As our firm has grown, so has the team of financial advisors. In addition to me, the experience of our investment committee is very impressive indeed. Here is some background on each member:
Bryan Bastoni joined our firm in 1999. After graduating with a Bachelors Degree from Curry College, with a concentration in finance, he obtained all the appropriate securities licenses and went on to become a CERTIFIED FINANCIAL PLANNER in 2009. Bryan resides in Rochester, MA with his wife Kerry, and their two young twin sons, Evan and Jason.
Louis Beaulieu recently joined our firm as an Advisory Representative, manning our office in Venice, FL, where he resides full time with his wife, Pauline. Louis has over 35 years of investment management, trust, compliance and financial planning experience and maintains the designations of Chartered Financial Consultant (ChFC); Certified Trust and Financial Advisor (CTFA); and Accredited Estate Planner (ARP).
Christopher Dupee has maintained his own CPA practice in Dennis, MA, since 2008 and became an Advisory Representative for Pearson Financial Services in 2009. Christopher received his Batchelor Degree in accounting from Bridgewater State College, and lives in Dennis, MA with his wife Lisa and their two children, Corinne and Cameron.
William Lord currently works as an Estate Administrator with the Law Office of Kathleen Fowler and became an Investment Advisor for Pearson Financial Services in 2008. He retired as a Managing Director for Mass Mutual Insurance Company and previously practiced as a CPA. Bill has maintained the Chartered Financial Analyst (CFA) designation since 1989. He lives in Hyannisport with his wife, Linda.
Attorney Kathleen Fowler has maintained her own Estate Planning Law Practice since 1991 and lives in Dennis, MA with her husband Neal and their two grown sons, Andrew and Nick. She has worked closely with Pearson Financial Services since 1994, helping her clients seek and understand the appropriate investment advice for their families’ financial security.
Clients, who use Pearson Financial Services and the Law Offices of Kathleen Fowler, have investments worth more than any other investment advisor alone can provide. Overlapping tax planning with Pearson Financial investment planning, yields a much greater return for clients who utilize our team approach.
Why are your investments worth more? With planning, your investments can escape the probate court process, saving costs of around 3% of the estate value. Your investments can escape MA estate taxation, saving 10-16% of the taxable estate value. Your investments can escape Federal estate taxation, saving 40% of the taxable estate value. Your investments can benefit from proper IRA beneficiary designations, allowing for estate tax sheltering between spouses and creating stretch required minimum distribution benefits for other family members. Your investments can be positioned among trust instruments to give maximum basis adjustment and capital gain tax avoidance.
These savings result in more value going to you and your family. Cutting edge investment advice, coupled with low fees and thoughtful and strategic titling of investments, yield a much greater return.
Currently, our investment committee is in agreement as to the likely outcome for the economy over the next few years. We see a worldwide economic expansion that will last longer than most, providing support for stocks and bonds. Slow growth will probably lead to the Fed increasing interest rates sometime in the near future. It seems that monetary policy is better equipped to control growth and inflation, leading to a moderation in the volatility of the stock and bond markets, as well as the economy in general.
Today, stronger regulation of bank and consumer debt means less risk but eventually business cycles will mature and inflation concerns will emerge. We will continue to revise our educated guesses as to future outcomes. This global expansion we are experiencing today could become the longest since World War Two. For the first time in twenty years the key indicators of growth in stock, bond and commodity performance around the world are up in unison for the first half of the year. This historic rally has occurred in the face of slow growth in the USA, the recent events in the Ukraine, Iraq and Syria.
In 1974, our firm was founded with the vision of providing all the most important financial and estate planning solutions under one roof. Then, over the years, our team of professionals designed the company to be so strong and so unique that it would certainly outlive its founders.
This team will preserve the long term stability and continuity of this company that they helped build and will lead into the future. What started 40 years ago will surely be here for the next 40 years to advise your family and mine.
Can you believe yet another year has come to an end? Meanwhile, the news flow from Washington has been non-stop. Even though the Democrats and Republicans canít seem to find common ground, the Republicans, by holding a majority, have been able to jam through a tax cut package which has already been signed into law by the president. The investigation into Russian collusion seems to be far from over. Tensions with North Korea seem to be ratcheting up. There are continued threats of terrorism around the world, along with the ongoing outbreaks of major cyber-attacks. Yet, with a mountain of worry to surmount, the stock market has continued its climb this year, with little, if any volatility to the down side! At the writing of this letter, the S&P 500 Index is up close to 20% and some International Indexes are up even more than that. We have enclosed a handout that shows the 2017 performance of our core Vanguard Exchange Traded Funds for your reference.
What happened to the ďslow growth/lower return environment for the next 10 yearsĒ, as outlined by many of the stock marketís largest asset providers? Our advice would be to not get too complacent and continue to plan for lower returns over time. As always, we believe that proper asset allocation is key to long term success. As pointed out in the latest issue of Financial Advisor Magazine, keeping the long term in focus shows us that since January 2000, the S&P 500 Index has averaged only a 5.3% return, including reinvested dividends. This statistic helps us to keep this significant rise in stocks in perspective. Our goal is always to help our clients be prepared rather than surprised.
Currently, we have had one of the longest running bull markets in modern history. So what is driving this? Today we have an economy in which the latest two quarterly readings of the GDP showed 3.1% & 3.2% respectively. We have a strong job market with low unemployment and a relatively subdued inflation rate. The Federal Reserve appears, for the moment, as though it can walk on water with its slow unwinding of the balance sheet and slow increase in interest rates. Itís interesting to note that many believe with synchronized global economic growth and continued easy global monetary policies, (see attached handout: ďIMF Continues to Believe World Growth Will AccelerateĒ) the Global Economy is likely to continue its growth trend into 2018.
When you step away from all the noise, corporate earnings are really what drives stock prices. The continued growth of corporate earnings and the prospect of lower corporate tax rates are some of what is fueling this stock market rally. The price to earnings ratio is a number derived by dividing a companyís current stock price by their earnings per share. At current levels, the average of the S&P 500 companies is somewhere between 21 and 22 (the 25 year average is closer to 18). We have enclosed a chart titled ďUS Return ExpectationsĒ which predicts the forward 12 month returns, when current valuation is factored in. At these levels, historically, the average return has been a negative 1.3%.
A study by Michael Thompson, president of Standard & Poorís Investment Services reveals that every 1% decrease in the Corporate Tax rate could potentially add $1.31 per share to the S&P 500 earnings. If you look at a current 35% Corporate Tax Rate and with a reduction to a 21% Corporate Tax rate, you could potentially see an increase in earnings for these companies. (Keep in mind many corporations are not paying an effective tax rate of 35%, when including all deductions). This could still mean that Price to Earnings ratios may not be quite as elevated as they appear.
Long Term Interest rates have held steady, while interest rates on the shorter end of the curve have increased. The Fed has now moved rates 3 times this year, increasing the Fed Funds rate each time by 25 basis points, to a current level of 1.25% - 1.5%. The 10 Year Treasury started the year at 2.44% and finished the year at about the same level. The 2 Year Treasury yield rose from 1.2% at the start of the year to approximately 1.9% at year end. This movement has led to a flattening of the yield curve, which is certainly something to monitor, since in the past, it has meant that the US economy is in the middle of a tightening cycle, not the beginning. Even though many economists expected interest rates to slowly rise in time, there are some larger forces that may keep longer term rates low. However, as we enter the early part of 2018, one caveat to that expectation which we will watch for, is if the optimism from the tax cuts starts to pressure the rates upwards.
An interesting piece from Kiplingerís Personal Finance Advisor stated that the top 10% of all tax filers (those with AGIís of $138,031 or more) bore 70.6% of the overall Federal Income tax burden. While on the other end of the spectrum, 70.6 million filers, in the bottom 50% of earners, paid 2.8% of the Federal income tax total. Early indications are that Washington might not be doing us any favors by reducing our own individual income tax liabilities. Yes, tax rates may go down a bit but limitations on State income tax and real estate tax deductions may offset those reduced tax rates. We will certainly address more about the tax changes and how they may impact your investments in our next quarterly letter. As our investment committee continues to review the current state of the economy, equity valuations, interest rates and their impacts on the core group of Vanguard Funds that we recommend.
While it is always nice to review the current state of the economy and learn a few interesting facts, many of you may ask, ďwhat does this mean for my investment plan?Ē We continue to recommend that you take advantage of this move up in the market and re-balance your portfolio. Is there need for a significant distribution at some point in the upcoming year? Maybe now is the time to draw up some of the cash needed. Or are you feeling anxious about your portfolio after this big run up in values? While itís possible that 2018 could still be a decent year for equities, with the current backdrop, itís also important that we prepare ourselves for a return to some volatility.
Please do not hesitate to call us with any questions on this information or concerns that you may have. Wishing you all a very Happy and Healthy New Year!
Bryan Bastoni, CFP
CERTIFIED FINANCIAL PLANNER, TM
Recently we have received a number of calls from our clients concerned about the Equifax security breach and how that might affect their accounts with us and custodied at TD Ameritrade. We have enclosed a print-out of information from TD Ameritrade on their top-notch Security Procedures, Systems and Policies. We think itís important for you to see some of the things happening both on the client and advisor side. TD Ameritrade has always done an excellent job staying ahead of all our technological needs, especially in regards to our clientsí security issues.
Most importantly, to many of you, is the ďAsset Protection GuaranteeĒ. That guarantee states if you ever lose cash or securities from your account due to unauthorized activity, TD Ameritrade will reimburse you for those losses. While the topic can be unsettling for many, rest assured that TD Ameritrade and Pearson Financial are doing everything possible to protect your sensitive information.
Itís possible that many of you have also read about the ďFiduciary RuleĒ, which has recently been a hot topic in the financial news. Basically it states that advisors should work in the clientsí best interest, not necessarily for their own financial gain. Our philosophy here at Pearson Financial Services has, and will always be, to work in the clientsí best interest! For us it has never been about selling products that may not be the best option for the client, but may pay significant commissions. Instead, we always strive to offer our clients the best suitable investment choices, at the lowest possible overall cost.
Transparency is another ďbuzz wordĒ that is getting a lot of press lately. Our business is built on trust, and without your trust we would not thrive as a business. As investment advisors we focus on a holistic approach that covers a low cost, transparent investment plan and those invoice statements you receive each quarter are an example of our commitment to full and ďtransparentĒ disclosure.
As the 3rd quarter of 2017 comes to an end, many wonder with North Koreaís threats, increased tension between Saudi Arabia and Iran, continued gridlock in Washington, and significant natural disasters (that have early estimates of upwards to $75-100 Billion dollars of damage), how has the stock market shrugged off all of these worries and continued to thrive. Somehow, 2017 has been a year that the stock market has taken everything in stride.
More than a year has passed since we have experienced a decline of 5% or more. This low volatility is something that we havenít seen since the 1990s. We know that volatility will come back at some point, but data reviewed since 1945 shows that even in declines of 5% or more, the market recovered to a breakeven point in an average of four months or less (per data from CFRS-S&P).
A GDP revision for the second quarter of 2017 shows that the economy expanded at a 3.1% rate; with solid employment data, expansion in manufacturing, and consumers in a relatively strong fiscal position. We still have a highly accommodating Fed Policy, a relatively low rate of inflation and continued corporate earnings growth. Aside from some turbulence in the market from unforeseen events, this backdrop bodes well for a recession that still appears to be a number of years away.
The US Stock market, as represented by the S&P 500 Index, is up close to 12%, year to date. International stocks are on track for an even better year, while some emerging markets are on track for their best performance since 2009. We have attached an ďInvestment Growth ChartĒ that outlines the performance of some key Vanguard Equity Funds, tracking from January 1, 2017 through the end of September, 2017.
The Fixed income market has been rather subdued. The 10 Year Treasury started the year with a yield of 2.44 % and as of the end September, had a yield that stood at 2.33%. The Federal Reserve Open Market Committee has raised rates by a half of one percent so far in 2017. It appears as though the Fed may raise short term rates again, one more time, by a quarter of a percent point before year end. However, this is dependent on key data points in the coming months and many believe that the back to back to back destruction of three major hurricanes may in fact give the Fed pause in moving again on short term interest rates this year.
We will be watching very closely to see how the Federal Reserve starts to unwind its balance sheet. From November of 2008 to October of 2014, the Fedís balance sheet had grown nearly six fold. The Fed has been keeping liquidity high, with purchasing new bonds to replace maturing bonds. Now it plans to slow down those purchases, (at an initial pace of $10 billion) and instead, increase that amount gradually.
Our investment committee will be meeting to review this unwinding of the Fedís balance sheet while monitoring the impact on overall interest rates. I will touch on this in our year end letter as the process gets underway.
Please keep in mind that asset allocation has always been key in maximizing returns while minimizing risk and we encourage you to make it a point to review your allocation with us at least annually to make sure it still matches your risk tolerance.
In the meantime, if anything at all is on your mind, please do not hesitate to call us.
Wishing you all a wonderful fall season.
Bryan Bastoni, CFP, TM
In order for us to always be able to reach you promptly, please remember to notify us of any seasonal (or permanent) address changes.
It certainly has been interesting to follow the news flow coming out of Washington these past few months! Hopes of tax reform and infrastructure stimulus now seem to be more of a discussion for 2018 and beyond. Although the stock market has taken all of this in stride, I caution that many of us have gotten too complacent, with a market that appears as though it cannot go down for more than a day or two without recovering. While we think the next recession is still probably a few years away, we may only be a headline or two away from a correction (which is defined as a drop of 10% or more). Corrections of 10% happen on average every year or two. While we expect something like this to be temporary, it can still be very unnerving to see, especially after an extended period of subdued volatility.
Our role is to help guide you through the ups and downs in the market and we continue to stress the importance of rebalancing some of that stock market growth back to the fixed income side of your portfolio. It is essential that you reach out to us if you have any concerns on your current allocation. Oftentimes our value is most important in times of market distress, as we help you stay with the original investment plan that you had put in place. Vanguard notes that an Advisor, as a behavioral coach, can act as an emotional circuit breaker, circumventing clients' tendencies to chase returns or run for cover in emotionally charged markets.
Our Team here spends a great deal of time working on each of the items below to bring you the best possible outcome and itís a far more detailed process than meets the eye. Listed are the main principles that we use to develop each individualized plan:
- Setting a proper asset allocation, striking the right balance between stocks and bonds for each client's unique situation.
- Designing an investment portfolio to take advantage of US Markets, Developed International, Emerging Markets, and Real Estate; then combining Large, Medium and Small Capitalization stocks of all sectors of the market, including appropriate Fixed income choices to diversify credit risk, liquidity risk, interest rate risk and duration risk.
- Determining the best cost effective implementation of investments, using the lowest cost funds in the industry.
- Using a thoughtful withdrawal strategy that can minimize taxes paid over the course of one's retirement, thereby increasing the net after tax return and ultimately the longevity of the portfolio.
- Specifically targeting assets to be held in taxable accounts vs. non-taxable accounts so we can control how assets are taxed. This strategy seeks to improve the after tax return on your investments.
- Advising on strategies for charitable giving. Proper planning of when, what and how, can help to maximize the donorís charitable intentions as well as overall tax planning goals.
Our experience has shown us that by implementing a fully integrated process which incorporates financial and legacy planning (lowest cost investment management, retirement, estate and tax planning) in one office, not only helps to simplify matters, but also improves the overall results of your plan.
The 2nd quarter of 2017 has been a strong quarter for the US and many International Stock Markets. The S&P 500 Index is up almost 4% in the second quarter alone and almost 9% year-to-date. Many International Stock Markets have started to turn, as their year to date performance has outpaced the US, a stark contrast to the last few years. Certain Sectors of the market have come on strong as well, with Technology and Healthcare outperforming so far in 2017. (Healthcare was the worst performer in 2016). Our investing philosophy, for good reason, has been to stay well diversified, by owning US Stocks, International Stocks, Emerging Market Stocks of Large, Medium and Small Cap companies, all sectors of the market, including both growth and value style. Attached we have included a chart that shows the trailing 1 year returns (6/30/16-6/30/17) on the Vanguard Stock Funds that we use to build the stock side of the portfolio.
Itís more of the same on the interest rate front. As short term interest rates have bumped up a bit, longer term interest rates have continued to hold steady and even drop a bit, with the Benchmark US 10 Year Treasury yield dropping from 2.45% at the start of the year, to 2.30% at the end of June, 2017. Not necessarily what one would expected with the Federal Reserve moving to raise interest rates. The attached piece from Morningstar gives a nice depiction of interest rates in other developed countries around the world. It's entirely possible that interest rates around the world will have a limiting factor on how quickly rates in the US can move up, as our economies today are more intertwined than ever. There are many moving parts to the Fixed Income market and our Investment Committee continues to monitor the fixed income market in an effort to improve yields where possible, without taking on unnecessary risk.
One strategy of note that we want to mention and may be very beneficial to some, is the use of Qualified Charitable Distributions direct from IRA's as a way to minimize tax. A QCD is a charitable donation that counts toward the required minimum distribution (from the IRA) but is not recognized as income for tax purposes. Because many tax related items, including itemized deductions and exemption phase outs, net investment tax, taxability of Social Security, and Medicare Part B premiums are based on adjusted gross income, QCD's are potentially more attractive than taking the RMD and then making deductible gifts. (This may sound complicated but if you are required to take required minimum IRA distributions each year and you give to charities on an annual basis - please feel free to give us a call to discuss this option).
Soon we will be mailing out invitations for a client dinner event that will take place in August. We hope to see many of you there, along with any family or friends that may be here visiting. In the meantime, please do not hesitate to call with any questions.
Bryan Bastoni, CFP
As the 1st quarter of 2017 comes to an end, spring time is upon us and the US Economy enters a time of uncertainty. As Mark Twain once said, October is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.
This could be the year when we have corporate and individual tax reform; business friendly regulatory changes and spending on US infrastructure. Or at the same time, we could experience a year of disappointment with little if any progress on these fronts. Just recently, hopes for a Healthcare system overhaul failed with a Republican health care bill pulled from the House floor before a vote. "There is a good chance Congress will greatly dilute or delay Trump's fiscal stimulus program and disappoint Wall Street and Main Street," said Bernard Baumohl, Chief Global economist of the Economic Outlook Group.
The Wall Street Journal ran an article on March 1st titled, ďThis is now the Third ĖLongest Economic Expansion in US HistoryĒ, by Josh Zumbrun. ďThe arrival of March meant that the current economic expansion has now entered its 93rd month, surpassing the 92-month expansion in the 1980ís, to become the third Ė longest in US History.Ē According to the National Bureau of Economic Research, in records dating back to before the Civil War, the US has had longer spells of growth only twice, one span in the 1960ís and one in 1990ís. If this expansion can make it to next summer, it would be the second longest in US History. By mid-2019, it would become the all-time longest on record. According to this report however, recessions have become less frequent and thus expansions longer, quite possibly because of an economy that is less cyclical, due to a shift away from an industrial economy.
Itís been a strong start to the year, with the stock market, as represented by the S&P 500 Index, being up 5.5% in the first 3 months of the year. Furthermore, itís interesting to note that the S&P 500 is up almost 10% since the election in November. The 3 year annualized return for the S&P 500 Index now sits at 8.1%. Still, that is below the average annualized return of 10.28%, over the last 91 years.
Attached is an interesting piece from Vanguard: ďWhen will we get back to average market returns?Ē Only 6 years out of the 91 years studied had a return that fell within 2 percentage points of that average annualized return of 10.28%. The back page of this piece outlines the bond market, showing an average annualized return of 5.31% over the last 91 years. Again, in only 24 out of those 91 years did the bond return fall within 2 percentage points of the ďaverageĒ annualized return of 5.31%.
We point this out to help everyone realize that the ďaverageĒ return is not a number that can be expected yearly with any predictability. There are actually many years of wide fluctuations in equity and bond returns and one must plan accordingly.
Interest Rates have recently ticked up a bit, with the yield on the 10 Year Treasury now near 2.35%. The 52 week high on the 10 year yield was 2.6%. Most interest rate forecasts seem to peg the 10 year Treasury Rate in a range of 2.5-3.0% for 2017. The Fed had raised rates for only the 3rd time in the last 10 years, in March. Itís possible that we may see 2 more rate increases for the year, (bringing this yearís total to 3). But I caution that if this year is full of disappointments, with little if any progress made on tax reform and other ambitious goals, not to mention other geopolitical risks; we could see the Federal Reserve having to temper its rate expectations.
The Gross Domestic Product for the full year of 2016 was 1.6%. Most estimates for the 2017 GDP fall between 2 -2.5%. Yet again, these forecasts carry far more uncertainty now than in years past, as they are predicated on a more relaxed regulatory environment. However, the risks remain high on the down side, with the potential of a trade war, or a strengthening dollar. According to the Kiplinger Letter, ďThe biggest tailwind for the economy is shoppers who are ready and able to spend. Consumer Spending accounts for 69% of U.S. GDP. Oftentimes, GDP estimates are a moving target that will have to be refined as the year progresses. ď
We have attached another chart titled: ďStocks, Commodities, REITS, and Gold 1980 Ė 2016Ē. This chart shows the compound annual returns since 1980 through 2016. The core Vanguard Funds used to build the equity side of our portfolios, encompass US & International stocks as well as REITs. Diversification is key and with Index Funds we use, you gain exposure to all of the different sectors of the stock market through just a few low cost funds.
Many of you may be asking, with all of this said, what does it mean to me? For many of you, your equity allocation has bumped up over the last few years from this move up in market values. It may be time to think about reducing your allocation to Equities. Hopefully, with interest rates moving up a bit, there will be more options for some of the cash that has been earning very little in the money markets, CDís and savings accounts.
For now, our view on investing in the fixed income markets has not changed. We are still focused on a core group of Vanguard Bond funds that are relatively short in duration. However, we do feel that we may be getting closer to having more options for you to improve yields in the coming year or 2, by way of allocating money to individual GNMAís, Treasuries, and Municipal Bonds. Please do not hesitate to call to review your portfolio or to speak with us about anything on your mind regarding your finances.
Our Investment Committee continues to meet monthly to review the current state of the economy as well as doing continuous research on the core positions that we recommend from Vanguard. We continue to monitor Interest rate changes and their implications to fixed income investments. Be assured that as that landscape continues to change, we will be out in front of the trends, working to provide you with the expertise you have come to expect over the years.
We want to thank all of you for the confidence you have expressed in us through all the referrals we have received in the past year. Our team welcomes the opportunity to work with anyone that you think would benefit from the services we provide. If you know of anyone that would like to receive our quarterly newsletter, please let us know.
Bryan Bastoni, CFP
January 6, 2017
As 2016 comes to an end, we look back at a year that was filled with many ups and downs. On January 20, 2017, we will swear in the nationís 45th president. Itís clear that with all of the promises made on the campaign trail, the new president will have his work cut out for him.
Top on the list, with a new Republican president and a Republican controlled Congress, we could be looking at the most significant tax changes in the last 30 years. How fast, and if that happens, is the big question. Per the latest Kiplingerís Tax Letter, the last major revision to the tax code was in 1986, under Ronald Reagan. Health care reform was also high on the list and it will be interesting to see what comes of Obamacare going forward. Itís clear that health care costs in the United States have spun out of control and something does need to be done. Many of us will agree that while some of these things may make sense from a financial standpoint, the temperament of our soon to be president is the one question mark that remains a worry.
Trade was also a hot button topic during the campaign and it will be interesting to see how that evolves. Many unresolved issues around the world still have to play out in 2017. We will have to wait to see the real impacts from Brexit. European Central Bank and Japan continue to expand assets and keep interest rates low with an easy money policy. Chinaís growth concerns, that have been mostly quiet during 2016, may come back to spook the market. Banca Monte dei Paschi di Siena, the 544 year old Italian bank, is having difficulty securing needed funding. Rules put in place by the Euro zone after the sovereign debt crisis of 2009, require creditors to face losses before any form of state aid is available. As the Business Insider reports, the problem is that a disproportionate number of creditors of the bank are not institutional investors but just regular people who bank there. So the concern is that the life savings of millions of ordinary Italian citizens could be wiped out. The strong dollar is also something to watch, as it can impact many US companies that rely on selling their goods and services overseas.
We have enclosed a handout titled ďGlobal Market BarometerĒ to help familiarize you with the trailing Global Marketsí one year returns, through the end of the 3rd quarter, 2016.
The US Economy had its strongest growth of 3.5% in the third quarter of 2016, dating back almost 2 years. That was after Q1 2016 Gross Domestic Product rate of 0.8% and Q2 2016 GDP rate of 1.4%. Even with the strong 3rd quarter GDP, we still expect the full year GDP for 2016 to come in around 2%. Pretty close to the ďrecovery averageĒ of 2-2.5%. Most predictions for 2017 put GDP growth around 2.5%. Some question if that will be too optimistic, with slowing employment gains; ďHeadline InflationĒ that may start to inch higher; and rising energy prices, which may start to impact consumer spending.
Now, as we get our DOW 20,000 hats out in anticipation of the big milestone, we want you to keep in mind that the Dow had started the year at 17,425.03 and within 2 weeks of the start of the trading year, had quickly shed almost 1500 points, to close January 15, 2016 at 15, 988.08 . If that was any indication of what the year would have brought, many would have missed out on the US Stock Market return of approximately 10% for 2016. We have included a printout on the Vanguard Stock Funds that we follow closely. The performance of these funds track back from the market bottom in March of 2009, through the end of December 2016. We believe that diversification through low cost index funds is still your best bet, with those (4) stock funds owning well over 11,000 individual stocks; encompassing over 42 countries; and made up of Large, Medium and some Small Cap stocks.
Lately, the fixed Income market has been getting a lot of attention. Interest rates are something we will watch very closely in 2017, as the 10 year yield that started the year at 2.25%, closed the year near 2.5%., after falling to a historic low yield in July 2016, of 1.375%.
The Federal Reserve raised Interest rates ľ of a percent in December, for only the 2nd time in 10 years. We now have a Fed Funds rate between .50% and .75%. The Fed said in its latest meeting that it would aim to raise rates 3 times in 2017. We find that to be very aggressive, especially since predictions by the Fed at one point noted possibly 4 rate hikes in 2016 and as it turned out, there was only one rate increase. With the market being caught off guard by a Trump election victory, we saw interest rates move up during the month of November. Post-election, the 10 Year yield moved from near 1.85% all the way up close to 2.5% but has since leveled off in December. We expect to see a much more gradual increase in rates in the year ahead.
We have also enclosed an additional print out on the Fixed Income Funds from Vanguard. The performance of those funds tracks back to the market bottom in March of 2009, through the end of December 2016. Keep in mind, there is no guarantee that interest rates will continue to rise in the short term as unexpected geopolitical events or new fiscal and monetary policy could result in downward pressure on rates.
I think the point we are trying to emphasize is that the ďeuphoriaĒ of the last 6 weeks is probably going to get a reality check in the coming months. It doesnít mean that itís time to sell, as trying to time the market has proven to be a bad formula. We still believe that the focus on a long term, diversified portfolio is the way to go. Our investment committee we be convening again in January to collectively review the market and your investment options. As always, please do not hesitate to call us should you have any questions or concerns with your portfolio.
We hope that you are able to spend time with family over this Holiday Season and wish you all a Healthy and Happy New Year.
Bryan Bastoni, CFP
Certified Financial Planner, TM
P.S. With the winter season upon us, we ask that in case of a weather emergency and we cannot be reached, you call TD Ameritrade directly at 800-431-3500, if you need to execute a trade quickly.
As the summer winds down and fall fast approaches, we turn our attention to the upcoming presidential election, as it’s sure to add volatility to what has been a relatively quiet period for the stock market. We have enclosed a very interesting piece from Morningstar, "Politics and Investment Performance" that outlines average annual returns from 1926-2015, when we have had a "unified government; a partially divided government; and a completely divided government." It’s hard to believe, but by the time our next quarterly letter reaches you, we will know who will be the 45th president of the Unites States.
As you read in our last quarterly newsletter, our goal each quarter is to update you on the stock and bond markets and take a look at the overall health of the economy. Through the end of September, the S&P 500 Index is up close to 6% for the year. Not exactly the 10% long run average return since 1926, (although we still have 3 months left in 2016) but very much in line with our thinking of what may be lower annual returns for stocks over the coming years. More realistic may be 6-8% annual average return for stocks, going forward.
Another piece we’ve included shows a chart on the Vanguard S&P 500 Index Fund, which just celebrated its 40th anniversary in August of 2016. It shows a $10,000.00 investment in 1976 that had grown in 40 years to $617,793.11, simply by reinvesting dividends and holding the fund through the ups and downs of the market! Sure, the next 40 years may very well be different but don’t forget, during the last 40 years we have seen Wars, Terrorism, Black Monday, Dot.com Bubble Bursting, and the worse financial crisis since the Great Depression.
This post-recession expansion, now in its eighth year, can certainly continue as consumer spending accounts for roughly 70% of U.S. economic activity and consumers are certainly spending, albeit in a more disciplined way since the last financial crisis. Gross Domestic Product, which is a measure of the value of goods and services produced, has cooled a bit and is now running at about 1-1.5%. It now appears that a 2% GDP Growth may be a stretch for this year, with 1.5% GDP a more likely full year expectation. Keep in mind, the long run average GDP rate in the United States, from 1947-2016, has been 3.22%.
Does the theme sound familiar, with numbers running below long term averages? While a recession does not seem imminent, it’s possible we stay stuck in this slower growth regime for the coming years.
Interest rates have continued to remain at very low levels. The Federal Reserve made its first move in December 2015, raising interest rates a quarter point. The 10 Year Treasury yield continued to fall, hitting a historic low of 1.375% on July 5, 2016. However, it’s quite possible that we’ll see the next quarter point increase when the Fed meets again in December, 2016.
While it appears that the US economy could very well withstand slightly higher rates, interest rates around the world in other developed economies have slipped to all-time lows. Government Bonds of Germany, France, Italy, Switzerland and Japan are all seeing negative yields on the shorter side of their yield curve. What all this means is that interest rates may in fact stay low for a longer period of time. That certainly does not mean they will not move up a bit, but it may be sometime before we get back to interest rates we were accustomed to in the early 2000s. It is interesting to note that many believe this extended period of extremely low interest rates will probably turn out to be the cause of the next recession.
Now may be a great time to look at your own portfolio and make sure that you’re still comfortable with the level of risk inside that portfolio. Maybe you are very concerned about the election and wish to draw up a bit of cash that you may need in the coming months, should short term volatility set in. Working with you we have always stressed the need to have money on the Fixed Income side to draw on during downturns in the stock market. Although no one knows exactly when a downturn will come, we do know that it will. Our belief is still that a balanced portfolio should continue to serve you well in the years ahead.
Here at Pearson Financial Services, our Investment Committee meets monthly to review the changing landscape of the economy, along with continuous research on the core holdings that we recommend from Vanguard. The Investment Committee is made up of a team of professionals with some of the most respected designations and includes Bryan W. Bastoni, CFP; William Lord, CPA, CFA; Louis J. Beaulieu, ChFC, AEP, CTFA; Christopher Dupee, CPA; Kathleen Fowler, Esq. and John Ward, MA, MBA.
As many of you know, we are optimistic in the belief that the best days lie ahead for this, the greatest nation on earth. We continue with the hope to see your children, grandchildren and great grandchildren have a life with many of the same opportunities that you have had, but I know at times it’s tough to see the glass half full, especially with everything going on today.
We hope that you can take the time to enjoy this fall’s beautiful weather and then enjoy the upcoming holidays with your friends and family. Please remember to let us know if, and for how long, you will have a different mailing address for the winter months. As always, if you should have any questions or concerns at all, please do not hesitate to call.
Bryan Bastoni, CFP
First, we want to thank all of you for the nice cards and kind words that were conveyed to us on the passing of Seth. He was a pioneer in the industry and a true visionary when it came to building this integrated team that will live on for years to come. It is very rewarding to see the relationships that we have developed with all of you over the years. Our mission has always been and will always be, “to help improve the lives of those we serve.”
Now, as the world starts to digest the vote for the U.K. to leave the European Union, it’s clear that the surprise of the “Brexit” vote added to the volatility of the market. The market had rallied before the vote, since a “stay” vote was all but expected. Yet, as we all know too well, oftentimes what is expected can quickly turn into the unexpected when it comes to the stock market. We saw a move up of close to 500 points in the Dow Jones Industrial Average in the week leading up to the vote, only to go down 850 points in the 2 days after the vote, then to erase the losses over the next 4 trading days!
Regarding “Brexit,” we suggest that everyone just takes a deep breath. Jim Paulson, from Wells Capital states, “It’s not like the U.K. is going to remove itself from the world economy and not trade with anyone. Once the emotion of this event fades, investors may get back to fundamentals, which at least in the U.S., are looking better.”
As the 2nd quarter of 2016 ends, the U.S. Stock Market, as represented by the S&P 500 Index, is slightly positive. It’s been a strong rally back to positive territory after a roller coaster ride through the first few months of the year, when the first 6 weeks took the Index down over 11%. On the bond side, we have an interest rate environment that continues to remain at very low levels. In fact, the 10 Year U.S. Government Bond yields have dropped from close to 2.24% at the beginning of the year, to close to 1.40% today. Clearly, not what one would have expected when last December the Fed made the first move to raise interest rates in nearly 10 years.
It’s clear that volatility will continue in the stock market. The Federal Reserve is still hanging over the market with the notion of 1 or 2 increases in interest rates this year. We have growth around the world slowing, yet here at home the economic data has been okay. The unemployment rate remains low at just under 4.7%. GDP growth for 2016 is still targeted to be close to 2% ‚Äź 2.5%, although that has been trending to the lower end as of late. A GDP of 2.5% has been the average for the last 7 years, which is below the longer run average of 3.5% a year.
It is important to remember that the U.S. Stock market returns over time are driven by corporate earnings. According to a new report from the rating agency, Moody’s, the health of those very companies seems to be strong, with U.S. companies cash pile hitting a record $1.7 trillion! And did we mention that the presidential election should certainly help add some volatility to the market as well?
Yet, with all this said, our conviction for keeping a long term balanced portfolio has not wavered. It’s impossible to time the market and react to the day to day reports on the state of the economy. John Bogle, founder of Vanguard Group, once said that the daily moves in the market are a “crazy game in that busy casino” and we could not agree more. That’s why we have long been proponents of the low cost Vanguard Index Funds. Changes in a portfolio should be driven by changes in your personal situation, risk level and income needs, not by the latest report of who will win the White House in November.
Attached we have provided a performance update of the Vanguard Equity Index Funds that we recommend, as well as the Vanguard Fixed Income Funds. These are the core building blocks for a low cost balanced portfolio. We have also attached a piece on the “Risk of Stock Market Loss Over Time.” As illustrated by this handout, of the 90 one year holding periods from 1926 to 2015, 24 have resulted in a loss. However, you will notice by increasing the holding period to 15 years, none of the 76 overlapping 15 year periods resulted in a loss. Be sure to keep in mind, holding stocks for the long term does not guarantee positive returns.
Please do not hesitate to call should you have any questions at all or if you would like to discuss your individual portfolio. We hope that everyone enjoys the summer with friends and family.
Bryan Bastoni, CFP
CERTIFIED FINANCIAL PLANNER, TM
May 16, 2016
For the last few years I had been being successfully treated for a very rare form of appendix cancer. However, recent circumstances have taken a turn for the worse, so I have written this letter to be mailed to you after I die.
Fifteen years ago, our business formalized a Succession Plan. The plan was designed to ensure that in the event of the death of an owner, the business would continue, unchanged, to provide guidance and the financial service you deserve and are accustomed to receiving. As you have been informed, this Plan was completed in October, 2015, between me, Atty. Kathleen Fowler, Coral Murphy and Bryan Bastoni, CFP.
For over 40 years, my vision was for Pearson Financial Services to be that place where all your financial, legal and tax issues could be resolved, under one roof and where my family and yours can go for the best financial outcome.
I am completely confident that my co-owners will maintain that level of excellence and expertise that we have all worked so hard to put in place. And, I also know that this team of experienced professionals will continue to excel at taking care of our clients for generations to come.
I thank all of you for your many years of confidence, trust and friendship.
(9/6/1945 – 5/11/2016)
It’s difficult to remember a time when there has been more bad news…4 terrorist attacks in 4 months; political divisiveness with continued gridlock in Congress; energy prices crashing; China’s economy sliding; the immigration crisis in Europe and the ongoing conflicts in the
Middle East and North Africa. We can’t ignore all this negativity but we can use it to focus on the investment choices we have that have proven to be the wisest over time.
To illustrate these choices, you will find four additional pages included with this letter. The first one shows stock market downturns and recoveries from 1926-2015. Every downturn, no matter how severe, was followed by a recovery.
Another page shows stocks, bonds, bills and inflation over the same period of time. Historically, you can see that just holding a diversified portfolio of stocks and bonds has led to positive inflation beating returns, over the long term. Investing in the stock market at times like this can feel like an emotional roller coaster ride. However, despite its’ ups and downs, stocks have returned around 10% for the last 90 years. Looking back, the wisest move you could have made was to stay invested, through the good times and the bad.
The next 2 pages enclosed show the performance of Vanguard stock and bond funds during the last recovery from recession. The growth since 2/28/09 led to complete recovery and new highs. Stocks are down over the last 12 months and on average, up around 10% for the last 3 years. Our economy has grown, on average, about 3.5% a year for the last 50 years and 2.5% a year for the last 7 years. During the last 7 years, corporate earnings have risen 282%. The earnings represent the real value of stocks.
Federal Reserve officials recently held interest rates steady and suggested that they would raise rates only twice more this year. Low rates usually help corporate earnings. Jobless claims remained below 300,000 for the 54th week in a row. That’s the longest streak since 1973. American home-owners wealth has recovered $7trillion since the last recession and is poised to reach a new record as early as the second quarter of this year. Home ownership is much wider than stock ownership and both help fuel consumer confidence and spending.
Future market downturns are inevitable but the wisest choice in the past has been to hold the course.
The Investment Committee
The second largest decline in US stock market history dating back to 1871, happened between August 2000 and February of 2009. The largest decline happened during the Great Depression over 80 years ago.
Since most investors put a lot more weight on losses than gains, they sell at the worst time. In 2012, DALBAR published a study that showed the average equity investor underperformed the S&P 500 Index by 4.32% a year during the 20 year period 1992-2011 due to consistently buying after the market has risen and selling when the market declines. Historically, the biggest mistake investors make is selling when the market is down. Vanguard, the largest not for profit mutual fund manager in the world, estimates the biggest value we can provide as your advisor is behavioral coaching, which they feel can add 1.5% a year to a portfolio return.
Our greatest value to you is not just peace of mind, but guidance during market turbulence when you may feel the need to abandon your asset allocation and move to cash. The concept of risk/return suggests that low levels of investment risk will result in low returns, while high levels of risk will generate higher returns. While increased risk offers the possibility of higher returns, it also has led to bigger losses. Balancing the risk you are willing to accept with the investment returns you need or want to stay ahead of inflation is the most important part of an annual review.
The mission of this letter and our upcoming luncheon seminars, is to help you determine the level of risk you are willing to accept.
How did you react in 2008 when the stock market started its 2nd biggest nose dive ever? That long, extreme market was unnerving for many investors. The key was to grit your teeth and stay the course. Those who did were rewarded by recouping all their losses and more. At times like that, the stock market can seem pretty dismal. But, when you step back and take a longer view, those dips are just bumps in the road.
Recent global events and stock market declines make this a very good time to gauge your tolerance for risk. One conclusion drawn from a survey of 31 economists (Sept. 9, 2015) is that the next recession will hit in 2018. Our view is that stocks are reasonably priced for now, but slowing global growth will probably be the main reason for that recession three years from now. On average, stock drops around 30% in a recession. No one, however, has ever timed the market consistently as to when it will rise or fall and no one of course can predict the future. Markets have moved dramatically as long as stocks and bonds have existed. Nobel Prize winning research in 1990 and 2014 indicates that choosing a diversified asset allocation of stock and bonds and sticking with it produces steady investment results with the least amount of volatility.
Since 1945, we have had 59 stock market declines of 5-10% and on average it took two months for the market to return those losses. Since 1945, the market has had corrections of 10% to 20% 20 times and it took about 4 months to recover from the bottom. Declines of 20% or more have happened 12 times since 1945 (70 years) and about 25 months to recover and go on to new highs. During these declines, it is important to have enough in bonds, cash and savings to draw on while you give the stock market the time it needs to recover. As you know, we feel history is the best guide to future outcomes but of course it is no guarantee. Time in the stock market has led to higher returns while timing the market by selling in the face of bad news has led to poor performance over the longer term.
The Fed left interest rates unchanged and voiced concerns that slowing economic growth outside the US would have downward pressure on our inflation rate in the US. Consumers and developed nations are saving more and spending less since the last Great Recession. These trends are not short term in nature and all have the effect of pushing inflation below the Fed’s target of 2%. It’s been under 2% for the last three years and sluggish inflation is a sign of economic weakness. As a result, the Fed has kept rates at this historic low of .25% for the last 6 years and 9 months.
We believe that this could be the tipping point at the end of the recovery from the last recession 7 years ago. The next recession may be three years from now, but it is not too early to temper our expectations and update our risk tolerance profile. The Fed will increase rates, possibly in December and almost definitely in the 1st quarter of next year. For the last 60 years (since 1955) the average duration of these rate hike cycles has been 22 months. After the start of these rate increases, the average time to the next recession was 41 months. You can see why most economists target about 3 years for the next economic downturn.
Year to date, the S&P 500 Index is down slightly and since the bottom of the global financial crisis in 2009, the index has enjoyed the second biggest gain in US history, an extraordinary run that may help put current concerns in perspective.
In order to address the need for you to update your risk tolerance and gain perspective on what we feel the next 10 years may have in store for investors, please try to attend one of our luncheon seminars. To help us help you, please answer the subjective risk tolerance questions included with this letter and return a copy to us for your file. Also, call us anytime with any questions that this letter may initiate.
Daniel Kahneman, a Princeton University emeritus professor, won the Nobel Prize in economics for his research on investor’s behavior. Some of his conclusions are worth visiting at this point in time of stock and bond market prices. Since the future is unknowable and because investors put a lot more weight on losses than gains, he feels it is imperative that they try to determine their tolerance for risk now while the markets are up. The biggest mistake investors make is to sell when the market is down. Inevitably, stock and bond prices will fall and investors will have to ask themselves these questions. How much am I willing to lose before I quit? Under what conditions will I change my mind about my investments?
Bond prices fall when interest rates rise. Stocks have temporary declines of 14% on average every year and declines of 28% on average every six years. Of course, everyone agrees that buying high and selling low is the worst strategy to follow. However, a year or two of losses weighs heavily on all of us. The last and worst recession of 2008-2009 is fresh in our minds.
The stock market losses were temporary, but severe. Fortunately, almost every one of our clients avoided the urge to sell at the bottom and rode the six year recovery to new, all-time highs. Today, the largest 500 companies in the USA, are priced at about eighteen times the past twelve months earnings and above the ten year average of about fifteen times. That important indicator suggests that stock prices may decline or that earnings over time will increase. Everyone should know approximately what percent of their investments are in stock or stock funds. The enclosed bar graph shows the best and worst one year return for stock and bond portfolios since 1926. Use this as a guide to approximate potential losses in your portfolio. Are you ok with this risk? Do you have the tolerance to avoid selling when the stock or bond market declines?
Riskless investments like Treasury bills or FDIC insured certificates of deposit are paying so little it is difficult to allocate a significant amount of a portfolio there. However, having a certain amount of money in the bank or in short-term, investment grade bonds will provide the liquidity you may need while you wait for stocks to recover from the inevitable corrections and recessions that will temporarily interrupt the long term trend of solid growth that we expect, based on the last ninety years of economic history.
Another way to determine your risk tolerance is to look back on how you reacted to the recessions of 2001 and 2008. If you were able to draw what you needed without too many sleepless nights and today your portfolio is as big or bigger than it was then, it is reasonable to assume that you have the tolerance you need to “stay the course” the next time the markets decline. Even though the current Price Earnings Ratio for stocks is higher than average and the US stock returns for the last six years of twenty percent a year are much higher than the ninety year history, the returns for the last ten years are close to normal at 8.5% and the fifteen year average is about 3% a year below the ninety year history of 10%. The last two recessions started with a huge bubble in the tech sector and in residential real estate mortgages. At the same time the Federal Reserve key interest rates were above four percent. Today that key rate is effectively zero and there is no apparent bubble in the economy in any way resembling those of 2001 and 2008.
We all are aware of threats to our top position in the economic world including cybersecurity, terrorism, Washington grid-lock and the huge gap between the wealthy and the poor. Think of all the threats we have faced since we entered World War II! Yet today, we are living longer, our standard of living is higher, our higher education is the best in the world, we have the power and will to protect ourselves, and our dependence on foreign oil is drastically reduced to levels unthinkable ten years ago. There are many reasons to be optimistic, but it is always prudent to be prepared for surprises.
We hope this letter finds you all well.
Seth M. Pearson, CFP
Our investment methodology here at Pearson Financial is to apply Modern Portfolio Theory (MPT), along with your tolerance for risk, to achieve a personalized, optimum portfolio for each client. The economists who developed Modern Portfolio Theory received the Nobel Prize for their groundbreaking research. Today, this theory is the most widely accepted solution for managing investment portfolios. Academic research continues to confirm this system’s effectiveness in the goal to achieve the highest rates of return with the least amount of risk. We expect that the system will guide educated investors for many years and even generations to come.
The first step in MPT is to identify the building blocks of the core investment solution. Then, select the lowest cost funds because research has confirmed that low cost is the best predictor of future returns. The lowest cost solution leads to Vanguard Funds.
Vanguard was created forty years ago by Jack Bogle to serve you as investors rather than let Wall Street serve itself. In 1976, he launched the world’s first index mutual fund. The company was formed as a not for profit and is owned by the investors who own its funds. Typical investment management companies are owned by outside stockholders. These companies have to charge fees to pay their owners which reduces investor’s returns. At Vanguard there are no outside owners therefore, no conflicting loyalties. Profits are returned to fund investors in the form of lower expenses. Low costs help investors keep more of their returns which can help earn more money over time. The company’s interests are completely aligned with those of the investors in their funds. This vision and structure has taken Vanguard to the position of the largest fund company in the world with over three trillion invested. Every decision they make, like every decision we make here at Pearson Financial, is guided by a singular vision to create the best possible outcome for its clients.
We use Vanguard stock and bond portfolios as building blocks along with your other existing investments to achieve a diversified, personalized investment solution. These building blocks include the following Vanguard stock and bond funds:
Short Term Investment Grade (VFSUX)
Massachusetts Tax-Exempt (VMATX)
Intermediate-Term Tax-Exempt (VWIUX)
Total US Stock Market (VTI)
Developed Markets (VEA)
Emerging Markets (VWO)
Modern Portfolio Theory is not a constant but a system using up to date returns as well as historical behavior in different economic scenarios to determine the appropriate, optimum portfolio for you. It is interesting to note that this October, Stephen Blyth, the manager of Harvard University’s $37.6 billion endowment, said he incorporates elements from Modern Portfolio Theory to gain superior long-term returns and avoid short-term disappointment. He went on to say, “Our objectives are to be achieved while maintaining a portfolio whose risk profile is in line with the University’s risk tolerance.”
So in summary, it is a proven system that leads us in fulfilling our role as your investment advisors, rather than an individual. Growing acceptance of the system that has worked so well for the last twenty-six years, gives us confidence that it will be a very valuable guide for the foreseeable future. For decades, as a team, we have helped families successfully meet the challenge of growing, protecting and distributing their assets. Pearson Financial was designed to provide a full breadth of financial services for generations to come and as your professionals gain experience, that promise of continuity is achieved.
The year ahead will have its share of challenges and we feel that you, together with our team, are on solid ground. Low inflation and low interest rates mean the investment grade bond market should be stable while the current price earnings ratio of stocks is close to the long-term average which suggests equities are fairly priced. The US gross domestic product is expected to grow at a rate of 2.5% in 2016, even with sluggish global growth in Europe and China. After four years without a correction, stocks fell 12% in September and gained back most of that this past quarter. Of course, no one can predict the future but we expect the long-term trend for the largest economy in the world to continue well into 2017.
Happy New Year to all from the Investment Committee of Pearson Financial Services.
2014 AND BEYOND
In addition to our outlook for 2014 and beyond, this letter includes contributions from team members Bryan Bastoni, Certified Financial Planner and Chris Dupee, Certified Public Accountant.
Our investment team at Pearson Financial focuses on two core solutions, stocks and bonds. We feel the stock market outlook for the long term is positive and of course the short term is unpredictable. History has been the best guide. A very shrewd and successful investor, Sir John Templeton said “Bull Markets (like the last 5 years) are born on pessimism, grow on skepticism, mature on optimism and die on euphoria”. We feel we are in the middle of the cycle, not the end of it. There is still a lot of cash on the sidelines and the price-earnings ratio is not out of line with previous long term, “bull markets”. Today, the price earnings ratio is about 16.9. In 2000 it was at 28.2 before the recession began. In this recent run up, the stock market has gone up 177% since March of 2009. In the 1990’s bull market it posted gains of 417% and lasted 9 ½ years. So strong market gains don’t die just from old age. It seems that the stock market is not overvalued by any measure. The Vanguard Total Stock Market Index Fund has gone up 24% a year for the last 5 years (past performance is of course no guarantee of future returns). This index fund has over 3600 stocks in it. We feel you should make this index fund the core investment in your stock portfolio. Here’s what the most successful stock investor in history, Warren Buffet, had to say in 1996 about the effectiveness of index funds for building wealth: “Most investors, both institutional and individual, will find the best way to own common stock is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”
In March of this year, Warren Buffet sent his annual letter to shareholders of Berkshire Hathaway and said this:
“My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. (I have to use cash for individual bequests, because all of my Berkshire shares will be fully distributed to certain philanthropic organizations over the ten years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors - whether pension funds, institutions or individuals – who employ high-fee managers.”
John Bogle created the first index fund and founded Vanguard – the largest mutual fund company in the world with well over 2 trillion dollars invested. In 2004, time magazine named Jack Bogle one of the world’s 100 most powerful and influential people. In 1999, Fortune Magazine honored him as one of the investment industry’s four “Giants of the 20th Century, in addition to Warren Buffet, Peter Lynch and George Soros. Dr. Paul Samuelson, Nobel Prize winning professor of economics at MIT, capsulated the significance of this simple investment strategy when he said: “the creation of the first index fund by John Bogle was the equivalent of the invention of the wheel and the alphabet.”
John Bogle read a book that we wrote about trust planning and investing and sent me a note a few months ago that said: “Dear Seth, I did read your fine book and agree with virtually all of your ideas.” In this book I outlined the core investment solutions my family should follow after I die. They will receive the money in Dynasty Trusts and IRA accounts. The money should be allocated as follows – 50% in the Vanguard Total Stock Market Index Fund and 50% in the Vanguard Short Term Investment Grade Bond Fund. They will have the experienced, professional, young team at the company I founded to help them implement this simple plan.
These young professionals with every respected credential (C.F.P, CPA, CFA, ESQ.) are committed to preserving the long-term stability and continuity of the company they helped build. John Bogle’s comment on the book we wrote about our firm validates everything we are doing now and will do for many years to come. I’m confident that this successful, service business founded over 40 years ago will be just as viable 40 years from now. How lucky for your family and mine.
America is also special. We are the reigning economic power in the world for the foreseeable future as evidenced recently with the market recovery after Putin’s invasion of Crimea. We are still enjoying the system of global management that we imposed on the world after World War II. For the first time since the Roman Empire, we had a single superpower regulating all trade in the world. We opened up our economic system to everyone. All countries could sell anything they wanted into our market and we protected the world shipping lanes for that trade. After 70 years of doing that, the world thinks that’s normal. We have huge populations on the coasts that can trade with the Asians when the Europeans are in recession and the reverse when the Asian economy is slowing. Our economy is the only one in the world that has grown every decade since the 1840’s.
America has far more navigable waterways than all the rest of the world put together and moving products on the water costs 1/15th less than on land. These natural advantages are not going to dissipate anytime soon. Because of the recent “Shale Revolution”, the US has more than enough gas and oil to maintain current growth rates of production for at least the next hundred years. Today, US power rates are 35% lower than just 5 years ago. In the last and greatest financial crisis since the Great Depression, the Fed Chairman, the FDIC Chairwoman and the Treasury Secretary sat around a table in 2008 and made financial policies for the entire country in about an hour. The European 28 countries still haven’t hammered together their response to 2008. There are fewer people at war than at any time in modern history. The Global standard of living is growing and Bill Gates recently said that there will be no poor countries left by 2035. We are not only the wealthiest nation, but also the most generous in the world. We will participate in the growth of emerging economies like the Ukraine, Russia, China, India and Africa.
Chris Dupee, CPA has contributed the following information:
Starting with the 2013 tax year, high-income taxpayers face a 3.8% tax on their net investment income (the net investment income tax or NIIT) that is imposed in addition to regular income tax. Here’s an overview of the new tax and steps you can take to reduce its impact.
The NIIT will apply to you only if your modified adjusted gross income (MAGI) exceeds $250,000 for married taxpayers filing jointly and surviving spouses; $125,000 for married taxpayers filing separately; $200,000 for unmarried taxpayers and heads of household. The amount actually subject to the tax is the lesser of your net investment income or the amount by which your MAGI exceeds the threshold ($250,000, $200,000, or $125,000) that applies to you.
Your net investment income includes your interest, dividend, annuity, royalty, and rental income; unless those items were derived in the ordinary course of an active trade or business. Taxable net gain from dispositions of property, other than property held in an active trade or business, is also subject to the tax.
There are many types of income that are exempt from the NIIT. Any item that is excluded from income for income tax purposes is likewise excluded from the NIIT. This means that tax –exempt interest and the excluded gain from the sale of your main home aren’t subject to the tax. Distributions from qualified retirement plans, including individual retirement accounts (IRAs) and Roth IRAs, aren’t subject to the NIIT. Wages and self-employment income aren’t subject the NIIT, though they may be subject to a different Medicare surtax.
It’s important to remember the NIIT applies only if you have net investment income and your MAGI exceeds the applicable thresholds discussed above. So, consideration should be given to the following strategies that may minimize net investment income:
Investment choices: If your income is high enough to trigger the NIIT regularly, shifting some income investments to tax-exempt bonds could result in less exposure to the NIIT. Tax-exempt bonds both lower your MAGI and avoid the NIIT.
Qualified plans: Because distributions from qualified retirement plans are exempt from the NIIT, upper-income taxpayers with some control over their situations (i.e., small business owners), might want to make greater use of qualified plans. For example, creating a traditional Defined-benefit pension plan will increase tax deductions now and generate future income that may be exempt from the NIIT.
Charitable donations: Consider donating appreciated securities to charity rather than donating cash. This will avoid capital gains tax on the built-in gain of the security and avoid the 3.8% NIIT on that gain, while generating an income tax charitable deduction equal to the fair market value of the security. You could then use the cash you would have otherwise donated and repurchase the security to achieve a step-up in basis.
As you can see, the NIIT may have a significant effect on your tax picture going forward. Anyone who might be subject to the tax should include it in their tax planning.
Also, we are proud and happy to announce a new member of our team.
Louis J. Beaulieu, ChFC®, AEP®, CTFA
Louis has over 35 years of investment management, trust, compliance and financial planning experience. Most recently, he has served as Head of Wealth Management for Enterprise Investment Advisors based in Lowell, Massachusetts and responsible for the growth and development of the Investment Management, Trust and Brokerage businesses.
Prior to joining Enterprise Advisors, Louis spent nearly 25 years at Chittenden Trust Company in Burlington, Vermont serving as Senior Vice President and Manager of the Personal Trust Business division. He holds a Bachelor of Science degree in Economics from St. Michael’s College. He graduated with highest honors from the Bank Administration Institute at the University of Wisconsin. Louis is a Chartered Financial Consultant (ChFC), Certified Trust and Financial Advisor (CTFA), and Accredited Estate Planner (AEP).
Over the years, he has been a volunteer in many community service organizations and has served as President and board member of numerous nonprofit entities.
Louis J. Beaulieu serves as an Advisory Representative for Pearson Financial Services and will represent us at our Venice, Florida office.
Bryan Bastoni, CFP
All of us here at Pearson Financial Hope this letter finds you doing well.
Over the last 100 years, owning common stock has been the best hedge against inflation. Warren Buffet said, “The best way to own common stock is through an index fund.” Dr. Paul Samuelson, Nobel Prize winning professor at M.I.T, capsulated the significance of this simple investment strategy when he said, “The creation of the first index fund by John Bogle was the equivalent of the invention of the wheel and the alphabet.” The enclosed page of research confirms this core investment solution for the stock part of your portfolio.
Past performance is, of course, no guarantee of future returns. Since 1926 stocks have averaged about 10% a year, bonds about 5% and certificates of deposit and 6 month treasury bills have averaged about 3%. Because stocks crash and take years to recover, we feel that prudent investors should have enough in bonds or cash or treasury bills to provide everything they might need to live on while they wait for stocks to gain back their losses.
Currently, interest rates are very low in the safest investments, but that will change over time and the need for liquidity must be recognized. As you know from our last newsletter, we feel the Vanguard Short Term Investment Grade Bond Fund is a good risk reward alternative for that money not invested in stocks. Ultimately, rates will go up and there will be more alternatives for this part of your portfolio.
Since we believe that history is the best guide to future expected returns, a simple allocation to stocks using index funds and fixed income (CD’s, short term bond funds and money market funds) is a solid strategy for lifetime income planning.
Even though the stock part has returned almost double that of the bonds and CD’s over the long term it has a much greater risk as measured by its volatility. Stocks lost 50% in a year before and it will happen again. So you personally have to decide on the percentage of your investments that you want to cover 3 to 5 years of living expenses and emergency funds. If you are uncomfortable with risk of stocks and would sell when they have the next inevitable big decline, then you should reduce or eliminate your allocation to stocks. It’s not complicated and your personal tolerance for risk should rule.
With history as the best guide, what can we expect for the New Year? The economy should continue its slow growth. More jobs mean more consumers spending and more tax revenue. The Feds will “taper” its stimulus programs and interest rates will slowly rise. Stocks could realize a 10% correction or more at any time but historically they do well when the Fed is keeping rates so low (“Don’t fight the Fed”). Because rates will go up as the economy improves, bonds will fall in value. The longer the term or duration of the bonds, the more they will fall in this cycle. Bonds performance this year should look a lot like last year.
In summary, virtually all academic researchers agree that history is the best guide to future, expected returns. It’s not about me and it’s not about the media or some guru. The most recent Nobel Prize winner in economics said “The research shows that it is impossible to pick people who can beat the market.” Once you are comfortable with your allocation to stock and bonds, the best long term strategy has been to leave it alone.
Our team at Pearson Financial is here to service your accounts, answer your questions and hopefully improve your financial lives. If you have gained some peace of mind with our services then together we have achieved an equally important reward.
Everyone here wishes you the best for the New Year.
Seth M. Pearson, CFP
WEATHERING THE STORM
Stocks and bonds act differently. Often bonds fall when stocks go up. This year, bonds lost money on average while last year they were up about as much. Attached you will find the details on two bond funds many clients own – the Vanguard GNMA Fund and the Vanguard MA Tax Exempt Fund.
Even though there are losses this year, the three year return on the GNMA is up a positive 2.27% annually and the current yield is 2.2%. The tax exempt fund has a positive three year return of 1.6% a year and a current tax free yield of 3.25%.
These three year returns are certainly better than what you would have earned in certificates of deposit and you have been rewarded for the risks of the bond market.
For the last four and a half years (see exhibit Investment Growth 2-28-09 to 8/31-13) The Vanguard US Stock Index (VTI) is up 22.84% a year. The Foreign developed market (VEA) is up 16.42% a year and the Vanguard GNMA bond fund (VFIIX) has averaged 4.16% a year. The bond market losses this year are a warning of what the future has in store.
THE PERFECT STORM
Since 1970 the average decline in price for intermediate-term government bonds like the GNMA is – 3.9% while the average rise during declining rates has been a positive 5.9% (see attached fixed income maturity risk for graph). But these are not average times at all for the bond market. If you look at the History of Interest Rates July 1954 – December 2012 (attached) you will see that Intermediate Government yields averaged 5.92%, but today are paying less than 3%. Even a partial return to normal rates will trigger significant losses. Because certificates of deposit rates have been so low for so long conservative investors have foolishly poured unprecedented amounts of money into high yield (junk bonds). Once again, Wall Street has created a bubble in the high yield market and when it bursts there will be a huge exit. Selling at that scale will create huge downward pressure on all bonds.
The economy is improving. Housing grew on average about 12% in the last 12 months. Stocks are up over 16% this year already. Unemployment continues to fall. The US is without doubt the world’s economic superpower. But, all of this good news is bad news for the bond market. Next year not only will the Fed slow or stop the quant easing stimulus strategy they will also start increasing the Federal funds rate from near zero today back in the direction of the average of 5.25% since 1954. So in addition to the other factors adversely effecting bond values, rising interest rates mean bond market losses. This perfect storm for bonds could linger for the next four or five years, until the reverse happens and stocks fall while bond prices move up.
So what should a prudent investor do now with the money they have in a GNMA bond fund? I think the time is right to sell the GNMA bond fund and buy the Vanguard Short Term Investment Grade Fund (VFSUX) and the details of that fund are included with this letter. The current yield is 1.58% and the duration is 2.4 years, which is much shorter than the GNMA fund duration of 5.54 years. Duration is a measurement used to estimate how much a bond fund’s share price may rise or fall in response to a change in interest rates. Bond funds with long average durations (more than 7 years) are likely to have negative returns during years when interest rates rise significantly. Bond funds with average durations of less than 3 years have rarely had negative calendar-years returns. “Past performance, of course, is no guarantee of future returns”.
If you own a Vanguard GNMA fund and wish to change to the Vanguard Short Term Fund, call the office and everyone here can help you make the change. Always feel free to call us with your concerns at any time. We are all in this together, and the driving force at the core of our business is to improve the lives of those we serve.
Seth M. Pearson, CFP
On June 20, 2013, Ben Bernanke surprised everyone when he said that they may start scaling back bond purchases this fall. The sudden reality of the end of the stimulus sent stock and bond markets into a steep decline.
Periods of economic growth include rising interest rates. So the Fed is forecasting a continued positive recovery. Higher interest rates mean lower bond prices, but the risk of government bonds is nothing like the risk of stocks. In fact, as rates rise, government bond funds will also start paying higher yields. Government bonds continue to be an “anchor to windward” to reduce the overall volatility of a portfolio that includes stocks. Higher interest rates also mean that riskless treasury bills and FDIC insured certificates of deposit will pay higher rates over the next four or five years. I expect bond prices will fall and their yields will increase for the next two or three years.
In my last letter to you 4/1/13, I said “I believe interest rates will rise and bond values will fall. Bonds and bond funds are not guaranteed like FDIC insured certificates of deposit. For those who cannot tolerate even a short-term loss, bond funds are not the best options.” For instance, the Vanguard GNMA government bond fund as of 6/21/13, has averaged 4.49% a year for the last 10 years and 2.74% a year for the last 3 years, but has lost 2.57% for the last 12 months. Vanguard is managing that fund to minimize losses and each month, as the bonds pay back principal and interest, they will reinvest in bonds currently paying a higher rate. Over time historically, this will reduce losses and increase yields.
In a crisis like the 2008-2009 recession, when stocks crashed by 50% this GNMA fund went up over 7%. That was the worst financial crisis since the Great Depression and government bonds were the safest place to be. For calendar years since inception (over 30 years) this fund lost once, in 1994 – a loss of less than 1%. Today, the stock market is up over 20% a year for the last 4 years. The 10 year treasury yield has just increased by .74%. Inflation remains subdued. Home construction is up. Existing home sales are surging. The Fed forecasts unemployment to fall to 6.5% or lower sometime next year and does not plan on raising the fed funds rate until then.
Even though the current and long term trend of the economy is positive, there is always some segment that temporarily underperforms. No one can time the market and today bond funds are that segment.
The steps to reduce the anxiety these recent losses have created, include accepting what has happened. The faster we disengage from setbacks that are unsolvable the sooner we can be realistically optimistic about what the future has in store for us. Rather than focusing on the Negative, I feel it is a good time to look at all the alternatives and then decide on the best plan of action. For some, getting out of bond funds may be the best action to take.
In 1994, Intermediate Government Bonds in general lost 5.14%. It happened before and it will happen again. One option you have is to get out of the bond funds now. You could move the money to the FDIC insured money market, the treasury money market or the tax free money market accounts available in your TD Ameritrade accounts. In these money market accounts you are protected from and will benefit from the rising interest rates we expect in the future.
Once rates have moved up, you will have more options, including certificates of deposit and individual government bonds with guarantees of principal at maturity. Riskless treasury bills have averaged 3.7% a year for the last 80 years. If you are patient, I believe you will have safer alternatives and higher yields as your reward. Currently, I believe that the expected return on bond funds is negative, while the expected return on the money market funds are positive. Call any of us any time at all. I am just one human being but you have an entire, experienced team at your disposal.
Some may decide to stay in Intermediate Government Bond Funds and or tax free municipal bond funds. In 2004, the Fed increased interest rates by 4.25% over a 25 month period. During that period, on average, intermediate government bonds averaged 1.8% a year in total return. Today, we are in a very slow recovery from the worst downturn since the Great Depression. Based on current and projected inflation, unemployment numbers, projections from the Fed and based on history – I feel the Fed will slowly increase their short term rates by at least 4% over the next 3 to 4 years. Bond fund values will fall as they have in the past and the income the funds pay will go up. Inside the funds, bonds will come due and the proceeds will be invested at higher yields. New money will be invested in these funds as well, increasing the overall yield. For those who own stock funds, these bond funds are still a very good hedge against the uncertainty of stock volatility. So even though the short term outlook for bond funds is negative, the longer term expected return is higher than riskless FDIC insured certificates of deposit.
Everything has risk. Even these ultra-conservative money market accounts have inflation risk so I do not expect that you will be in them for long. The attached article describes a new U.S. government bond that may be available later this year. When interest rates rise this bond would protect you from the losses that I expect in bond funds. It could be a year or more before rising rates give us higher returns from the safest investments. Anticipation of faster U.S. economic expansion explains why stock prices continue to reach new highs and bond prices drop. This cycle we are in is not unexpected. In January of 2011, I sent a letter to everyone who owned the Vanguard GNMA bond fund. The first paragraph of that letter stated: “I think this is a good time to give you a guess on what to expect in 2011. I’ve included more than I normally do on the bond market because the media will certainly be creating a lot of anxiety as the economy improves, interest rates inevitable rise, and bond prices fall.”
The media creates a distorted, more complicated take on the state of our economy. Nowadays, you can’t escape the minute-by-minute information from the magazines, the TV, the smart phones, the websites, the radio, and all are buzzing and beeping green and red arrows at you all day long. All of this, I believe, creates stress that is much more significant than it needs to be. Historically, even short and intermediate bond funds, if held for their average duration of 4 or 5 years, have little interest rate sensitivity.
When the reality of how slowly this recovery unfolds over the next 12 months, I feel the recent bond market, volatility will subside. I will continue to monitor the bond market and will reach out to you with letters, seminars and meetings to help you make the best decisions.
Seth M. Pearson, CFP
The future is uncertain but I feel it is reasonable to expect slow, continued economic recovery from the last worst recession since the Great Depression. Investors who held on to stocks since the March 2009 bottom have been richly rewarded with an average gain of over II 0%. Could this staggeringly positive advance in prices and corporate earnings be signaling the start of a decade long period of higher returns? I feel part of investment success IS a result of recognizing that historically, disappointing periods for stocks have been followed by periods of higher returns. Since 1928, there have been eleven 10 year periods when stocks delivered a disappointing return of less than 5% including 2000 - 2009 when stocks earned a negative 1%. In every past case the 10 year period following each disappointing period produced above average returns of9.3%, 6.6%, 8.5%, 12.1%, 17.6%, 14.8%, 14.3%, 15.3% and 16.3%. These periods of recovery averaged 13% per year. Past performance is, of course, not a guarantee of future results and Warren Buffett wisely advised that "if you can't be in stocks for 10 years, you shouldn't be in them for 10 minutes." In 2008 stocks lost almost 38%. It will happen again but no one knows when.
Government bonds often go up when stocks crash. In 2008, the Vanguard GNMA Bond Fund, that many clients own, went up 7.33%. It is interesting to note that for a 10 year rolling periods, with returns from 1926 to the end of 2011, a portfolio with 50% stocks and 50% bonds, never lost money. (There were 77 ten year rolling periods during that time.)
All investments involve some form of risk. Bonds are subject to interest rates, credit and inflation risk. Sooner or later, bond investors will face a loss of money or at best, meager returns. Expect bond market volatility until the unemployment numbers improve and the Fed begins to increase interest rates. In December, Fed Chairman Ben Bemanke said that current economic conditions would likely warrant holding the benchmark interest rate target near zero into 2015.
When interest rates rise bonds prices fall, but it is important to remember that when interest rates rise, income increases as long as a bond fund portfolio is actively and professionally managed to maintain its interest rate sensitivity over time. A professional bond manager like Vanguard will attempt to anticipate changes in rates to position the portfolio maturities to minimize the short term losses. Over the long-term, bonds, like stocks have recovered from short term losses to produce long term, positive risk reward ratios. Since 1926, intermediate term government bonds have averaged over 5% a year.
If most corporate and academic economists are right, we can expect very slow growth for the next decade which would translate into a relatively stable bond market over that same period.
We will continue to monitor the bond market environment and do our best to educate you about what to expect going forward.
My guess for 2013 is; a slow recovery in Europe, continued unrest in the Middle East, more terrorism around the globe, improving employment numbers in the US, big swings in oil prices and of course, unpredictable natural disasters.
I do expect the disconnect between what the people want and what the politicians will do, to continue. However, today the central banks of the developed nations around the world invest most of their reserves in US treasury securities. That collective wisdom, that vote of confidence, is based on their belief that the largest economy on this earth can overcome, and is able to resolve any threat - including our debt. I agree with them.
As always, I will monitor your accounts on a periodic basis. I will also monitor the stock and bond market daily. I feel a tremendous burden of responsibility to help you make the best financial decisions in the face of an unknowable future. I hope the knowledge of this will make your life a little less stressful.
You also have responsibilities. You should know what you own in your accounts. You should know the allocation you have to stocks and bonds as well as the historic risks and rewards of those investments. It is your responsibility to inform us of any changes in your objectives or financial situation, or tolerance for risk. Working together can only improve the chances for a better outcome.
Happy New Year!
Seth M. Pearson, CFP