However, this news should not come as a big shock to everyone.  Goldman Sachs, Bear Sterns, Merrill Lynch, Wells Fargo and the many other large financial institutions alike have a priority to their shareholders, and that is to make a profit.  Greg Smith stated “if you make enough money for the firm you will be promoted to a position of influence” and later went on to add that the most common question he received from junior analysts was, “how much money did we make off the client?”  Mr. Smith claims that clients are referred to as “muppets” by senior staff, suggesting that those clients are oblivious to their sole purpose of providing profit for the firm!

According to a study by Harvard and MIT economists, many financial advisors are often more likely to give advice that will lead to higher fees for them than higher returns for their customers.  These economists sent hundreds of actors to financial advisory firms and found that in many cases those advisors steered their clients away from a logical investment and instead into one that produced more fees.

Former Bear Stearns CEO Alan Greenberg once said that he would not hold an M.B.A. against prospective hires, but that he much preferred job candidates with a P.S.D. – his term, which is short for Poor, Smart, with a Desire to be rich.  After graduating from Cornell University with a degree in Economics, I was eager to put my newfound love for finance to the test in my first job with a well-known national investment firm.  However, much to my surprise, the three-week training that came with the position was spent solely on sales techniques.  A few weeks later, after bringing in several clients, I then realized that I had no clue what to do next in regards to investing their money!

So what can individual investors do to avoid being a “muppet” for the firm they decide to work with?

Here are a few qualities to seek:

Fiduciary.  They act only in your best interest; a fiduciary relationship means we’re legally obligated to do so.  Registered Investment Advisory firms are held to a fiduciary standard.  This is not the case with others such as insurance companies or broker/dealers.

Fee-only.  Their compensation is fully disclosed, fairly priced, and paid strictly by you, their client.  Fee-only advisors accept no commissions or other types of incentives from outside sources to distract them from serving as your fiduciary.

Having worked at a brokerage firm prior to my time here at Rockbridge, I personally understand Mr. Smith’s frustration.  This is one of the reasons that I am so passionate about our firm’s investment philosophy and the fiduciary standard that we hold ourselves to as fee only investment advisors.  At Rockbridge, we have a strong desire to do right by our clients and carry forward the belief that the “Golden Rule” applies to all that we do, including financial planning!

“Bonds are the worst asset class for investors,” says Professor Burton Malkiel, the author of A Random Walk Down Wall Street, in an opinion piece published in late March in The Wall Street Journal.  “Usually thought of as the safest of investments, they are anything but safe today.  At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser.”

This prediction may or may not be correct; however it is important to review the reasons why investors should hold bonds in a diversified portfolio.

What Are The Risks of Owning Bonds? 
There are 3 components of risk in owning bonds.  Issuers of bonds (corporate or government) can default and not repay you.  Default risk can be very low (U.S. Treasuries) or quite high (corporate junk bonds).  As interest rates rise, the market value of your bond holdings will go down (interest rate risk).  Over the past ten years bond returns have been very good due in large part to the increase in market value as rates went lower and lower.  Inflation is a source of risk that greatly impacts an investor’s purchasing power in retirement.  For retired investors, interest and dividends are an important source of income.  If inflation outpaces interest rates, the bond investor’s purchasing power decreases.

It is likely that bond returns will not be nearly as good as they have been over the past ten years.  So what should an investor do about it?

1. Sell bonds and move into cash or CDs, waiting for interest rates to rise.
   While it seems like a good strategy, it’s very difficult to predict when rates will rise.  They may stay low for several more years.  Inflation is likely to outpace interest payments from cash reducing their real value and purchasing power.
2. Sell bonds and re-invest in the stock market.
   In addition to expected return, high quality government bonds are a low-risk way to diversify a stock portfolio.  An investor would greatly increase portfolio risk using this strategy.  Ask yourself if you can stomach the volatility of a 100% stock portfolio during a period like 2008.  Most investors would be unable to ride out that storm.
3. Reach for higher dividends by reallocating to longer-term or corporate bonds.
   This strategy will also increase risk in a portfolio.  Longer-term bonds are more volatile and sensitive to interest rate changes.  Corporate bonds increase default risk if the business offering the bond fails.   
4. Do nothing.
   Bonds are in a portfolio for good and valid reasons.  Over the long term, interest income – and the reinvestment of that income – accounts for the largest portion of total returns for many bond funds.  The impact of price fluctuations can be more than offset by staying invested and reinvesting income, even if the future is similar to the rising-rate environment of the late 1970s and early 1980s.

I don’t recommend selling bonds and buying either cash or stocks.  However, there is merit in adding longer-term Treasury Inflation-Protected Securities, or TIPS, and short-term corporate bonds into a portfolio for investors willing to accept the additional risk.  There is no way to reliably predict future interest rates or inflation, so most investors will fare very well by leaving their bond allocation alone and riding out the market cycle.

Equity returns exceeding 10% would be welcome for the year, say nothing of the quarter.  Some fear that we are now due for a correction, as the markets have risen too rapidly.  We try never to predict future market movements, but it is worth noting that the S&P 500 index, ignoring dividends, reached 1530 back in March 2000.  It got back to 1560 in the fall of 2007 before retreating, and it is now hovering around 1400, meaning that the value of the 500 largest U.S. companies is still well below the level first attained twelve years ago, and earnings continue to improve.  So while a correction is always possible, there seems equal opportunity for further upside.

It is also interesting to note how much less volatile markets have been in the last quarter as the debt crisis in Europe generates fewer alarming headlines, and other economic news has taken on a positive tone.  The European debt crisis seems far from solved, and yet just the absence of bad news has had a surprisingly positive effect on global equity markets.

Should Passive Investors Feel Bad About Getting a Free Ride?
The efficient market allows passive investors to get a free ride – market returns at minimal cost while others do the work.  Diligent, hard working analysts and active managers are determining the true value of individual stocks and bonds, and driving prices toward those values in an auction market.  Meanwhile, index funds come along and buy a market basket of securities at the market price without doing the work to determine if the prices are fair.

But What Happens When Everyone Buys the Index?  Who Keeps the Market Efficient?
As a believer in the advantages of index funds, I have been asking these questions since before we started an investment advisory firm in 1991.  By that time, index funds had been available to institutional investors for a few years, but they were just beginning to take off with smaller investors using mutual funds.  The new products allowed us to utilize institutional money management strategies for small investors, and it seemed clear that everyone should adopt the new innovation that allowed anyone to get market returns at low cost.  Alas, not everyone saw the world as we did, and they probably never will.

Nonetheless, we now see growing talk of passive management dominating markets, and having a detrimental effect on market function.  In fact it has become the topic of serious research.

The latest issue of the Financial Analyst Journal includes an article, “How Index Trading Increases Market Vulnerability” (Sullivan and Xiong, March/April 2012).  It reports that, “the authors found that the rise in popularity of index trading – assets invested in index funds reached more than $1 trillion at the end of 2010 – contributes to higher systematic equity market risk.”  The implication is that traders are buying and selling the whole market basket without regard to the merits of individual stocks.  I have seen presentation materials from at least one active manager using this argument to help explain why it has been so difficult for them to outperform the market.

On the other hand, Jack Bogle, the founder of Vanguard often credited as the father of index funds, sees the growth of passive investing as a triumph.  About 25% of mutual fund assets are now invested in index funds.  Also, ETFs (Exchange Traded Funds) which typically track an index but trade throughout the day, now represent about 30% of trade volume in U.S. equity markets, having grown from essentially zero in 12 years.   Appearing at a recent conference, Bogle said that in the last five-plus years, index funds have gained $600 billion in assets, while active managers have lost $400 billion.  He says that investors have to be persuaded by the growing evidence that index funds work.

So, will the dominance of passive investing destroy the free ride?  I am not worried.  I believe there will always be plenty of people willing to pay smart analysts to keep the market efficient.  My latest evidence of this was published in the New York Times on April 1, 2012 in an article entitled, “Public Worker Pensions Find Riskier Funds Fail to Pay Off.”  The article reports on public workers’ pension funds across the country, increasingly turning to riskier investments in private equity, real estate and hedge funds…“but while their fees have soared, their returns have not.” 

It goes on to explain that the states using more of these alternative, actively managed investments have incurred higher fees and worse performance, compared to the states that stuck with a more traditional mix of stocks and bonds.  Yet the Oklahoma Teachers Retirement System, which has done well over the past five years with a mix of stocks and bonds, is putting 10 percent of its fund into private equity and real estate funds.  When asked about the higher fees, the fund’s executive director said, “We believe the outperformance from moving into these categories can justify the additional fees,” demonstrating that hope springs eternal, and that Mr. Bogle is an optimist to think that investors will be persuaded by the facts.  I think passive investing has a bright future, and I will be happy to continue taking that free ride.

Make Work Pay Credit Gone
Many are disappointed with the amount of refund or amount owed compared to last year, primarily due to the elimination of the Make Work Pay credit that could be as great as $800 for a couple.  A credit is almost always better than a deduction because it is subtracted directly from the tax, whereas a deduction is subtracted from taxable income prior to the tax calculation.

Residential Energy Credits
As usual, many are confused about the Residential Energy Credit.  Homeowners have new windows, insulation, furnaces, etc. installed by suppliers and contractors with the expectation that their taxes will be greatly decreased, a convenient sales tool.  Actually, not all of the labor and materials qualify for the credit, and then the credit is only a small percentage of the cost, usually 10%, with dollar limits on specific items and with a maximum accumulative limit of $500 over the past five years.  I had a salesman tell me about the credit while presenting his replacement windows for my seasonal lake property.  What he didn’t say, or probably know, was that the credit is only for a primary residence.  When challenged on this aspect, he moved on to the next selling point.

New York State Changes
NY State has added a new e-file requirement for individual taxpayers.  Individual taxpayers who file their own returns using tax software are generally required to file electronically.  A taxpayer who is required to e-file and fails to do so will be subject to a penalty and will not be eligible to receive interest on any overpayment until the return is filed electronically.  They say that if your software supports the e-filing of your return, you must e-file, and if you are required to e-file but you file on paper instead, you may be subject to a $25 penalty.  Looks like NY State is serious about automation and reducing paperwork.  Why then have they discontinued the Form IT-150 short form (two pages), and now require the four-page Form IT-201 for full-year residents?  Why not just reform the tax system and reduce the amount of paperwork that way?

Cost Basis Reporting – Valuable, But Not Entirely Accurate
We are hearing lots of talk about the new cost basis reporting by custodians, and confusion for taxpayers.  The Form 1099Bs that are used for reporting security sales now include the original cost of the security or cost basis for the security sold (stock, bond, mutual fund, etc.).  New legislation that took effect January 1, 2011, now requires the custodian to report this information to the IRS.  This cost basis information is quite valuable for the taxpayer preparing income taxes because it eliminates the need to go back over months and years of statements showing when and for how much the security was purchased and reinvested capital gains and dividends, all of which go into the cost basis.

My first experience was enlightening.  The cost basis for several mutual funds sold was accurate.  They were purchased four years ago and reinvested all dividends and capital gain distributions.  The US Treasury note that matured in 2011 at $18,000 was purchased in 2008 at a premium of about $19,300 because it carried an annual interest rate of almost 5%.  The custodian showed a cost basis of $18,000.

Although the custodian included a notice that cost basis is furnished to the IRS, these securities I mentioned actually were not furnished to the IRS.  Cost basis reporting is only for “taxable” (non-retirement) accounts.  Cost basis is required for:

1. Stocks acquired on or after January 1, 2011 and
2. Mutual funds and some other less common security types acquired on or after January 1, 2012.

The cost basis information is valuable for the taxpayer, but not entirely reliable.  The custodian has no knowledge of the cost basis of securities purchased through one custodian and transferred to another custodian.  The responsibility for cost basis lies with the owner of the securities.  Rockbridge Investment Management has historic cost information available for our clients upon request.

This year the filing deadline is April 17, 2012.  Be sure to file by that date, or file a request for extension if your actual return is not ready.  Be sure to estimate any amount owed and include it with the extension request.  At least you will still have another six months to get your act together and get the proper return filed.

Successful investing and financial planning also require balancing tradeoffs. For example, a common investment tradeoff is that of risk and return. One of the competing demands is preservation of capital versus preservation of purchasing power. The former may allow for a better night’s sleep during periods of heightened uncertainty and corresponding volatility, but the latter helps ensure you’ll have a comfortable bed in the future when accounting for rising prices from inflation. Once again, there is no right answer, no “optimal” solution. Understanding the tradeoffs between preserving capital and preserving purchasing power will help investors find the balance that is right for them. This balance will depend on their definition of risk and attitude towards it.

Some investors may consider risk to be volatility. They have difficulty stomaching the daily ups and downs associated with investing in asset classes that experience significant price fluctuations, such as equities, because declining prices are often accompanied by predominantly negative headlines. Although information will be reflected in prices before one can react to it, this is little solace to investors who extrapolate the recent past into the future and see the bad news as an indicator of what’s to come rather than a commentary on what has already happened. These investors yearn for short-term preservation of capital.

Other investors may define risk as a diminishing standard of living. They have long-term financial obligations, such as spending during their retirement years, and their primary goal is building wealth to meet those future expenses. They recognize that, while the cumulative effects of inflation are sometimes glacially slow or even undetectable in real time, inflation can be the silent killer of a financial plan. These investors desire long-term preservation of purchasing power.

Investing is relatively straightforward when the definition of risk and attitude toward it are so black and white. For example, you can virtually guarantee the preservation of capital by investing in the equivalent of Treasury bills as long as you accept the corresponding potential for the loss of purchasing power. On the other hand, you can preserve purchasing power by investing in asset classes with expected returns exceeding inflation, providing you accept price fluctuations that can temporarily impair your capital.

Unfortunately, in practice, investing isn’t that simple. Individual investors rarely have black and white objectives or well-defined definitions of and attitudes towards risk. Some expect long-term preservation of purchasing power and short-term preservation of capital. Making matters worse is the tendency for the priority and relative importance of their competing demands to change through time, often in response to what’s happened in the recent past.

Investors who succumb to the cycle of fear and greed end up chasing a moving target. Advisors can try to mitigate this destructive behavior by focusing investors on the tradeoffs that were made at the outset when determining their balance between assets that are expected to grow faster than inflation and those that stabilize the portfolio and reduce its fluctuations. So if an investor is now fearful and therefore more focused on capital preservation, it is time to reframe the tradeoffs by emphasizing why growth assets were in the portfolio to begin with and how the so-called “riskless” asset (i.e., bills) can actually be extremely risky in the long run.

For example, Table 1 contains annualized returns from Australia, Canada, the US, and the UK for more than a century. Bills only slightly beat inflation before tax, but this small return advantage can easily disappear on an after-tax basis.¹ Nonetheless, the table clearly demonstrates that equities have delivered returns exceeding both bills and inflation by a wide margin, even when accounting for taxes.²

Table 1: Annualized Nominal Returns (1900–2010)

In local currency. Dimson Marsh Staunton (DMS) Global Returns Database. Past performance is no guarantee of future results.

However, the tradeoff for pursuing higher expected returns of equities is accepting the risk of substantial declines compared to the relative stability of bills. Table 2 shows that equity values in the four markets have dropped from 50–69% over a two- to six-year period, whereas bills have always been flat or better (if you consider minus 2 basis points a rounding error).

Table 2: Worst Performing Periods for Equities and Bills, Nominal Returns (1900–2010)

In local currency. Dimson Marsh Staunton (DMS) Global Returns Database. Past performance is no guarantee of future results.

The risk and return relationship from a preservation of capital perspective is apparent in these nominal returns, but the picture is a bit different after considering the impact of inflation. In terms of preserving purchasing power, now the “riskless” asset looks far from risk free.

Table 3 contains the biggest peak-to-trough declines, in real terms, for equities in these four countries over the same time period. It likely comes as no surprise that the magnitude of the real declines is substantial, with stock prices dropping anywhere from 55–71% after inflation. However, the duration of the declines is still relatively short, ranging from two to five years, and it took equity investors in these countries anywhere from three to eleven years to break even.

Table 3: Worst Performing Periods for Equities, Real Returns (1900–2010)

In local currency. Dimson Marsh Staunton (DMS) Global Returns Database. Past performance is no guarantee of future results.

In contrast, the data in Table 4 for bills, or the “riskless” asset, in these four countries is revealing. The biggest peak-to-trough declines after inflation now remarkably range from 44–61%, a similar order of magnitude to equities. Furthermore, the duration of the declines extends to a range of seven to forty-one years with investors in bills waiting an astounding seven to forty-eight years to recover!

Table 4: Worst Performing Periods for Bills, Real Returns (1900–2010)

In local currency. Dimson Marsh Staunton (DMS) Global Returns Database. Past performance is no guarantee of future results.More than ever, comparisons like these are needed when discussing the trade off of preserving capital versus preserving purchasing power. Investors feel the risk of equities in real time. Volatility is immediate and apparent as their portfolio value shows up in the mail every month or on their computer screen every day. Conversely, the risk of investing in bills and other low-volatility assets is less discernible and may take time to detect as it shows up when investors open their wallet at the grocery store or gas station many years later.

Investors may still want to revisit the tradeoffs they made and alter course if appropriate. However, changes to a long-term plan should reflect an informed decision rather than an emotional one. Fear and greed are powerful forces, but we should resist letting them dictate the tradeoffs we make in our lives or in our portfolios.

As the Most Interesting Man in the World would say, “stay invested, my friends!”

View the PowerPoint here!

Over the last decade investors have been faced with a tremendous amount of volatility in the financial markets.  The “technology bubble” was the first obstacle investors ran into and unfortunately had to bear with for over two years before the markets began to recover in late 2002.  That recovery lasted for around five years and culminated in late 2007 when the Dow Jones hit its all time high.  Unfortunately, this high was short lived and in 2008 investors saw one of the worst market corrections of their lifetimes!  So has this decade been a waste for investors? Are their depictions of the market over the last ten years correct? Hardly, as long as you were properly diversified.

The graph below shows the performance of various benchmark portfolios and how they have fared over the past ten years.  The green line tracks a well-diversified all stock portfolio.  What this graph shows is that if you wanted $100,000 today, you would have needed to invest $64,500 ten years ago to achieve that.  The blue line shows the returns of a moderate portfolio (50% stocks, 50% bonds), which is a more realistic holding for most investors.  With a moderate risk portfolio, an investor could meet his $100,000 demand today with an investment of only $59,200 ten years ago!  I know these are double digit annualized returns we are looking at, but to see this kind of growth in supposedly a “lost decade” seems pretty good to me.

Now, let’s take a look at how your investments would have done over a longer period of time.  The graph below shows the path of those same benchmark portfolios over a time period of 32 years; a time horizon more indicative of what many investors face during their years of saving.  In this case, a mere $4,500 was needed back in 1979 to reach our goal of $100,000 today.  That equates to over a 10% annualized return!

The “investment rollercoaster” of the past decade has played with many investors’ emotions and has been hard to handle.  However, for those who have stayed the course and were properly diversified, you are better off for it.

It is times like these that we need to step back and look at the bigger picture and realize that the recent volatility is nothing more than a few potholes on the road to your financial success!

Related Articles:

• Investment Philosophy
• Investment Process
• Implementation

Financial Results
As a firm, Rockbridge continues to grow steadily.  Over the past two years we’ve grown the amount of assets under management by 20% from $194 million to $232 million.  While the markets have contributed to this increase, most of this rise is due to new clients who have discovered our firm via a referral from a current client or through our website.

Surprisingly, a significant number of our new clients have found us via our website after searching for a local fee-only advisor.  We’ve invested in website improvements to bring our story to more people.  We don’t have an advertising budget and rely on referrals as our main source of new clients.

Our Business Model is a Winner
While our clients know this, it’s worth repeating.  Rockbridge is a fee-only Registered Investment Advisor (RIA).  Our only source of revenue is from fees paid by clients.  We have never accepted a commission from a product we recommend.  The fee-only RIA business model has experienced steady growth while commission-based brokers continue to lose market share as individual investors discover the value of working with an objective fee-only investment advisor.

Our Fees Are Modest
Our mantra continues to be “costs matter.”  The amount an investor pays in investment costs will definitely affect their standard of living.  We continue to have a relentless focus on costs for our clients.  Each year, Charles Schwab surveys the advisors they service.  Rockbridge participates in order to benchmark our firm against others like us.  The survey revealed that our management fees are less than our peers.  Our fees for a typical client average .50% of assets managed versus our peers whose fees average .67%.  Lower investment costs mean more money in our client’s pocket.

Education Never Ends
Our firm is part of a study group of likeminded advisors committed to the passive investment philosophy.   We meet quarterly in New York City to discuss investment strategies or products and compare notes on our business practices.  The insight we get from these meetings makes us better advisors.  We also continue to be a member of The National Association of Personal Financial Advisors (NAPFA).  NAPFA is the country’s leading professional association of fee-only financial advisors—highly trained professionals who are committed to working in the best interests of those they serve.  NAPFA holds several training events throughout the year that we are proud to be a part of.

Plans for 2012 and Beyond
We will continue to meet with clients to review their investment plans.  There is no way to predict future returns; however, we are confident that markets will reward investors for taking investment risk over the long term.  Expected future returns may not be as high as in the past, as articulated in Craig’s accompanying article, so we will continue to help clients determine the right amount of risk to take in order to meet their financial goals.

Changes in technology and new investment products are introduced at an ever increasing pace.  We take time to evaluate new technologies and products on a regular basis.  We spend money on technologies that make us better, more productive advisors.  We are slower to make changes involving new investment products since many are designed to maximize profit  for their own companies, not necessarily for their investors.

Our strategic plan for the next three years calls for modest growth both in new clients and firm revenue.  Our five professional fee only investment advisors have capacity to help more individual investors.  As the baby boom generation is poised to start retiring, we look forward to referrals from our clients and professional networks.

Recent regulatory changes to be enacted in 2012 will shine a light on the abuses in the 401(k) marketplace, especially for small employers.  At Rockbridge, 31% of our revenue comes from managing 401(k) plans for small business owners.  We are poised to be an objective partner for other small firms who care about their employees and their retirement goals.

In conclusion, we continue to be passionate about our investment philosophy and thoroughly enjoy working with and educating our clients.  Personally, I enjoy coming to work every day surrounded by smart, confident, passionate people.

It is unusual for the S&P 500 to move so little from one year to the next, but it is also unusual for it to behave the way we “expect” it to behave.  Since 1926 the average annual return has been about 11%, and yet over those 86 years, the annual return has fallen between 8% and 13% only 6 times.  The range has been -43% to +54%.

TWO – Regardless of the returns we realize, markets are volatile.  
In other words, we often experience the risk without realizing the commensurate level of return.

2011 certainly felt like a rollercoaster, and the stock market was indeed volatile.  Yet was that volatility unusual considering world economic events?  The experts at Vanguard say no, and provide evidence in a recent paper.  Their evidence is based on a comparison of economic volatility and market volatility, which turn out to be closely correlated.  Moreover, they show that the volatility of the economy and markets was higher in the 1970’s than it has been over the past five years.  Risk and return are related, but we only observe the correlation in the long run.

THREE- When “everyone agrees” on the likely direction of a market (or prices, or interest rates) they can still be wrong.
At the beginning of 2011 “everyone agreed” that interest rates had to rise from current levels.  Bill Gross was one prominent expert who put his money where his mouth was, declaring that U.S. Treasury yields were so low they did not adequately compensate investors.  He sold Treasuries out of his portfolio.  It turned out to be a spectacularly bad decision as Treasury rates fell further and his fund, PIMCO Total Return, the largest bond fund in the world, underperformed.

What is a reasonable range of expected returns…
We have all read the standard performance disclaimer, “Past performance is no guarantee of future returns.”  That warning has rarely been more important or relevant than it is today.

Bond returns have now outperformed stocks over the past ten years.  Mutual fund investors continue to pour money into bond funds in response to stock market volatility and, we assume, in part because of attractive past returns.

Vanguard published a paper in November 2011 that tried to answer the question, “What is a reasonable range of expected returns for a balanced portfolio of stocks and bonds based on present market conditions?”  For the full paper, click here:  https://advisors.vanguard.com/iwe/pdf/ICRLYVE.pdf?cbdForceDomain=true

They present several interesting conclusions including:

•  Expected returns for a 50% stock/50% bond portfolio are 4.5% to 6.5% nominal and 3.5% to 4.5% in real terms (after adjusting for inflation).  This result is modestly below the average since 1926 (8.2% nominal and 5.1% real) but better than the past decade.

•  Expectations for the next decade are driven by the current level of bond yields, which are highly correlated with future annualized returns from bonds.

•  The chart below shows expected returns for a more risky portfolio (80% stocks/20% bonds) more consistent with the historical average while the expectation for a less risky portfolio (20% stocks/80% bonds) less likely to achieve historical results.

Real (inflation-adjusted) returns

Notes:   Percentile distributions are determined based on results from the Vanguard Capital Markets Model.  For each portfolio allocation, 10,000 simulation paths for U.S. equities and bonds are combined, and the 10th, 90th, 25th, and 75th percentiles of return results are shown in the box and whisker diagrams.  The dots indicating U.S. historical returns for 1926-2010 and 2000-2010 represent equity and bond market annualized returns over these periods.  The equity returns represent a blend of 70% U.S. equities and 30% international equities; bond returns represent U.S. bonds only. 

Sources:  Barclays Capital, Thomson Reuters Datastream, and Vanguard calculations, including VCMM simulations, and index returns.

•  With ten-year Treasury rates below 2%, it is irrational to expect bond returns over the next decade to be anything like the past decade, and nearly impossible mathematically.

•  Stocks, on the other hand, appear reasonably priced, capable of providing average historical returns, and quite likely to do better than the past decade, which began with stocks very highly valued (Price/Earnings ratios well above historical averages.)

Conclusions/Take-Aways

1.  Expect returns from balanced portfolios to be below historical averages over the next decade due primarily to low bond yields.

2.  The incentive to take stock market risk (relative to bonds and cash) may be as high as it has ever been.

3.  Chasing the bond returns we have seen over the past decade is ill-advised.

4.  Taking more stock market risk may be tempting, but comes with greater volatility.

5.  Most investors should stay the course, with a balanced portfolio that reflects their long-term tolerance for risk.

Medical insurance is not like any other insurance you have.  Some common insurances, like home owners and auto, may be required by lenders and or state authorities, but you hope you never have to use it. You really have little choice on how much coverage or how much to pay.  Medical, however, is much more personal in that most of us have a pretty good idea of what medical services we will need from year to year.  Of course there will be unexpected illnesses or accidents from time to time.  But overall, we can estimate our medical needs and how much they may cost.

So, we base our coverage on what premium we can afford, how many doctor visits we expect, what drugs we need, and how much risk we are willing to take with major medical expenses.  High costs of health care pretty much dictate that we must have at least some protection against doctor and hospital visits that could lead to financial ruin. For example, my heart cath last year was expensed at $16,000.  How would I have paid for that without insurance coverage?  What if I had been diagnosed with a blockage that needed surgery?  My out-of-pocket amount was $150.  I can handle that, but not $16,000.

There are many, many questions you need to ask yourself and the insurer when deciding on what coverage type and coverage plan is right for you.  Here are a few to get you started.

How much insurance do I need?

You may know the number of primary care and specialist visits, what prescriptions, and what lab tests you will have in a year’s time, and what they may cost.  If you don’t know, you better find out so you can decide if extra insurance is worth the premium.  Why pay a monthly premium of up to $200 per person, in addition to standard Medicare, if you don’t expect that there will be claims?

What is my basic health status?

A person with a history of heart problems, diabetes, back pain, eye problems, or any other regularly occurring health issues requiring hospitalization or specialist care can expect the possibility of them recurring during the year.

Which type of additional insurance should I get?

Medicare is standard and (somewhat) understandable.  The Medicare Advantage and Medigap plans require lots more analysis to understand their options and coverages.  They all are unique as to costs, restrictions, claims processing, etc.  Learn as much as you can about how each would work for you.  Don’t assume that the highest premium plan would be best for you.

What is a Medicare Advantage Plan (MA Plan)?  Is it Medicare?

MA Plans are a form of Medicare administrated by private companies approved by Medicare.  They must cover all of the services of Medicare (except Hospice) but can charge different out-of-pocket costs and have different rules for referrals, doctors, facilities or suppliers.  For instance, a recent visit to an urgent care facility cost me $35 under my MA Plan, where original Medicare would have been $0.  All MA Plans are not the same as to premiums and coverage, so they must be examined to determine how they work for your individual situation.  You must still carry and pay the premium for Medicare Parts A & B.  MA Plans are not Supplemental Plans.

  What is a Supplemental Plan?  (Also called Medigap)

This is insurance that can help pay some of the health care costs not covered by Medicare, like copayments, coinsurance, and deductibles.  They are standardized policies, but different insurance companies may charge different premiums for the same exact policy.

 Do my doctors participate with this plan?  Some plans provide “in network” and out of network coverage, with a different co-pay for each.  Using the latter usually means you pay more and have more paperwork to complete a claim.  Ask your doctors if they “participate” with any plan you choose.

How much will I pay for prescription drugs?    Are they covered under this plan?

Medicare A & B does not include coverage for prescription drugs.  One recent mailing from a private insurer showed a monthly Rx premium of either $40.30 or $89.70 for the same coverage I now get for $0 premium.  One friend of mine has the same plan as I and doesn’t even think he has drug coverage.  He does, but hasn’t needed to use it.

Additional Questions:

 What if I travel, go south for the winter?

What kind of plan should I get just to make sure I would not suffer financially if I had a serious illness or operation?

What would Medicare have paid if I didn’t have Medicare Advantage or a Medigap plan?

How do I access details on line?

What if I have other company retiree coverage?  Should I keep it or change?

The questions and personal issues go on and on.  By now it should be obvious that this is a very complex area and the best way to address it is to go to the seminars put on by most, if not all, of the insurance companies.  Bring your “Medicare & You” booklet.   Be an informed consumer!

Here is the communication from Schwab to advisors:

We want to make you aware that the indices for the Schwab Small-Cap Index Fund^® (SWSSX) and the Schwab International Index Fund^® (SWISX) will be converted from Schwab’s propriety indices to the Russell 2000® Index and the MSCI EAFE Index, respectively. Although these conversions will not happen until December 14, 2011 and December 20, 2011, we are required to mail a 60-day notification to your clients invested in either fund as of October 14, 2011. Additionally, as of November 1, 2011, the Schwab Small-Cap Index Fund’s expense ratio will decrease from 19 basis points (bps) to 17 bps. You may review a copy of the prospectus supplements here and here.

The Russell 2000 Index is an established index that measures the performance of the small-cap sector of the U.S. equity market. The Russell 2000 is a subset of the Russell 3000, representing approximately the 2000 smallest issues and approximately 10% of the total market capitalization of the Russell 3000.¹ The MSCI EAFE Index is an industry-recognized index composed of MSCI country indices representing developed markets outside of North America—Europe, Australasia, and the Far East.

Converting to these indices from Schwab’s proprietary indices offers more transparent fund management for all segments of investors, plus better tracking and comparison data from third-party providers. Lowering the expense ratio of the Schwab Small-Cap Index Fund offers a better investment value for your clients.

Both funds have performed as expected against their respective benchmarks in the past.  We believe these are positive changes and both funds will  continue to be excellent representatives of their respective market segments.

Please give us a call if you have any questions or concerns about the changes.