The Tried-and-True Way to Build Wealth

In today’s ultra-connected world it’s even more tempting to compare ourselves to our family, friends, and neighbors. Are we falling behind in our career? Is our family life sub-par? Should we be making more money? Although we all know that people post their best images and experiences on social media, it’s easy to forget that we are tuning in to a lop-sided view of reality. Ironically, this warped perspective can encourage ideas and behaviors that move us further away from what we’re trying to find: a happy and rewarding life.

At Parsec, we work with one aspect of a happy and rewarding life: helping our clients reach their long-term financial goals. Often these include becoming financially independent and retiring comfortably.  While social media and the popular press would have you believe that the right image, owning an expensive car or home, and living a lavish lifestyle translates into financial success, it doesn’t. What does lead to financial independence – and happens to be highly correlated with happiness – is much less glamorous and a lot simpler. It’s the age-old adage of living below one’s means.

Although it’s not sexy, spending less than you earn month-in and month-out is one of the most dependable ways in which to accumulate wealth. Sure there are a handful of folks who will strike it rich with the next great idea, but for the vast majority of us, we will earn our livelihoods working for a company. This is good news, really. The risks are much lower with a nine-to-five job, along with stress levels, and the path to financial independence is quite clear. Time and again, research confirms that spending less than you earn while regularly contributing to a low-cost, well-diversified investment portfolio can lead to significant wealth accumulation.

No, it’s not very exciting and unfortunately, it’s not that easy either. We can see how difficult it is for Americans to live below their means by examining our aggregate retirement savings metrics. According to the Economic Policy Institute (EPI), the median retirement savings of all working-age families in the U.S., defined as those between 32 and 61 years old, is a mere $5,000! That stands in stark contrast with the amount of money most experts suggest we need to retire at age 67. While retirement savings will vary considerable from one person to another, one rule of thumb recommends having ten times your final salary in savings. Given a median U.S. income of $59,039, this suggests that the average American needs about $590,390 in savings to retire.

So why is it so difficult for most Americans to live below their means? Of course, it varies from person-to-person, but there are some recurring themes. In general, Americans seem to want instant gratification more so than in the past. One theory is that as an over-worked, time-crunched culture, we are dealing with higher stress levels than earlier generations. We then try to manage our stress by turning more and more to material things and experiences. While we know intellectually that spending on items we don’t really need only provides temporary relief, our tendency to accumulate things often becomes habit-forming. Big money problems can then arise when our need for immediate gratification gets paired with a lack of financial awareness. America’s current retirement savings situation reflects just such a scenario.

All that said, if you are reading this article it suggests you have or are starting to cultivate financial awareness, which we believe is a big part of the solution. As we start to question our spending motivations individually and as a culture, it will help us become clearer on what we’re really after and how to get there. While we are a vastly diverse nation of people, it would seem that at the end of the day most of us are after the same thing: a happy and fulfilling life.

Once we realize this, we can start to eliminate habits or tendencies that get in the way. We can start to simplify our lives and spend our time, energy, and money on things and activities that contribute to a happy and fulfilling life. Doing so naturally helps us live below our means and comes with the added benefit of reduced stress levels. From a financial perspective, a simplified lifestyle not only helps accelerate your ability to save for retirement but it means that once you reach retirement, you will require less income in your golden years. Starting to live below your means early-on, questioning your spending motives, and simplifying your life can become a virtuous cycle that suggests your retirement years can truly be golden.

Carrie Tallman, CFA, CFP®

Guest Blogger

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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

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Why Don’t We Trade in Round Lots (or at least round off the shares)?

Over the last two years, you may have noticed that some of your individual stock holdings have gone from neatly-rounded share amounts, to odd-numbered share amounts. Why did this happen?

First, a little history.

In the days before computers, market specialists traded shares on paper in a physical stock exchange (think Trading Places). In order to make the math easier, they traded in what are called “round lots” or shares in multiples of 100. If you wanted to trade an odd lot back then, you would incur an additional cost. Once computers took over the trading landscape, odd-lot trading was no longer difficult. It’s just as easy for a computer to match round lots as it is for them to match odd lots, so there’s no extra fee associated with trading an odd lot. In addition, the advent of algorithmic trading has contributed to the increase in odd-lot trading.

Since there is no longer any impediment to trading odd lots, this is how we’ve purchased shares of stocks and ETFs for our clients for many years. Up until a couple of years ago, however, we still rounded off the share amounts to the closest 5 or 10 shares, primarily because those of us who work with numbers tend to appreciate evenly-rounded shares, neatly made beds, and spice cabinets where all the labels are lined up (and in my house, parsley/sage/rosemary/thyme must always be arranged thusly).

Alas, two years ago, our hospital corners came untucked by none other than a software program called iRebal. A fantastic program in so many ways, one of its features is, that it likes to calculate trades in dollars. This makes a lot of sense for the type of rebalancing that we do, which is always dollar-based. With our previous software, Portfolio Managers took an extra step to manually round-off the stock shares to the closest 5 or 10 before sending the trades to the blotter to be executed. iRebal saves the rounding to the last minute, so that it happens AFTER the trades reach the blotter. Prior to execution, the trader refreshes the stock prices and the share amount is calculated at that time. In this way, we are protected from buying or selling too much based on stale pricing. In addition, we found that having the software round the shares to the nearest 1 (rather than 5) resulted in a more accurate portfolio rebalance. And yes, we did have a lengthy discussion about switching to a nearest-one rounding convention, but decided that 1) since odd-lot trading does not result in a price disadvantage, and 2) it helps us achieve our stated rebalancing goals on behalf of our clients, it’s worth wrinkling the sheets a little bit.

Sarah DerGarabedian, CFA
Director of Portfolio Management

Sarah DerGarabedian

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2017 IRA Contribution Rules

The deadline to make IRA contributions for tax year 2017 is Tuesday, April 17. 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. Keep in mind that if neither you nor your spouse participates in a work-sponsored plan, you can deduct IRA contributions regardless of your income.

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 2017 Contributions For 2018 Contributions
Single, participates in an employer-sponsored retirement plan: $62,000 – $72,000 $63,000 – $73,000
Married filing jointly, participates in an employer-sponsored retirement plan: $99,000 – $119,000 $101,000 – $121,000
Married filing jointly, your spouse participates in an employer-sponsored retirement plan, but you do not: $186,000 – $196,000 $189,000 – $199,000

Do you qualify to contribute to a Roth IRA?

Modified Adjusted Gross Income Phase-Out Range – Roth
Tax Filing Status For 2017 Contributions For 2018 Contributions
Single: $118,000-$133,000 $120,000-$135,000
Married, filing jointly: $186,000-$196,000 $189,000-$199,000

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®

 

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What Do You Need to Know About the Tax Cut and Jobs Act?

Major tax legislation generally only happens around once a decade. The last time we had a major re-write of the tax code was in 2003. Just like that round of legislation, most of the individual provisions in the Tax Cut and Jobs Act of 2017 (TCJA) are not permanent and will roll back in 2025. Legislators have indicated that they want to revisit the permanency of those provisions if fiscal indicators show that the bill is not adding to the deficit. Focusing on individual tax laws, we will look at the most common and impactful changes.

Beginning with income deductions, TCJA will remove personal exemptions from the tax code. In 2017, the value of this deduction was $4,050 per individual claimed on the tax return. This deduction was effectively collapsed into the standard deduction, which is currently $6,350 for a single person and $12,700 for a couple filing jointly. The new standard deduction will be $12,000 for a single person and $24,000 for a couple filing jointly. This creates a higher threshold for those seeking to utilize an itemized deduction. To make matters worse, many of the allowable itemized deductions have been either limited or fully eliminated. One sore spot for those taxpayers living in high tax states is a deduction cap of $10,000 on property taxes and state income Taxes. This limitation is an aggregated cap of these deductions. Miscellaneous itemized deductions have also been eliminated. The most common of which include tax preparation fees, investment management fees, and various unreimbursed employee expenses.

The mortgage interest deduction is also another itemized deduction that has come under scrutiny. The deductible limit of a new mortgage after December 15th, 2017 is $750,000 – a reduction from the current limit of $1 million. In addition to this, home equity interest will no longer be an allowable deduction on the Schedule A and there is no grandfathering of this rule. Charitable giving deductions were maintained, as well as medical expense deductions, with a lower threshold for two years. However, with the reduction of taxes paid deductions, removal of miscellaneous deductions, limitation of mortgage interest, and raising of the standard deduction; it will become more difficult to meet the threshold of itemized deductions going forward. This is especially true for retirees with paid off homes.

Now for some good news – tax rates are headed down. There will still be 7 tax brackets, but the rates are going down by 2-3% in each of the brackets. There are some adjustments to the income limits of each bracket, but the top bracket is reduced by 2% to 37%. Another sigh of relief for many taxpayers is that the Alternative Minimum Tax (AMT) will no longer affect taxpayers with under $500,000 of income for a single person, and $1,000,000 of income for a couple. In addition to raising the income limit, the exemption was also expanded. Additionally, those with minimum tax credits will be eligible to carry them forward and utilize them in future tax years. The relief on the tax rate and AMT front should help soften the blow of the lost deductions for many.

For those with children or grandchildren, the next two sections are important. With the loss of personal exemptions for dependents, this could have created a tax burden for families with more than two children. However, there was an expansion of the child tax credit, including an increase in the credit from $1,000 to $2,000, and an increase in the income phase out to $200,000 for a single person and $400,000 for a couple. As a result, a family with 4 children and income under $400,000 would receive an $8,000 tax credit. It is also important to note that there is a new tax credit for dependents who are not qualifying children, which could include college age students or even dependent parents or siblings.

The new law makes an important-to-note change to how kiddie taxes are calculated. Currently, unearned income is taxed at either the child’s tax rate, or the parent’s if it is above $2,100. Under TCJA, instead of the additional tax being calculated at the parent’s rate, it will now be calculated at the Estate/Trust tax rate. This is problematic, especially for inherited IRAs with minor beneficiaries because the tax rate hits the top tax bracket of 37% at just $12,500 of income. Fortunately, much of the income being earned by custodial accounts is tax-advantaged qualified dividends and capital gains, which will be taxed at the long-term capital gain rates of 15%, 20%, or 23.8% (where the Medicare Surtax applies). One strategy to reduce future tax rates in custodial accounts is to consider incurring capital gains in 2017 where the capital gain tax rate will be at or below 15% on the parent’s return. This is preferable because the tax brackets for individuals are much larger than the tax brackets for Estates and Trusts. A relatively small amount of income for minors will cause them to be taxed at the highest capital gain rate in 2018 and beyond. 529 plans also received some attention in the new law. The qualified usage of 529 dollars was expanded to include a $10,000 per student per year tax-free distribution for private elementary and secondary schools.

For those looking for additional estate planning options, TCJA has resulted in an expanded estate tax exemption of $11.2 million per person. This results in a maximum exemption of $22.4 million for a married couple utilizing both exemptions. The law continues to have a tandem gift tax exemption, tied to the amount of the estate tax. This means an individual is able to give away up to $11,200,000 without incurring any gift taxes.

There were a few notable new provisions, including a 20% deduction to “pass through” business income (excluding service based businesses like attorneys, medical professionals, and accountants, unless their total income is less than certain income limits), future alimony treatment, the repeal of the moving expense deduction, and changes to the Roth re-characterization rules. Additionally, corporate tax rates have been reduced to 21%, the new inflation measure for tax purposes will be Chained CPI, and the individual insurance purchase mandate has been repealed. These three provisions are permanent and will not rollback after 2025.

There were also a number of provisions floated in either the House or Senate bills along the way that never made it into the final bill. A few of these items are the removal of the student loan deductions, removal of the medical expense deduction, changing to “FIFO” or First in, First Out accounting method for selling stock, and changes to the capital gains exclusion for selling your primary residence.

It may be beneficial to defer income into 2018 as much as possible, and incur deductions in 2017 where possible.   If you have questions about increasing charitable giving prior to the end of the year to take advantage of 2017’s lower standard deduction, reach out to your advisor as soon as possible. Our custodians work on a best effort basis as we near the end of the year. Those utilizing a Qualified Charitable Distribution from IRAs as their sole charitable giving mechanism are not affected by the changes to the standard deduction. With all of these changes, we continue to stay on top of optimal tax planning strategies both for end of year purposes, as well as looking forward into 2018.

Tax Cut and Jobs Act “Cliff Notes” Version

  • Tax Rates:
    • Overall, they are down, with 7 brackets continuing and rates of: 10%, 12%, 22%, 24%, 32%, 35%, 37%
  • Exemptions/Deductions
    • Personal exemptions are going away
    • Standard deduction rising to $12,000 for a single person and $24,000 for a couple
    • State, property, and sales tax deductions are aggregated and capped at $10,000
    • Medical deductions remain, and AGI limitation reduces for next two years
    • 2% miscellaneous itemized deductions are eliminated
    • Mortgage interest deduction is limited to mortgages up to $750,000 and home equity debt is no longer eligible for deduction
  • AMT
    • AMT remains, but with much higher exemptions and income phase-in limits of $500,000 for a single person and $1,000,000 for a couple
  • Child Tax Credit
    • Has been increased from $1,000 to $2,000 per qualifying child and income phase-outs are raised to $200,000 for a single person and $400,000 for couples
  • Kiddie Tax
    • Will now be subject to fiduciary (Trust/Estate) tax rates
    • Includes inherited IRA income
  • 529 Plans
    • Now allow for up to $10,000 per child, per year tax-free distribution for private elementary and secondary education expenses
    • Also now includes up to $10,000 per year tax-free distribution for home school expenses
  • Estate Tax and Gift Tax Exemption
    • Has been increased to $11,200,000 per person with portability of exemption between spouses
  • Business pass-through rules
    • Preferential tax deduction for pass through entities, not in the service industry. However, Engineers and Architects are able to take advantage of this deduction.
    • Of pass through income, 20% is eligible to be taken as a deduction from income
    • For those in service based fields, namely physicians, accountants, attorneys, etc, deduction is still eligible for MFJ taxpayers with less than $315,000 income
  • Proposed Changes that did not make the final bill
    • First in, First out recognition of capital gains for appreciated securities
    • Removal of the student loan deduction
    • Removal of medical expense deduction

 

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Get Ready for Tax Season

Regardless of whether you prepare your own tax return or hire a professional to do it for you, you are still responsible for collecting the information necessary to complete it.  Well-organized records can make the process significantly easier and potentially save money with your CPA who typically charges by the hour.

One way to tackle this chore is to create a checklist of the documents and information needed to complete your return.  As you gather the documents, start to organize them in a file by the following categories and check them off the list.

Prior Year’s Tax Return

Use last year’s tax return as a starting point to create your checklist.  Although you may have new sources of income or different deductible expenses for the current year, this is usually a fairly comprehensive list of needed documents such as Form 1099 or 1098.  It will also serve as a reminder of information you may need to determine from bank statements or receipts such as medical expenses.

Sources of Income

This category generally includes wages, dividends, interest, partnership distributions, retirement and rental income.  You may receive a Form W-2, 1099, or K1 that indicates the amount of income reported to the IRS.  For other types of income, such as alimony received, you may need to determine the amount to report from bank statements.

Adjustments to Income

These are direct reductions to taxable income that commonly include deductible IRA contributions, alimony paid, Health Savings Account (HSA) contributions, SEP, SIMPLE or other self-employed pension plan contributions,  and self-employed health insurance payment records.

Deductible Expenses

If you itemize deductions rather than taking the standard deduction, you may need to collect source documents indicating the amount of mortgage interest paid (Form 1098), real estate and personal property taxes paid, medical expenses, and charitable contributions to be reported on Schedule A.

Tax Credits

Tax credits are a direct reduction of your tax bill so take a few minutes to research available 2017 credits.  You may be able to claim the American Opportunity Credit if you have a child in college or a Residential Energy Credit if you have made any “green” home improvements.

Basis of Property

This is also a good time to review and update the basis of property if necessary.  Home improvements made during the year may have increased the basis so collect and file those valuable receipts.

Taxes Paid

Federal and state taxes you have already paid may be found on your W-2 but if you pay quarterly estimated taxes you may need to collect records of payment.

While this is not a comprehensive list of every possible tax document needed to complete a tax return, it is a starting point from which you can develop your own, one that reflects your unique life circumstances.  Start organizing now and maybe tax season won’t be your least favorite season of the year.

Nancy Blackman - Parsec Financial Corporate Headshots
Nancy Blackman – Portfolio Manager
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Happy Donating!

As we approach the end of the year and the holiday season, we seem to be bombarded with opportunities for charitable giving. Happily, many of us answer this call and donate generously to our favorite charitable organizations. Your generosity may also be beneficial at tax time if you remember a few IRS guidelines for charitable contributions.

  • You must itemize deductions on Schedule A to deduct a charitable contribution.
  • Donate before year end to claim a deduction for 2017. Please remember if you are making a stock donation, to submit the request a few weeks before the end of the year. This will allow your custodian enough time to fulfil the request in time for the deadline.
  • Verify that the charity is tax-exempt (sometimes called 501 (c) (3) organizations) or qualified. The IRS considers the following types of organizations qualified for charitable donation purposes.
    1. A state or possession of the United States, or the United States for public purposes
    2. A community chest, corporation, trust, fund or foundation of the United States organized for charitable, religious, educational, scientific, or literary purposes or for the prevention of cruelty to children or animals
    3. A church, synagogue or other religious organization
    4. A war veterans organization
    5. A nonprofit volunteer fire company
    6. A civil defense organization
    7. A domestic fraternal society if the contribution is used for charitable purposes
    8. A nonprofit cemetery company if the funds are used for the perpetual care of the entire cemetery

More information about qualified organizations can be found in IRS Publication 526, Charitable Contributions. You can also verify the tax-exempt status of an organization on the IRS.gov website.

  • When making your donation of cash or goods, be sure to get a receipt. The IRS requires a receipt for donations greater than $250.
  • Large donations may be limited in the current year to 50% of AGI for public charities or 20-30% for private charities. Any excess donations can be carried forward for five tax years. When planning a large gift, talk to your tax professional to develop the most beneficial giving strategy.
  • Lastly, many employers will match gifts made by their employees, so remember to check your company policy and do twice as much good!

Nancy Blackman - Parsec Financial Corporate HeadshotsNancy Blackman, Portfolio Manager

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How Parsec Monitors Investment Securities

Parsec invests in a variety of securities for its clients.  These may include mutual funds, exchange traded funds or ETFs, and individual stocks, among others.  All of these investments can and do experience significant price pullbacks from time to time.  While Parsec’s Investment Policy Committee (IPC) focuses on investments it can hold for the long-term and performs significant research before adding any new positions, price declines still happen.  In this email we’ll discuss how the IPC monitors investment securities and we’ll share with you our process for when a stock or fund doesn’t perform as expected.

Investment security returns are driven by a number of factors.  For individual stocks, earnings growth, competitive environment, and exogenous events can significantly affect price performance.  For mutual funds and ETFs, the general capital market environment as well as portfolio management departures or changes at the parent company can influence both fund flows and price changes.  At Parsec, in addition to reviewing all covered securities at regularly-scheduled meetings, the Investment Policy Committee continually monitors client investments for these types of factors in between our ongoing investment reviews.

We do this by reading sell-side research reports, company government filings, and the news.  Likewise, the financial software we use alerts us to any new developments on our covered securities and helps us manage the large volume of news flow in order to focus on the most important stories of the day.  When a significant event does happen that negatively affects a security, we research the development by listening to a company’s conference call, reading industry reports, and conducting our own due diligence.  We review our thesis on the fund or stock and determine if and how the latest events could affect the security’s long-term prospects going forward.  In order to gauge an investment’s upside potential we adjust our growth assumptions to reflect the new information and evaluate the security’s risk/reward profile in light of its new price level.

Oftentimes when a major story surfaces there is minimal information on which to make a decision.  At the same time, the market has a tendency to overreact to news events.  For these reasons, Parsec’s Investment Policy Committee may intentionally wait before taking action when a stock or fund experiences a significant negative development.  Although it may appear that we are not responding to the event in question, we are in fact working diligently behind the scenes to gather as much data as possible while reviewing our thesis and assumptions.  This can be a frustrating time for clients who would, understandably, prefer us to take immediate action.  However, we have found that taking a wait-and-see approach allows us to collect more information and answer important questions before making an uninformed or premature decision.

Waiting for the dust to settle while collecting additional information also allows us to better understand how a development could affect a stock or fund’s long-term prospects.  If we determine that a company or fund can recover from an adverse event and the security has fallen significantly in price, it’s often an attractive buying opportunity.

However, on other occasions it may be clear that it’s time to sell a position.  This can happen when an investigation surrounding a security is new but affects multiple divisions or aspects of the underlying company’s or fund’s operations.  Another example may include an environmental disaster or a significant product recall that could take years to resolve.  In these instances the best action may involve taking a modest loss now in order to avoid a much larger loss in the months or years to follow.

While our bias towards higher-quality stocks and funds may mean we’re more likely to hold a security or even add to positions following a negative news event, we are closely monitoring client investments and performing in-depth due diligence as new developments arise.  Our intention is to make objective and thoughtful decisions that will benefit clients and their portfolios over the long-term.

Thank you,

The Parsec Team

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