Super Human Power to Save

“How does anybody ever make money in the stock market?” my buy-and-hold investing father asked me. I couldn’t believe he was asking me this because he’s made a lot of money in the stock market over the last 30 years. It’s just that over the last decade, even the tried and true stock market investors are weary.

The way my dad has made money in the stock market is with two simple strategies. Save your money. Invest and be patient. First and foremost, my dad has a super-human power to save. He is a minister and chaplain and this does not add up to an enormous salary. But he has saved religiously (no pun intended) a little bit of every pay check he ever received. Most people cannot do this. It is by saving his money, that he has made money.

Secondly, once that money is invested, keep it put. This is something else that requires serious strength of conviction, particularly during 2001, 2002, 2008 and the first part of 2009. My dad asked “How does anybody ever make money in the stock market?” during 2008 when it felt like everything he’d saved was washing away. But he stayed invested and it has paid off. Despite the various market declines, the long term trend is up. For instance, when my dad starting investing in 1980, the S&P 500 index was at 107, in 1990 it was at 353. Now it is hovering around 1100, and these levels do not even consider dividends.

This is how you make money in the stock market. Even when things look grim, keep saving, keep investing. You can’t control the stock market (believe me, I’ve tried), but you can control what you do with your money. You can spend it or you can save it. Choose to save regularly. Choose to invest wisely, and stay invested. Be patient and give it time.

Harli L. Palme, CFP®

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The Importance of Dividends

The current dividend yield on the S & P 500 index is about 2%. According to a recent article in Barrons’, dividends accounted for 43% of stock market returns over the past 83 years. The remaining return came from the change in stock prices. So far in 2009, dividends have accounted for only about 10% of the market’s total return.

We believe that dividends help put a floor under the value of a stock, because you are receiving an ongoing stream of cash flows from the time that you make your investment. Growth stocks, which pay lower or no dividends, must earn their total return exclusively from the change in price.

It is important to consider both the level and sustainability of dividends. The S & P 500 has a payout ratio of about 45%. This means that for every $1.00 in earnings, companies are paying an average of about $0.45 in dividends. Significant levels of debt or off-balance sheet obligations like under funded pension plans or post-retirement health care benefits may restrict a company’s ability to pay dividends in the future, since they have other needs for this cash. When evaluating individual stocks for inclusion in client portfolios, our Investment Policy Committee considers both the current dividend yield and the payout ratio. A high payout ratio of 75% or more may indicate that the dividend is at risk of being cut in the future. An unusually high dividend yield is also a sign that the dividend may not be sustainable. If something seems too good to be true, it usually is.

Why not buy all dividend paying stocks? Different clients with different investment objectives may have different levels of dividend paying stocks. A retiree who is spending from their portfolio, in addition to possibly having an allocation to fixed income (bonds), may have more dividend paying stocks than a younger client in the accumulation phase. Increasing portfolio income is one factor that we take into consideration as we review client portfolios for potential improvements. Also, a cornerstone to our investment philosophy is broad diversification including growth and value companies, small, medium and large companies and international companies. We never know for sure what is going to do better, so we want to have a mix of assets that will perform well under a variety of market conditions. If we focused exclusively on dividend-paying stocks, we would be forced to underweight sectors of the economy like technology that we believe have attractive future growth prospects. This year, large growth companies have returned over 32% versus 17% for large value companies. Small and mid-sized growth companies have also outperformed their value counterparts during this period. Therefore, including an allocation to growth companies that pay little or no dividends has helped portfolio returns this year.

Currently, dividends are taxed at the same rate as long-term capital gains. With the Bush tax cuts currently set to expire at the end of 2010, dividends are scheduled to be taxed at higher ordinary income rates for 2011 and beyond. The main implication of this from an investment perspective is asset location. If the tax on dividends does rise, we would lean towards putting higher-dividend stocks in a tax-deferred account such as an IRA where feasible.

Bill Hansen, CFA
November 25, 2009

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ORGANIZE! ORGANIZE! ORGANIZE!

Are your affairs in order if you died tomorrow? Is your will or trust up-to-date? Do you have the assorted legal documents all in place: healthcare power of attorney, durable power of attorney? Have you checked the beneficiaries on your retirement accounts lately? Be Prepared – isn’t that the Boy Scout motto? We have seen clients with five or six separate IRA accounts or brokerage accounts at various places. Combining like-type accounts is much simpler and certainly less paperwork. Do you have old stock certificates lying around? If you would deposit them now into your brokerage account you will save your beneficiaries much time and trouble. Do you have a safe deposit box? We have seen clients that have had multiple bank accounts and more than one safe deposit box. Your beneficiaries need to know where to find the paperwork that leads them to your various accounts, certificates and safe deposit boxes. I recently had a client die and his daughter found a notebook in his residence with detailed instructions on where everything was, including a map of downtown Asheville with instructions on how to find Parsec Financial. You might also consider checking on your parent’s situation (if they would permit that).

Barbara Gray, CFP®
Partner

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The Holidays Are Approaching!

Can you believe it is November already? The holiday season is fast approaching, a time when everyone is frantically looking for gift ideas for loved ones or considering year-end charitable giving. Have you considered giving highly-appreciated stock this year?

I will give you a minute to catch your breath from laughing. Yes, some people still have it, even after the market meltdown. You could certainly sell some of the stock and offset the gains with losses you are carrying over from last year. You might also consider it for gift giving.

A gift of stock to a minor can lead to valuable lessons about investing and financial responsibility. Just ask our founder, Bart, and his wife, Elaine. If their children wanted the hottest sneaker or the latest video game, they had to use funds from dividends on stocks they owned. Mom and Dad were not an ATM. Their children learned good money management skills, which is something everyone could use.

No, I am not trying to score brownie points because year-end reviews are soon. Kids learn a lot when they have a vested interest in the activity.

Also, charities would welcome a gift of stock. You must have owned the stock longer than one year. You can claim a tax deduction on the value of the stock at the time of transfer. You will not incur a capital gain, as long as you give the shares, not the proceeds from a sale. You will incur a capital gain if you sell the shares first.

Of course, there are tax issues, exclusions, and other requirements, depending upon the type of gift. If you have a particular stock you would like to give, please contact your financial advisor.

It is important to process the transaction early. The later you wait in December, the harder it is for brokers to complete the transaction before year end. Besides, with all the chaos that surrounds the holiday season, wouldn’t it be nice to cross off one thing on the to-do list as soon as you can?

Now, let’s all take a deep breath and prepare ourselves for the madness to come. I hope everyone has a safe and happy holiday season.

Cristy Freeman, AAMS
Senior Operations Associate

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Who Says it isn’t Easy Being Green?

Well, I finally broke down and invested in a socially responsible mutual fund. I don’t know what’s happening to me – I’m starting to have feelings, a conscience – and I was so convinced that I’m perfectly logical. I blame it on becoming a parent. I’m suddenly much more concerned about how companies are making profits, rather than just if they are. And apparently, I’m not the only one – socially responsible investing (or SRI) has been around for over 250 years, beginning with early religious proponents such as the Society of Friends (a.k.a., Quakers) and John Wesley. Though the objectives of some socially responsible mutual funds are still rooted in religious principles, most are now concerned primarily with environmental sustainability and corporate governance. A mutual fund (or fund company) with socially responsible objectives screens its investments both for elements it doesn’t want (business practices that are harmful to individuals or the environment) and for elements it does (clean technologies, ethical business practices, respect for human rights).

Finding out the objectives of a particular socially responsible fund is a relatively simple matter of searching for the fund company online – they usually list that sort of information on their website. (Well, I say simple, though recently my computer was infected with a virus that attacked my search engine of choice. I noticed something was amiss when Google was all dressed up for Thanksgiving – on October 12th. After glancing at my calendar to make sure it wasn’t already the fourth Thursday in November, I saw it was Thanksgiving – in Canada! The virus was redirecting me to Google Canada, for some reason, as well as to malware-loaded sites, but our IT folks got me all cleaned up.)

In this article I’ve focused mainly on mutual funds, because with individual stocks, it’s easier to pick and choose the companies in which you’d like to invest. When you buy shares of a fund, though, you are buying a basket (sometimes hundreds) of individual companies, and it’s hard to know what you own, since you are in effect paying the fund manager to choose the investments for you. However, you can find a socially responsible fund that screens companies for the qualitative measures that are important to you, a process for which they are much better equipped than the typical individual investor. And, with SRI accounting for about 11% of the US investment marketplace (according to socialinvest.org), it’s getting easier to find funds with good track records and reasonable expenses. 

So, what’s the main takeaway here? That apparently, Canadians celebrate Thanksgiving, too. Not that there’s anything wrong with that, eh?

Sarah DerGarabedian

Research and Trading Associate

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When Mutual Funds Make Sense

The best thing about mutual funds is that they are an easy way to hold a diversified investment.  The difficult thing about mutual funds is that many mutual funds underperform the broader market, they can be expensive, and there are so many options available that picking among them can be daunting.  But it is possible to pick high quality, low expense mutual funds that are suited to you, and it is important to determine when a portfolio calls for them.

It is our philosophy that in large portfolios, mutual funds are best used to get exposure to international, small-cap, and some mid-cap companies.  This is because the universe of international and small companies is so large, it is best to rely on an active manager who specializes in those areas.  Also, research and financial data is not as readily available on international and small-cap stocks, making active managers all the more important. 

We do believe, however, that we can create a well-diversified portfolio of large-cap, domestic (S&P 500) companies by buying individual stocks.  There is a plethora of research available on these companies, making financial data transparent and easy to obtain.  The trading costs on individual stocks is low enough that this is a more cost effective way to get exposure to this area if your portfolio is large enough to fit 30-50 individual positions of a reasonable size.

In smaller portfolios it becomes less cost effective to buy individual stocks.  To get 40 individual stocks in a portfolio that already encompasses bonds, international and small-cap funds, we would need to resort to very small position sizes.  The smaller the position size, the larger the transaction cost as a percentage of the holding.  Therefore, we believe that depending on the size and the number of accounts within a portfolio, mutual funds may be the best option.

When we choose mutual funds we look for those of the highest quality.  We focus on long-term performance track records, various risk measures associated with the funds, and low-cost investments.  We routinely assess the quality of the funds we hold, and screen for new additions to our fund buy list.  If a fund no longer meets our criteria, we will replace it with a fund we view as better.

To what extent a client has mutual funds in their portfolio is determined on a case-by-case basis.  Sometimes this comes down to client comfort level and perspective.  Other times it is a function of the type and size of accounts in a portfolio.  We work with clients to determine what makes the most sense for their particular situation.

Harli L. Palme, CFP®

Financial Advisor

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Inflation Ahead?

With the extraordinary amount of fiscal and monetary stimulus pumped into the financial system over the last 12-18 months, many investors are concerned with the prospect of future inflation. The large U.S. budget deficit is another potential inflationary factor if it is financed by the government expanding the money supply.

Despite these factors, inflationary expectations in the bond market are quite low. There is even a small but vocal minority of market participants that believe that deflation remains a significant risk. One way to determine the markets’ expectation for inflation over the next ten years is to compare the yields of U.S. Treasury Notes against those of Treasury Inflation Protected Securities (TIPS) of similar maturity. The current yield on the 10-year U.S. Treasury Note is 3.33% as of this writing, while the 10-year TIPS yield is 1.5%. The difference of these two numbers is the implied inflation rate over the next 10 years of 1.83%. If inflation over the next 10 years turns out to be higher than 1.83%, then you would be better off buying the inflation-protected security. Since 1926, inflation has averaged about 3% annually. While we do not believe that there will be a sharp increase in inflation over the next 1-2 years, it certainly is a possibility over the longer term. Therefore, within the fixed income allocations of our client portfolios, we have been avoiding purchases of traditional Treasury securities in favor of TIPS.

 What asset classes would perform better in an inflationary environment? Among fixed income investments, we would expect inflation-protected bonds and high-yield bonds to perform better. Although the short-run impact of inflation on stocks has historically been mixed, stocks typically act as a hedge against inflation over longer time periods. This is particularly true of companies and industries that have the ability to pass along price increases to consumers, or those that have comparatively low levels of fixed assets. Our core strategy of broad diversification and no market timing would remain unchanged, whether the environment is inflationary or deflationary. The main determinant of a portfolio’s return is the asset allocation. Having the discipline to stick with your chosen allocation is more important than the specific allocation that you choose.

Within the equity portion of client portfolios, we may overweight certain sectors or industries that we believe would fare better in a particular inflationary environment. However, since the future is uncertain, our main goal remains to create client portfolios that will perform well in a variety of economic scenarios.

 Bill Hansen, CFA

October 9, 2009

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The Uncertain Future of the Estate Tax

Although it isn’t a pleasant subject, estate taxation will probably begin to seep into media coverage.  Why?  Because currently it is set to disappear entirely in 2010 only to return in 2011 with a 55% rate on the portion of estates over $1 million.  

In 2009 the value of an inheritance shielded from taxation is $3.5 million with the excess taxed at a 45% rate. This is the next to last year of President George W. Bush’s 10-year $1.35 trillion across-the-board tax cut effecting estate taxation.  

Politically speaking, President Obama has proposed permanently locking in the exclusion of $3.5 million and the current tax rate of 45%.  Congressional Republicans favor a full repeal.  The central players on estate tax policy are currently preoccupied with the health care debate: Senate Finance Chairman Max Baucus (D, Mont.) and House Ways and Means Chairman Charles B. Rangel (D, N.Y.).  So, you can imagine that many different scenarios could play out. 

Given all the issues facing our lawmakers and demanding their time, I would suspect the simplest route would be to fall back on a one year extension of the current rate and exemption.  Then, it could be more adequately addressed next year.   

Although I personally favor repeal, I’m reminded of the quote from Mark Bloomfield, president of the American Council for Capital Formation, “Those people who believe repeal of the estate tax will happen are probably more delirious than Ralph Nader thinking he could be president of the United States.”    

Michael E. Bruder, CFP®, CTFA

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Risky Business

The wild 700-point, daily market swings certainly gave us all a nasty lesson in market risk. Let’s take a closer look at risk because market risk is not the only risk involved in investing.

There are two main categories of risk: systematic and unsystematic. Think of systematic risk as non diversifiable or risk that is inherent in the system. Investors cannot control which direction interest rates will go. The value of the dollar will most likely be different ten years from now, but who knows what that value will be? Systematic risk encompasses market fluctuations from all the unknowns in the system as a whole.

Unsystematic risk, however, is unique to a particular investment. For example, the future of the company who makes the hottest trendy item might be more uncertain than the company who makes peanut butter. You can reduce this type of risk by having a well-diversified portfolio.

Keep in mind that there are risks in not being invested, such as opportunity cost and purchasing power risk. Opportunity cost is the cost of missing a positive return because a person was not invested in a rising market. Purchasing power risk occurs when an investor’s lower-returning asset class does not keep pace with inflation. For example, money market interest rates are now near zero, yet the price of everything else continues to rise.

Each of us has a different risk tolerance. As you evaluate yours, please consider your financial goals. Do you plan to retire soon? Are you already retired? Do you have children who will be entering college soon? Do you want to start your own business?

If your risk tolerance and financial goals have changed, please talk with your advisor.

Cristy Freeman, AAMS
Senior Operations Associate

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Gold as an Investment

We are frequently asked about gold as an investment. Sir Isaac Newton set the gold price in 1717 and it remained the same for two hundred years. The gold standard was lifted in the 1970’s and the price has fluctuated since then. The price was $40.62 in 1971 and it rose to $615 in 1980. The return from 1980 to 1990 was -4.6% (1990 price was $383.51). The return from 1990 to 2000 was -3.12% ($383.51 to $279.11). The period from 2000 – 2008 was good for gold with a return of 15.2% ($279.11 – $871.96).

Large company stocks (from Ibbotson) had a return of 9.62% from 1926 – 2008; small company stocks returned 11.67%; and long term government bonds returned 5.7%. Gold returns for the same time period returned 4.67%. Don’t forget those returns do not factor in the average inflation rate of 3%. If you bought gold in 2000, you would have out-performed stocks as the last decade has been dismal for stocks. Gold is currently at a very high price of $1,006 today, so if you are thinking of buying gold, you just might be buying high. Another drawback to investing in gold is that it is considered a collectible and is not granted favorable capital gains treatment.

Barbara Gray, CFP®
Partner

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