Staying the Course and Holding Fast to Your Investment Strategy

From social media feeds to financial news outlets, we’re constantly bombarded with a stream of updates, opinions, and analysis. Access to so much information can be empowering, but can also be overwhelming. How do we know which sources to trust and where should we focus our attention? With inflation making daily headlines, stock market volatility, political unrest and global tension, it’s easy to see why an investor might want to take a step back and seek safe harbor.  Investors don’t need to look far to find a pundit claiming to have the answer, however, the lack of consensus between opinions is a reason for investors to be wary of making changes to their long-term strategy.

Given the rapid increases in interest rates as of late, bonds and CDs have garnered investors’ attention. From 2008 to 2019, the Federal Reserve kept interest rates at historic lows in response to the global financial crisis and the prolonged economic recovery. This resulted in the yield of the 10-year US Treasury Bonds falling to 1.37%. Even more recently the COVID-19 pandemic and economic downturn resulted in the 10-year yield dropping to 0.52%. Not exactly an attractive investment return. However, investors have recently taken notice in the uptick in return on secure investments, with some institutions like Ally Bank offering an 18-month CD with an APY of 5.0%. In any given year, you’d be hard pressed to find an investor that isn’t intrigued by a relatively risk-free 5% rate of return. With all the turbulence surrounding the economy, wouldn’t it make the most sense to move your portfolio to these safe and reliable investments?

First, let’s look at the historical returns for equities and bonds. According to a study conducted by Vanguard, the average annual return of the US Stock market has been 9.5% over the last 90 years. Comparatively, the average annual return of US bonds over the same period was 4.9%. While there may be uncertainty surrounding the stock market today, investors often benefit from a phenomenon called “reversion to the mean”. Over the long term, markets deliver average returns and periods of underperformance eventually revert to historical average returns. Given the headwinds facings the investment landscape today, why trust historical averages?

While it may seem like a “safe play”, to shift your portfolio away from equities, it can be more detrimental than one might realize. In attempting to time the market, investors often miss out on the most crucial days when markets rebound and they often re-enter the market too late, missing out on those large upswings. As illustrated below, this behavior typically results in returns that lag behind those who remained invested.

 

 

 

 

 

 

 

Investors also need to consider inflation, which can erode the purchasing power of your financial assets if you’re out of the market. According to the US Bureau of Labor Statistics, the average annual inflation rate in the US from 1991 to 2020 was 2.3%. In recent months we have seen year-over-year inflation on consumer prices as high as 9.1%. Hypothetically, if the stock market has an average (by historical measures) year, and returns 9.5% on your investment, and we see another year of exceptionally high inflation, you would have at least kept pace. An investor locked in to an 18-month CD at a rate of 5.0% would have lost purchasing power over that 18-month period, with a real rate of return of -4.1%.

The obvious question is, what if the market declines? While a 2023 market pullback is possible, as we saw above, attempting to time the market and bring emotion into your investment decisions often leads to less desirable long-term results. It’s important to remember that investment risk and return are directly correlated and the data supports investors staying committed to their investment strategy over the long-term.

So, should we turn a blind eye and ignore these relatively risk-free opportunities? Absolutely not. Depending on your investment goals and objectives these opportunities could provide moderate short-term returns that roughly keep pace with inflation. In the next six to twelve months, maybe you have a home improvement project planned, or a wedding or upcoming tuition expenses. Investors can sidestep short-term stock market volatility yet still allow your money to work for you. A high yield CD with a maturity coinciding with your expense timeframe could be a great solution for short-term goals but doesn’t replace your long-term investment strategy.

In conclusion, focus on what matters and stay the course with your investment strategy. Times like these can be a great barometer to measure your true risk tolerance and how it may align with your investment strategy. Revisit what you feel is an acceptable level of risk and align your portfolio to match your goals.  As always, talk to your advisor with any questions or concerns you may have.

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Silicon Valley Bank Commentary

The Silicon Valley Bank failure that occurred late last week caused a flurry of news articles and speculation that have driven down bank stocks across the board. Investors may be concerned about the implications, but it’s important to understand the facts and how they may or may not affect individual investors and more importantly, Rockbridge clients.

Andrew Ross Sorkin of the New York Times summed up the current situation this way in the opening paragraph of his daily newsletter:

“Federal regulators yesterday unveiled the most sweeping backstop for the U.S. banking system since the 2008 crisis, to limit carnage from the collapse of Silicon Valley Bank. The decision has shaken up global markets, with investors selling bank stocks and betting that the Fed would hold off on further interest rate rises.”

There will be much discussion about how it could have been prevented, who is to blame, who should suffer the consequences, and how these situations can be prevented in the future. That discussion can wait. For now, let’s consider what investors should do today:

  • Review your direct exposure to banks and take steps to reduce deposits or cash holdings to FDIC insured levels ($250,000 per customer at any one bank). The average deposit balance at SVB was something like $1.4 million meaning there were billions of dollars of uninsured deposits in excess of the FDIC limits. It’s important to remember that checking/savings accounts and Certificates of Deposit are insured by the Federal Deposit Insurance Corporation up to $250,000 per depositor.
  • Evaluate your overall risk exposure along with cash and liquidity needs. Consider the potential for job loss, business emergency, or family emergency and ensure that you have enough financial flexibility to avoid selling assets in a down market, when others may be panicking.
  • Understand that the Federal Reserve and Treasury Department have already taken steps to provide assurance that this isolated incident will not spread to other banks. The Federal Reserve created the Bank Term Funding Program (BTFP) to provide liquidity to banks and they are using this program as it was intended.
  • Maintain perspective of how banks operate. Banks generally use a large portion of depositors’ cash to fund loans to borrowers, or invest in bonds. They rarely have enough cash on hand to return depositors’ balances all at once if there is a run on the bank due to a loss of confidence. Over time, borrowers will repay loans and bonds will mature. In 2008, the concerns stemmed from homeowners defaulting on mortgage payments. This time the concern seems to stem not from the loan portfolio, but from the realized (and/or unrealized) loss on bond investments caused by rising interest rates hurting bond prices.
  • Keep in mind that investors have a long time horizon; a diversified portfolio of stocks and bonds will reward investors as the economy grows and prospers over the long-term. Investors own actual shares in company stock and government/corporate bonds that will weather this storm.
  • Leave speculation to the speculators. This might be a time to sell bank stocks short, before they go down more OR it may be the time to buy bank stocks at a discount, before the market snaps back. Getting that bet right could be lucrative. Getting it wrong could be a financial disaster. Either way, it’s a speculative bet that we can’t recommend taking.

What about Rockbridge clients with assets held at Charles Schwab?

Schwab Bank is a separate legal entity from the Charles Schwab Brokerage business (where your investment assets are held). Each is thoroughly and separately regulated with no real commingling of assets. It’s also important to remember that brokerage accounts are insured up to $500k by SIPC (covering up to $250k in cash). Schwab Bank’s business is fundamentally different from most retail banks, and less exposed to panicky cash withdrawals of balances above the “uninsured” threshold of $250k (which represents a small percentage of its account holders). The bank is also exceptionally well-capitalized, with a tier 1 Equity ratio of more than 25% (Banks are considered well-capitalized at just an 8% ratio). That means the bank has significant capital and external lending facilities available (even before today’s lending measures) before needing to take losses on their investment portfolio.

Charles Schwab investors and Schwab banking customers should feel confident in Schwab’s financial position and protection measures in place. We feel as though Schwab’s global presence and diversification, as compared to Silicon Valley Bank’s hyper-focus on tech-start up funding and banking, puts them in a significantly more secure position. We continue to recommend that clients maintain appropriate emergency funds, but otherwise stay fully invested in a diversified portfolio. If you have any specific questions, don’t hesitate to ask.

(Photo credit: Tony Webster)

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Rockbridge Institutional – February 2023 Market Review

Stocks

All stock markets were down In February no doubt reflecting the ongoing uncertainty of rising interest rates, inflation and an economic slowdown.  With its 0.25% increase in its Federal Funds Target Rate, the Fed continues to signal its commitment to rein in inflation.  While Consumer Price Index (CPI) increases are looking better recently, no one is declaring victory.  How far the Fed will go with increasing rates and whether it will trigger a recession remains uncertain.  Not only does this uncertainty impact stocks negatively, but also Increased interest rates reduce the present value of future cash flow and stock prices generally.

This ongoing uncertainty helps to explain losses in domestic large cap (S&P 500), small cap (Russell 2000) and international developed markets of about 2% this month.  Emerging markets were off nearly 4%. After a pretty good January, these February results brought the quarter-to-date returns in a global stock portfolio to under 5%.  While short-term stock returns are unpredictable, continued volatility remains a safe bet.

Bonds

Yields for Treasuries maturing beyond a year, yields were up 0.05% in February pushing prices down. An index of 3-to-5-year Treasury securities was off 2% in February.  An index of shorter maturing Treasures was off a little less than 0.1% while those maturing in 7-to-10 years were down over 3%.

While the future path of inflation is far from clear, market predictions over 5- and 10-year periods obtained from the spread between nominal and inflation adjusted yields has remained relatively constant at about 2.5%, which provides some comfort that inflation may be short-lived.  We’ll see.

The Value Premium

After trading at significant discounts in recent years, over the most recent twelve months an index of domestic large cap value stocks traded at a premium of 8% to the S&P 500.  These results prompt an examination of the persistence of value premiums.

Stocks are often divided into two categories – “growth” and “value”.  Expected cash flows from growth stocks reflect future investment opportunities and a steeper trajectory, expected cash flow from value stocks, on the other hand, are from assets in place, and consequently the slope is flatter and more immediate. Growth stocks are distinguished by higher price to earnings (P/E) ratios, value stocks by lower PE’s and higher book to market ratios.  Value investing goes back to 1934 with the publication of Benjamin Graham’s “Security Analysis – Warren Buffett is a disciple.  Metrics that distinguish growth and value stocks are used to build indices and allow us to measure value premiums in past data.

Using indices published by Russell and MSCI we observe an average 1% premium in domestic small cap and international market indices.  We don’t see an average premium in domestic large cap market in Russell indices.  However, an annual average value premium that exceeds 2% with greater volatility is present using the so-called “pure value index” published by Standard & Poor’s. While there is evidence of a value premium over the long run, taking advantage means accepting volatility.

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Why hire a fee-only financial advisor?

If you are looking for a financial advisor, you may have heard the term “fee only financial advisor” and wondered what it means. A fee only financial advisor is an advisor who is compensated solely by the fees they charge to clients for their services. They do not receive commissions from selling financial products, which can create conflicts of interest.

But why should you consider hiring a fee only financial advisor? In this article, we’ll explore the benefits of working with a fee only advisor and why it may be the right choice for you.

Transparency
One of the main advantages of working with a fee only financial advisor is transparency. Since they are compensated only by the fees they charge, there is no incentive for them to push specific financial products on you. This means that their advice is based solely on your financial goals and needs, rather than on their own financial gain.

Objectivity
Fee only financial advisors are also able to provide objective advice because they are not tied to any particular financial product or company. This means that they can provide unbiased advice and help you make the best financial decisions for your individual situation.

Holistic Approach
Fee only financial advisors take a holistic approach to financial planning. They look at all aspects of your financial situation, including your income, expenses, assets, and liabilities, to develop a comprehensive financial plan that meets your goals and needs.

Fiduciary Duty
Fee only financial advisors are held to a fiduciary standard, which means that they are legally obligated to act in your best interests. They must disclose any potential conflicts of interest and provide advice that is in your best interests, even if it means recommending a financial product or strategy that does not provide them with a commission.

Value for Money
While fee only financial advisors do charge for their services, they often provide more value for money than advisors who work on a commission basis. This is because they provide comprehensive financial planning services, rather than just selling financial products. They can also help you save money by reducing your taxes and investment fees, and ensuring that your financial plan is aligned with your goals and risk tolerance.

In conclusion, working with a fee only financial advisor can provide many benefits, including transparency, objectivity, a holistic approach, fiduciary duty, and value for money. If you are looking for a financial advisor, consider choosing a fee only advisor to ensure that you receive the best possible advice and support for your financial needs. To find a fee only financial advisor near you, you can use online directories or consult with professional associations such as the National Association of Personal Financial Advisors (NAPFA).

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