consecutive 4 year down period for stocks. 1973-74 was a 2 year decline, and 2000-02 was a 3 year decline.

If you don’t know when the declines are going to come, what can an investor do to maximize their chances of success?

Make sure you have an appropriate asset allocation (mix of stocks, bonds and cash) that suits your individual risk tolerance and spending needs. You should keep enough cash to provide for emergencies (we typically recommend 3-12 months of after-tax living expenses) and enough fixed income to serve a source of spending when stock prices are lower. While bonds are not particularly attractive right now with interest rates likely to rise from here, you will be glad you have them to help weather the periodic declines that historically are short-lived.

-Avoid making dramatic changes to your portfolio based on news headlines or the mood of the day.  The sudden “I’ve got a feeling” moves in to or out of the market, with a large portion of your portfolio are what can really hurt investors.

Focus on portfolio income. Dividend income from the stocks in your portfolio should be higher each year since more companies will increase their dividends than cut them. Many S & P 500 companies have histories of consecutive dividend increases of 25 years or more, with some over 60 years.

Understand how much you are spending, including what is discretionary and what is not.  The household spending level is the hardest question for most people to answer as we are updating their financial plans. If you are a Parsec client, take advantage of our eMoney portal to get a better idea of your spending by linking your credit cards and bank accounts. Access to the eMoney portal is included at no additional cost to Parsec clients.

Once you have a good grasp of your expenses, periodically monitor your spending level in relation to your portfolio income and investment assets, and adjust if needed.

Historically, the stock market has many more up years than down years. The key is having an appropriate asset allocation, not making dramatic changes to your portfolio based on the mood of the day, and periodically rebalancing to your target mix (which forces the discipline to buy low and sell high).

 

Bill Hansen, CFA

President and Chief Investment Officer

Share this:

What a Rising Rate Environment Could Mean for Bond Funds

After the yield on the 10-year U.S. Treasury Bond – a widely used economic bell weather – bottomed in July 2016, interest rates have risen substantially through March of this year.  The recent upward pressure on yields has pushed bond prices lower.  Strong economic growth, ongoing interest rate hikes from the Federal Reserve, and recent political developments could mean higher yields ahead.  Given the current environment, we’d like to take a closer look at bonds and bond funds.  We’ll examine how they work, a key risk metric to consider, and how these investments might perform if interest rates continue to rise.

Bonds are a type of fixed income investment given the regular cash flows a bondholder receives.  Similar to your home mortgage but with the roles reversed, investors who own bonds are loaning money to an entity (usually a corporation or a government) in exchange for a variable or fixed interest rate over a specified period of time.  This interest rate is known as the bond coupon and it varies based on the credit worthiness of the entity and the length of the payback period, among other factors.

While a bond’s coupon rate, or its stated yield at issuance, remains fixed for the life of the bond its price or value on the open market will vary based on prevailing interest rates.  When interest rates rise, bond prices fall, and when interest rates fall, bond prices rise.

How sensitive a bond’s price is to a change in interest rates is measured by a term called duration.  Specifically, duration is a measure of interest rate risk.  It indicates how much a bond’s principal value will rise or fall due to a change in interest rates.  Measured in years, a bond or bond fund with a higher duration will be more sensitive to changes in interest rates than a lower duration bond or bond fund.  As a result, a portfolio of bonds with a higher duration will fall more in price as interest rates rise than a portfolio with a lower duration, all else being equal.  Fortunately, bond mutual funds or ETFs report their portfolio duration and investors can use this metric to gauge short-term risk.

I say short-term risk because while a jump in interest rates – as we’ve seen recently – will weigh on a bond fund’s near-term performance, the higher current income that comes as a result of an increase in interest rates will often offset much of the decline in a bond fund’s value over the long-term.  This is one benefit of owning multiple bonds or a fixed income fund versus an individual bond.  Because a portfolio of bonds or a bond fund doesn’t have a single maturity date (instead it contains many bonds with different maturity dates), it can provide more income flexibility.  For example, in a rising rate environment, as some bonds in the portfolio mature, the manager can reinvest proceeds from those securities into new bonds that now have higher yields.  In turn, this pushes the portfolio’s yield up and helps to offset price declines.  In particular, bond funds can offer significant diversification benefits given their exposure to many individual bonds with different durations and credit profiles often for a low fee.

While a bond fund’s duration will indicate how much it declines (or rises) in price when interest rates rise (or fall) over a given period, it also indicates how much of a boost it will get from new, higher yields.  Bond funds with higher durations – which are more sensitive to interest rates – typically offer higher current yields to compensate for their higher risk profiles.  So while bond portfolios with higher durations will experience sharper price declines when interest rates rise, they’re also more likely to benefit from higher current income over the long-term.  At the same time, bond funds with shorter duration – which are less sensitive to interest rate changes – won’t benefit as much from higher current income associated with rising interest rates, but they won’t fall in price as much either.

The point is that bond duration is a useful risk metric.  When a fund has a higher duration it tells us that its price will fall more dramatically when interest rates rise as compared to a lower duration fund, but it should benefit more from higher current income tied to higher yields.  The key, however, is your investment time-horizon.  As an investor, you’ll be able to benefit from the higher current income of a longer duration bond fund only if your time-horizon exceeds the fund’s duration.  When it does, higher income over the long-term should offset near-term price declines.

This dynamic – of higher income offsetting falling bond prices – is related to the nature of bonds and is nicely illustrated by the Bloomberg Barclays U.S. Aggregate Bond Index.  According to Charles Schwab, since 1976 over 90% of this index’s total return has come from income payments rather than price changes.

While most investors should fair well with a bond fund that is aligned with their investment horizon, diversification is another important consideration.  As stocks have historically delivered the strongest long-term returns and have outpaced inflation since the early 1900’s, bond investments are best used when there is a specific income need.  When this is the case, having a mix of shorter and longer-duration bond funds can help an investor take advantage of a changing interest rate environment and mitigate sharp price swings.  In today’s environment, owning bond funds with varying durations – in proportion to one’s income needs, investment time horizons, and risk tolerance – an investor should be better able to take advantage of rising interest rates.  For example, let’s take a client with 20% of his bond holdings in a short duration fund, 20% in an intermediate duration bond fund, and 60% in a long duration bond fund.  If interest rates were to rise sharply, the lower duration fund would see a small if negligible decline in value. In some cases, it may make sense for the investor to sell some of those shorter duration securities and use the proceeds to add to their long duration bond fund, which would now have a higher current yield.

In addition to duration and price sensitivity, Parsec’s Research Committee considers many other factors when constructing a client’s fixed income portfolio.  We also look at where we are in the credit cycle, the underlying quality of each bond asset category, valuation levels, and inflation sensitivity, among others.  Although thorough and well thought out research is critical to meeting your financial goals, staying invested for the long-term is even more important.  When appropriate, doing so with a fixed income portfolio can help you better weather significant price swings and ultimately benefit from current income.

Thank you,

The Parsec Team

Share this:

Why Trying to Time the Market is a Losing Game

The U.S. stock market has returned 282% since bottoming in March 2009, following the Financial Crisis.  Since that time, the S&P 500 Index has delivered positive returns in seven out of the last eight years and appears poised to produce another gain in 2017.  While it’s true that valuation levels are above long-term historical averages, in this email we’ll explore why trying to time the market is a losing game.

As a client you may be concerned that higher stock valuation levels coupled with a long-running bull market could mean an imminent pullback.  If so, you’re not alone.  Many investors have noted that it’s been a while since we’ve had a major stock market correction (defined as a drop of 10% or more).  This makes sense given that historically, the stock market has averaged three pullbacks of about 5% per year, with one of those corrections typically turning into a 10% or greater decline.  While it has been twenty-two months since our last market correction, we’ve seen longer.  Since 1990, we’ve experienced three periods lasting longer than twenty-two months over which markets did not experience a 10% or greater pullback.  So although we’re not in uncharted territory, the historical record suggests we could be closer to a market decline than not.

Given the above facts, clients often ask why we don’t sell stocks and raise cash in order to avoid the next market correction.  It’s a fair question, but when examined more closely we find that it’s a very difficult strategy to implement successfully.

Research has shown that trying to time the market is a losing game.  One reason is that an investor has to accurately predict both when to get out of the market and when to get back in.  While it’s difficult enough to time an exit right, the odds of then correctly calling a market bottom are even lower.  Part of this relates to the nature of market declines.  Looking back to 1945, the average stock market correction has lasted just fourteen weeks.  This suggests that investors who correctly sell their stocks to cash may be sitting on the sidelines when equities surge higher, often without warning.  While moving into cash may avoid some near-term losses, it could come at the higher cost of not participating in significant market upside.

Another reason to avoid market timing relates to the nature of market returns.  History shows that since 1926, U.S. large cap stocks have delivered positive returns slightly more than two thirds of the time.  As a result, you’re much more likely to realize higher long-term gains by remaining fully invested in stocks and weathering some of the market’s admittedly unpleasant downturns.

At Parsec, instead of market timing, we recommend investors stay invested throughout market cycles.  While this can be difficult at times, investing in a well-diversified portfolio has been shown to help mitigate market volatility and provide a slightly smoother ride during market downturns.  This is because portfolios that incorporate a thoughtful mix of asset classes with different correlations can provide the same level of return for a lower level of risk than a concentrated or undiversified portfolio.  It also ensures that investors participate in market gains, which often materialize unexpectedly.

In addition to constructing well-diversified portfolios, we believe in setting and maintaining an appropriate asset allocation based on your financial objectives and risk tolerance.  We then rebalance your portfolio to its target weights on a regular basis.  This increases the odds that you sell high and buy low.

Share this:

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

Share this:

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

Share this:

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

Share this:

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

Share this:

What is an Index (and why should you care)?

Recently I was on vacation with a friend, and while enjoying the sunshine she received a CNN alert…

Breaking News: Dow Jones Industrial Average soars to an all time high.

She then asked me what the Dow Jones was exactly … “Should I know what this means?” My response was, “it’s a stock market index, of course.” Seeing the perplexed look on her face, I realized that she had no idea what I was talking about. After having this conversation, I wanted to share with you what I shared with my friend.

  1. What is a market index? – A stock market index is simply a measurement of the value of the market or a section of the market. Let’s break it down into a simple example. Assume ABC index is made up of 6 companies. At the end of trading on Monday the index is at 5,000 points. On Tuesday, three of the companies go up in value, two of the companies go down and the sixth company stays the same. The total value of the stocks change by 3% on Tuesday, so now the index is at 5,150 points. This tells you that this section of the market went up in value from Monday to Tuesday.
  2. Why are market indexes important? Choosing appropriate investments is only the beginning. One of the biggest challenges of an investor is to determine how well your portfolio is performing. Are you lagging behind the market or beating it? You can only know the answer to these questions if you have something to compare your investments to. Indexes allow you to measure the performances of your investments against an appropriate benchmark.
  3. How do you choose the right benchmark? In general, when you are tracking the performance of an investment, you look at a benchmark that is most similar to your investment. For example: If your portfolio is all U.S. large cap stocks you would likely use the S&P 500 as your benchmark. If your portfolio is all fixed income then you would most likely benchmark against the Barclays Aggregate Bond index. If your portfolio is a combination of both large-cap stock and fixed income you would want to use a blended benchmark of the two indexes.
  4. All of this is for naught if you don’t know what indexes track which stocks. Here are some of the most common market indexes and the companies they are comprised of.
  • Dow Jones Industrial Average (DJIA) – This is one of the most popular measures of the market. A.K.A. “The Dow” or “Dow 30” is a price-weighted measure of 30 US blue-chip companies. The index covers all industries with the exception of transportation and utilities, which are covered by other Dow Jones indexes.
  • S&P 500 Index – This index is based on 500 U.S. large cap companies that have common stock listed on the NYSE or NASDAQ. These companies are representative of the industries in the U.S. economy.
  • Russell 2000 – This index tracks 2,000 small-company stocks. It serves as benchmark for the small-cap component of the overall market.
  • Dow Jones Wilshire 5000 – This index covers over 5,000 US companies listed on major stock exchanges. This includes US companies of all sizes across all industries.
  • Barclays Capital Aggregate Bond Index – This is a broad-based benchmark that measures the investment grade, US dollar-denominated fixed-rate taxable bond market.
  • MSCI EAFE Index – This index is designed to measure the equity market performance of developed markets outside of the U.S. and Canada. EAFE is an acronym that stands for Europe, Australasia and Far East. (Check out Sarah DerGarabedian’s blog post from last week to read why it’s important to have an international allocation – http://wp.me/plOKq-oE)  
  1. It’s important to remember when comparing your investment returns to compare your results to the long-term market, not just the past year. Typically analysts look at 3, 5 and 10 year returns. Short-term results can often be misleading due to short-term volatility. A quick Google search should provide you with the long-term returns of any of the major indexes.

After explaining all of this information to my friend, I think she had a better grasp on market indexes and hopefully this information is helpful to you too. One realization that came from our conversation is that sometimes financial advisors (nerds) forget that things that seem so common to us aren’t as familiar to those not in the industry. We never want a client to leave a meeting or conversation feeling confused or uncertain. If you have questions, please ask! We may just write a blog post about it.

Ashley Woodring, CFP®

Financial Advisor

Ashley_Woodring(b)

 

 

Share this:

Gen Y, Say Yes to Stocks!

It started with anecdotal evidence: a conversation with a co-worker about a group of professionals he spoke to about their 401k. The wiser (by which I mean older) folks were asking about the outlook for the economy and how they could maximize their 401k contributions. But the young man in the group, who was in his early 30s, expressed complete contempt for the stock market.  All of his money, he said, was in cash. Then a client of mine who is nearing retirement called me just to tell me about a dinner he went to where the topic of investing came up.  He was shocked at how vehement the young people at the table were about not investing in stocks due to their risk.

Since then I’ve read about a growing body of evidence coming from surveys and other research that suggests that the younger generations are too conservative in their investments. Gen Y is saving but not investing aggressively enough. The problem is that they distrust financial institutions (we don’t count) and believe another financial meltdown is all but imminent.

Gen Y, we don’t blame you. You were in your teens on Sept. 11, 2001, which had to have rocked whatever concept of stability you had. By the time you were old enough to know what the stock market was, the technology-driven crash of 2001-2002 was causing strife in budding 401k plans. And just when you were starting to dream about home ownership the housing market was spiraling out of control in 2008-2010. Many of you watched your parents go through extreme financial duress during this time period, something you were well old enough to understand.

It’s no wonder that Generation Y is too conservative. Your generation doesn’t have the benefit of personally experiencing the roaring 80s and 90s to boost your confidence about the markets. You don’t know who Crockett and Tubbs are. Looking at historical stock returns on paper just isn’t the same as living through it. And it’s hard to understand why men ever wore over-sized shoulder pads, but they did. Even the last five (amazing) years of positive stock markets seems like mere payback for the horror of 2008-2009. Despite this, we have to remember that stocks have historically provided the highest long-term return. No matter what your steadfast beliefs are about the future of the economy, it probably carries no more predictive capacity than the next differing opinion. That’s why we look to history as a guide, rather than trying to guess the future.

When you look at stock volatility over long time frames, it isn’t nearly as risky as the day-to-day movement would have you believe. In the last 87 years large company stocks’ annual returns ranged from -43% in the worst year to +54% in the best. That’s quite a spread! But those same stocks in any given 20 year period (starting on any given day in any year) averaged returns in a range of +3% in the worst 20-year period to nearly +18% in the best 20-year period. That includes the Great Depression and the market crashes of this century. That’s a lot easier to swallow. You have a long time before liquidating your accounts for retirement – probably more than 30 years, so you should be taking a longer term view.

And let’s not forget about inflation. That cash that’s in your 401k is doing less than nothing for you. Long run inflation is around 3%. If you are getting a 0% return on your cash, that is actually -3% in real dollars, guaranteed.

Saving money isn’t good enough. Millennials need to invest with a little more oomph. Yes, diligently putting away $500 a month for 30 years is hard work and no one wants to see their money shrink. But consider this: if you get a modest 4% average return on those savings, you will have $347,000 in retirement; if you double that return to 8% an amazing thing happens: $745,000. Taking risk means a lot of ups and downs along the way, but potentially twice the money in the end. If you can go cliff-jumping with your friends, you can buy stocks, right? (No? Was that just my friends?)

There is no reward without risk, to be sure. Any investment plan should be done with the full comprehension of the volatility, range of outcomes and potential for return. There certainly is risk in losing money in the stock market over short and intermediate time periods. However, those losses only become permanent if you sell out during periods of decline. It seems all but certain that an all-cash/fixed income portfolio is doomed to growth too slow to possibly reach any long-term financial goals.

 

Harli L. Palme, CFA, CFP®

A Gen-exer who believes all of the above applies to her generation too, except the part about over-sized shoulder pads.

Share this: