Tag Archives: investing

Beware the Hooks

When my kids were little we watched a lot of SpongeBob SquarePants—so much so that my now 18-year-old still calls up references to it in everyday conversation. SpongeBob aficionados will get this reference.

It is just a cartoon, but the subtle messages are often very deep and very real. I tell you all this upfront because the tone of this post takes a darker turn and I don’t want my reference to a cartoon to trivialize the matters herein.

In this episode, the main characters (small underwater sea creatures) find themselves in a field where human fisherman on the surface above have cast their lines. Grabbing “The Hooks” results in a sudden, adrenaline fueled “ride” to the surface, where they can let go, and drift slowly and safely back down to the bottom. But only if they let go before being pulled out of the water.

The symbolism should be apparent now. “The Hooks” in real life take so many different forms it’s difficult to know exactly when we’re being lured. From the slower, more insidious dietary or overspending variety that could kill us or drive us to bankruptcy, to the more sinister, and immediately threatening, illicit and dark. While we may not be completely conscious of the lure, at some point soon after we begin thinking about grabbing the hook, our instinct tells us we should turn away from it.

When a celebrity dies, especially at a young age by taking their own life, we all mourn publicly in social media because, in a small way, we knew them. When that friend from years ago dies too young from their vice, again, we mourn. Succumbing to temptation is human, and so are the feelings of shame and self-degradation that stem from it. Of course, this doesn’t always lead to suicide or death. But it can. Some might argue that thoughts of suicide themselves are a form of temptation. Non-celebrities die from overdose, war veterans commit suicide, and we all play on the hooks. Every day.

We eat the garbage, take the drink, gamble, or just spend the money, when deep down, we know when we shouldn’t. The gleam of the pointed barb underneath that enticing lure warns and hypnotizes us at the same time.

You might say I’m stretching here. This is a personal finance blog after all, and I’m talking about personal vice. Two counter points to this claim. First, there are no lawyers on a broker dealer payroll scrutinizing everything I say. So it’s my blog and I’ll write what I want. Second, I’ve played on the hooks all my life, and while I may rationalize and live in denial about my own, I immediately recognize when one of our clients is playing on them. Money is emotional, and yes, the money hooks do lead to suicide or death for some.

In fact, much of what concerns our clients and leads them to our door in the first place can be traced back to the hooks. One of our primary responsibilities is listening to what concerns them. After we’ve done that, we give them an honest read back of what they’ve just said to us. I am not afraid to tell a client when I recognize the situation, and sometimes my telling them to beware the hooks is enough to convince them to turn away. Not always, but sometimes.

Whatever your personal hook might be, there is no debating one fact. There will come a time when you are open to a message from within or without that you need to stop. Or there won’t be, and you’ll be hooked forever. Being open is the key phrase in that statement. So open yourself to that message. And beware the hooks lad. RIP Cubby.

Drowning in a Sea of Cash

I’ve been reminded a few times this week of how little there is in the way of investment opportunity in the current marketplace, and that we are drowning in a sea of cash.

Recently I read an article about how Warren Buffett (or to be more specific, Buffett’s company Berkshire Hathaway), has $116 billion to spend.  Berkshire Hathaway got shut out of a few deals last year so their cash hoard has gotten bigger. A lot bigger. Buffett said part of the reason they got shut out of the two big deals they worked on last year was because interest rates are so low, the other suitors were able to borrow and offer a lot more than he and Charlie Munger were willing to spend. Buffett and Munger will use debt when called for, but always evaluate a deal on a cash basis first.

So on the big stage, the deals are harder and harder to find, and there’s clearly a lot more competition for them when they do eventually present themselves. What does this mean for people like you? Decent investment opportunities dry up like rain drops in Death Valley.

Stock prices have been higher only once before. Can you say party like it’s 1999?  I guess we might as well.

A lot of our clients invest in real estate, and more of our clients are headed that way as stock prices soar.  But now real estate prices (and property taxes) are skyrocketing too. Even in places that have never been hot markets before, hedge fund managers are deploying cash in amounts never seen before to buy up everything and anything they can in the search for yield.

In 2014 oil went from over $130 a barrel to under $40 a barrel, and the other commodities followed it off the cliff. So I told clients to emphasize commodities in their portfolios. Now even commodities are well off their lows and I’ve read about investment managers recommending them. Prices in this asset class are no where near those of the paper assets (stocks and bonds), but there’s still a sea of cash swishing around.

There is simply too much cash chasing too few investments.

I’m reading Mohamed El-Erian’s The Only Game in Town. In it, he staunchly defends decisions made by central banks, but cautions that they have been asked to do too much. (It’s a great book by the way.) I beat up on the Fed in this blog a fair bit, but I’ve also acknowledged that without their intervention in 2008/2009, we’d probably be in the depths of a global depression to this day. The problem is monetary stimulus has its limits, and without reformative economic policy, it’s limits will be seen.  Probably sooner than later. We’re drowning in a sea of cash right now.  Let’s hope it has a shred of value when the tide finally goes out.

So, you may be wondering: OK, what the heck do I do about it?  And you’d be wise to question this.

To be clear, buying assets at high prices just because markets are appreciating does not make good financial sense (not to me anyway, and not to Buffett and Munger, either, apparently). Sometimes accumulating cash, or its equivalents, makes good sense.

When I say there are high valuations everywhere you look, I’m generalizing. Obviously there are opportunities in every market, but at times like this, you have to be patient, very patient, and look long and hard to find them. When you do, there will be lots of competition for them, so having a pile of cash will help you to capitalize when you find yourself in the right place at the right time.

That said, be mindful of getting caught up in bidding wars if others sniff your deal out before you close on it. Also, if you have not allocated any of your long-term investment money to commodities and natural resources, there’s still time.  As an asset class, they have not been driven into la-la land, yet.  They say patience is a virtue. In the world of investing, it can make or break you.

The Writing on the Wall

They say every prognosticator is eventually right, and I’m starting to feel like it might be my moment.  But it’s a moment I never wanted to come, and it does not feel good.

The bond market is finally opening its eyes to the handwriting on the wall. I’ve been saying interest rates are going to go up for so long I sound like a kook. When I’ve said those words, a few clients have replied “you’ve been saying that for years.” Because I have.

I’m not an economist. But you don’t have to be one to know central banks can only manipulate markets for so long before nature takes over, and the lid they’ve kept on rates wouldn’t last forever.

At the nadir of the last debt crisis in March 2009, The Federal Reserve handed US mega banks a mountain of tax payer cash, with no restrictions, and set them right back to doing the business that brought the crisis on in the first place. Yes, their intervention precluded a much deeper economic decline, which could easily have been a global depression. But they did practically nothing to address the structural problems that lead to the crisis. And neither did Congress. So the stage was set for the next crisis.

After they handed banks all that cash, they proceeded to create and spend four and a half trillion more dollars to buy Treasuries and mortgage backed securities (MBS), in an effort to further contain interest rates. The message they sent us was that this would encourage borrowing and spending, which will stimulate economic growth. And that was accurate. But the other motivation behind keeping a lid on rates has been to contain the cost of borrowing for the drunken sailors in Congress.

Actually, I take that back. Drunken sailors have nothing on Congress.

All that spending in the Treasury and MBS markets drove bond prices higher, and interest rates lower.  But every check they wrote had less and less impact on rate containment. So clearly they saw the hand writing on the wall well before bond investors, and announced they wanted to get out in front of inflation risk, stop all the bond buying, and begin raising rates. Slowly and incrementally.

That messaging has worked brilliantly. When I say rates are going to rise, people say to me, “But she says she’s only going to raise them slowly and a little at a time.” As if to suggest that Janet Yellen has had the interest rate markets on a string, and has complete control over everything.

To be clear, Janet Yellen is a very intelligent woman. Much smarter than me. But she and her successor Jerome Powell and her colleagues at the Federal Reserve Board do not have complete control over everything. In fact, they are in uncharted waters, and I suspect are feeling quite naked right about now.

As the Fed increases the amount of maturing debt proceeds they remove from the market, interest rates have nowhere to go but up. And the nine-year bull market in stocks, which was built on a foundation of more cheap, easy debt, will end by its removal.

Crisis Breeds Opportunity

No matter how you see things, 2017 was a tumultuous year. Some say we’re in a state of crisis.  Others say we’re on our way out of one. Your perspective may fall in between these two extremes, but one thing is certain: crisis or not, opportunities for improving your financial position are always present if you look hard enough.

To me, financial planning is the ongoing process of examining one’s current position as a collective unit with an eye to mitigating as many of the prevalent risks as possible, thereby minimizing the effect of the things that erode and jeopardize our financial well-being.

In other words, pay attention to the things you have control over, and plug the leaks where money is leaking out, rather than the one thing you have absolutely no control over, and picking the stock or fund that will go up the most.

Taking this approach not only helps us keep more of our money, it gives us financial flexibility, so we can take advantage of opportunities.

Adopting this mindset and executing on it consistently takes practice, presence of mind, and patience. Our ever more short-sighted culture encourages the opposite, though, and this creates even more opportunity for those who have the muscle memory to step back and look for that space when crisis hits.

Flexibility is strength, and developing it takes time, discipline, and planning.

While I can’t help but worry over what’s to come, and every passing day seems to present a new challenge, I’m ready to look for the opportunities that these challenges present. Our business plan for 2018 is done and we’re ready to move forward into 2018, come what may.

From all of us at QLC, here’s wishing you all a happy, healthy, flexible, and prosperous 2018.

Required Minimum Distributions

RMD. If you’re seventy years old, or near it, or you have inherited an IRA from someone, you have probably heard this acronym.

Most retirees have some basic understanding that they need to take money out of their pre-tax retirement accounts at age seventy and a half. Not many understand all the ins and outs of managing them. Even fewer understand the impact Required Minimum Distributions, and the corresponding tax liability, will have on the value of their nest eggs, and the taxation of their other sources of income.

The primary benefit of saving money in a traditional IRA or 401(k) is tax deferral, and in the case of a 401(k), if you’re lucky, a matching contribution from your employer. The money goes in before taxes are withheld, and the earnings accumulate, uninterrupted by taxation. Until it’s time for RMDs.

In my experience, most people end up taking money out of their IRAs well before age seventy and a half, and they take well more than they are required to, because they need or want the money for expenses. These folks are rudely awakened to the impact their withdrawals, and the tax liability, have on the value of their accounts.

For those fortunate enough to have the luxury of not needing or wanting money from their pre-tax accounts until age seventy and a half (isn’t it weird that the rules are made around half ages?), the addition of this income can be a source of frustration. “No one told me I was going to have to take all this money out and pay tax on it” and “If I’d known this was how it worked, I wouldn’t have put my money in this thing” are comments we’ve heard in our office.

Whether you need or want the money, or not, the IRS is going to make you take it out, and pay tax on it. They don’t care if you spend the net proceeds, or if you reinvest them, but they’re going to make sure you take it out of the pre-tax plan, and give them their cut. The fifty percent penalty for failing to do so is a very strong motivator.

Some one may have told them that they’ll be in a lower tax bracket when they retire, so putting money in this account will save taxes. And selective human hearing translates this to “you’ll pay very little tax on the money later” or maybe even “you won’t pay tax on it later”. But other than a very small increase in the standard deduction and exemption amount after age sixty-five, the tax brackets don’t change by age.

I find most folks don’t want to have less income the day after they retire, so almost all of the people I have walked from their working years into their retirement years are paying the same effective tax rate they were before, or more. And we’ve had declining tax rates since the 1980’s.

So when you step back and look at how these things really work, they don’t save taxes, they postpone them. Funny the government doesn’t call them “tax postponed” plans. Something tells me they wouldn’t sell as well.

Here’s some context for you: let’s say I pay a twenty percent effective Federal income tax rate. It’s April 15th and my tax preparer or financial advisor tells me I could reduce my tax bill by $1,000 if I make a traditional IRA contribution of $5,000. Great! Where do I sign?

But where does that $1,000 go? Do you think most people set that money aside to make sure they have it for when RMDs begin?

Mmmm no. I spend it. So in effect, I’m borrowing that $1,000 from the IRS. And I’m borrowing it at a to-be-determined interest rate. If you asked me for a loan and I said sure, I’m flush right now, I’ll let you know what interest rate you’ll pay me when I figure out how much money I need later, would you take that loan? Probably not.

But wait, it gets better.

Once we retire and forgo the ability to earn a paycheck, what we have becomes very, very finite. And our financial flexibility declines sharply.

I have a client, we’ll call her Jane. She retired with a good amount of money that her physician husband left her when he died, in his SEP IRA. After she retired, her expenses stayed at roughly the level they were at before she retired, and for the first year or two, everything went along as planned. And then she took a little extra out one year to help one of her kids. She was unpleasantly surprised by the tax bill the following April, and found she had to take a little more out just to pay the tax on the little more she took out the year before. I see this a lot. I call it the IRA downhill snowball.

When you begin taking your RMDs, if your account grows after this point, so does the RMD amount, because the government wants you to take all the money out and give them their cut before you die. So increasing RMDs also means higher taxable income, potentially an increasing marginal tax bracket, and almost always, an increasing portion of your Social Security benefit being subject to income tax, driving your effective tax rate even higher. And yes, lots of people are surprised to learn that their Social Security will be taxed too.

Now, you might say: “But Brendan, the government is saying they’re going to lower taxes. Maybe that will save me.” You might not guess from the tone of this blog at times, but I am an optimist. I believe in the power of love, and that the truly remarkable adaptability of the human species will lead us to new heights. But if you tell me you believe the government is going to lower taxes for the likes of you and me, and that this will rescue your retirement income plan, I can assure you I will not laugh, but I will be compelled to tell you that you are setting yourself up for disappointment and maybe disaster.

Our national debt is as high as it was during World War II. Our Medicare and Social Security benefit payments are draining the money our politicians want to give their friends. Mark my words: the government will be taking more of your money in the future, not less.

But back to RMDs. After all this, traditional IRA’s and 401(k)s are not in and of themselves, bad. The problem lies in the lack of understanding people (financial and tax advisors too), have of them, and the fact that this is what people are being driven to put all of their retirement savings in. If more truly understood how these accounts work, they would balance what they save among vehicles that offer another form of tax treatment. They would develop a strategy for balancing the tax they pay now, AND in retirement.

If you want to develop a strategy like that, give us a call. It’s what we do all day every day.

Work Smarter, Not Harder

I met with a personal trainer this morning who told me I need to work smarter, not harder. I’d been doing hour-long weight lifting and aerobic workouts five days a week, which poses greater injury risk and, potentially, long-term heart damage. He told me I could achieve a higher fitness level, reduce injuries, and just be healthier by working out less, and modifying other detracting behaviors.

He evaluated some basic movement patterns and asked me lots of questions about my exercise and health history. Then he told me, in a roundabout way, I’m killing myself for very little gain when I could step back and focus in on some foundational aspects of my health, especially my diet.

It was hard not to liken this to the work we do with our clients in their finances. The similarities are almost endless.

Lots of the people I talk with work long hours and endure very stressful job or business pressure to earn more income. Then they put their money in investments they don’t understand. The rationale? They don’t have time to understand it. They’re too busy.

From my perspective, this is a fairly common approach. People pay hefty fees to leave this due diligence to advisors and the companies they represent, in part because they’re overwhelmed by their own work and information overload. In short, it’s just easier to hand it off to someone else.

The big investment companies know this about human behavior and they take advantage of it. For example: “Target date funds” are promoted as a set-it-and-forget-it investment. In fact, they usually serve as the default investment in retirement plans when participants don’t make an election as to what they want to invest their contributions in. But this convenience comes at a cost. Target date funds are almost always made up of shares in other funds, and have higher expense levels than the funds they’re made up of, even in the lowest cost fund families.

I’ve said it here before. There is no product or advisor that will be the solution to your financial stress without your active participation. If someone tells you otherwise, be skeptical. We take great pains to engage our clients in our process and we stop working with people who don’t.  We’ve seen how it ends.

Our process is uniquely designed and tailored to maximize the efficiency of each client’s financial resources. Smarter, not harder.

In the work I do, I see people struggling to work more and faster every year just to keep up.  And then fritter money away in small and large amounts that they don’t have to. Just like this trainer identified that I’ve been laboring in the gym with inefficient movement patterns and over compensating, while at the same time, not getting the sleep I need or maintaining proper nutrition and hydration.

So I’m guilty of it, too. We all have room to work smarter. In the end, this is what will afford us more time, and allow us to take a well-deserved break.

What Goes Down

There are two major economic trends that have been unfolding for almost forty years now, and both are nearing a turning point. Interest rates and tax rates have been declining since the early 1980s and both must go up at some point. I’ve been telling our clients that tax and interest rates are going to go up for so long now I sound like a nut job. But sooner or later, every prognosticator is right.

When I tell people rates could rise very quickly, the response is usually a doubtful one.  “But Janet Yellen said she’s only going to raise them slowly and in small increments,” is a common response.

This shows how successful the Fed has been in their messaging. We’ve been conditioned to believe Yellen has the entire interest rate market on a string. She does not.

For example, take a look at this chart, which illustrates how fast interest rates can change.

The point at which the yield really shoots upward here occurred when then the Fed, chaired by Ben Bernanke, released notes from a meeting where they discussed ending their quantitative easing policy. Rest assured, Bernanke and his colleagues did not want the ten-year treasury yield to double inside of eighteen months from July 2013 to December 2015. Market participants refer to this period as The Taper Tantrum. That is to say, the bond market threw a temper tantrum at the prospect of the Fed taking away their lollipop.

This is the critical point that the layperson is missing. The Fed has significant influence over the interest rate markets, but they do not control them. The bond market en masse controls interest rates. When bond investors collectively decide there is greater risk to lend, interest rates will go up, and they could go up very, very sharply.

Fast forward to this past week when I read a few articles referring to an interview retired Fed Chairman Alan Greenspan did on Squawk Box. Greenspan said there’s no bubble in stock prices (a point I’ll debate in a minute here), but there certainly is in bond prices, and when it bursts, rates will probably go up rapidly. He does not blame the Federal Reserve Board, because no one likes a turn coat, and who knows what his real motivation is in doing this interview, but he clearly wanted to call attention to this issue, and himself for predicting it.

Now let’s rewind. Interest rates have been declining since 1981. Why? I’m not an economist, and I don’t have a view to the minds of all the major market players who’ve influenced this long-term trend, but my gut tells me rates have declined all this time because the Treasury has needed them to decline in order to facilitate ever increasing government spending.

Since 1981, government spending exploded as we entered the nuclear arms buildup race portion of the Cold War, and then as the war against Jihadist anti-western terrorism escalated. War costs money. A lot of money. And we’ve been at war for a long time. Throughout history when we’ve entered wars, overtly or covertly, our debt has skyrocketed, and then tax rates have followed to bring down that debt.

As our national debt expands (because the government spends more then it collects in tax revenue), our interest payments go up. Our national debt is now at the level it reached at its peak during World War ll, and if interest rates increase, it will cost too much for the government to continue borrowing the way it has been. So, the Fed has been acting as an arm of the Treasury, trying to suppress rates so the Treasury can keep borrowing cheaply and Congress can keep spending.

Greenspan said there’s not a bubble in stock prices. I don’t know what measure he’s using to base this statement on, but stock valuations have only been this high two other times in modern history: just before the 1929 crash, and just before the dot com crash. The stock market rally that began in April of 2009 has been built entirely upon low interest rates. Big companies borrow cheaply in the bond market, then use that cash to buy back their own stock. It’s been a boon like we’ve never seen for executives at the top of these companies.

I also saw this week that Director of the Office of Management and Budget, Mick Mulvaney, came out in support of Treasury Secretary Steve Mnuchin’s appeal to Congress for a naked increase to the debt ceiling. After months of posturing about tying yet another increase to spending decreases and more rigid fiscal discipline, he now says this The Treasury’s recommendation is the right way to do it. Shocker.

One might say I’m just looking for company, because misery loves it, and reassurance in the form of mutual opinion from Alan Greenspan is a thin measure. I’ll cop to that. However, I’d remind you that denial is not a river in Egypt, and what goes down must come up at some point. One whiff of unexpected risk, and bond market participants could cause another major disruption in this long-term trend.

True Diversification

We meet a lot of people that tell us their investments are “pretty conservative,” or that they’re “diversified.” But on closer examination, they own the same things everyone else does.

Spoiler alert: if you own the same things everyone else does, by definition, your investments are anything but pretty conservative and diversified. True diversification requires the fortitude to put money into things that the herd is not buying.

What happens at big financial firms is fairly simple. Representatives advise all their clients that by buying their packages of securities, in the patterns their pie charts reflect, their money will only be in a “moderately aggressive” allocation. Putting money into anything else is a bad idea because it won’t earn as much as their pie chart, or it’s “too risky.”

I’d say this advice serves the industry’s profitability, but that’s obvious, isn’t it?

Some individual investors (like you) are starting to get wise to the fact that the industry does not have your financial interests at heart. But many investors have not begun to fully comprehend that much of what they’ve been told about the way to invest is all wrong. The conventional wisdom serves the industry, not individual investors.

Here’s the view from high up: The central banks have created an unprecedented amount of currency in the last ten years, and all of it has had to go somewhere. More has gone into the bond market than any other asset class, directly, because this has become the main lever for central banks and their quantitative easing policies.

Next on that list, behind the bond market, is the stock market. Central bank money has gone into stocks indirectly, as executives borrow money cheaply in the bond market to raise cash for share buy backs.

Real estate values have also, of course, benefited from central bank money as investors and home buyers alike borrow the money from banks to buy properties. Commodities and natural resources are really the only asset class that could arguably be out of favor at present. Though there has been a little bit of movement to the upside there since early 2016 as well.

My point here is this: central bank policies, coupled with financial services industry dogma, has made it very difficult to find places to put money that are not obscenely priced since the herd has already poured tons of money into them. True diversification in this environment can only be achieved by significant research, effort, and being in the right place at the right time, or, luck.

Most people do not want to break from the herd. It’s too scary. Most people tell themselves (consciously or otherwise) that they, or their advisor, will get them out of any investment that begins to fall out. I hope I don’t have to tell you neither of those things are really going to happen.

I just watched a Denzel Washington movie called “Unstoppable” where two railroad men unwittingly send an unmanned train down the line. It starts off at a slow speed, so they’re lackadaisical about getting on board to grab the controls. But their missteps allow it to gain enough speed so they can’t regain control and it eventually ends up speeding down the line at full steam, taking lives as it goes.

I had a manager once tell me, “There are no emergencies in this business.”  I think there are, but we lack the foresight that would establish the urgency needed to step up and gain control now.

Rationalizing Our Way to Another Crisis

8koeusir1zm-jimi-filipovskiFrom a pretty early point in my time as a representative of a big financial corporation, there was always a small part of me that had to rationalize the mediocrity of the products I was offering my clients.

That rationalization went something like this: “The fees to buy and own these mutual funds are high, and cheaper options exist for these people, but I don’t get paid if they buy those cheaper options and they’ll be better off for having invested in something, rather than not invest at all.”

At the beginning, I didn’t know what I didn’t know, and I was just excited to be a part of something that big, but it didn’t take too long for doubt to start creeping in. Rationalization is a basic human defense mechanism, and there’s an awful lot of it going on right now.

I pay very close attention to the ads and images the industry puts out and there are times when I shake my head and think, “What a load of garbage. How can they even say that?” But as is evidenced by the horrible things we human beings do to each other, we can rationalize anything.

The financial industry rationalizes molding the truth to meet their profit margins, and investors, big and small, rationalize spending and investment decisions to ease their conscience. These rationalizations feed on each other and snowball into crises like the one we had ten years ago (yeah, it’s been just about that long since the global financial crisis), and the ones we had every ten years or so before that.

I’ve been saying for years that the broad stock and bond markets are overpriced and that individual investors should exercise caution. I’ve issued so many warnings that I often feel like I’m out of step with the rest of the investment world. Valuations in these markets have continued to defy fundamental investment logic even when something happens that’s expected to result in a sell off. But then, markets have never been logical and maybe I should know better than to try and justify decisions based on logic.  I guess I just can’t bring myself to buy something that I want to go up in value when it’s already higher than it’s ever been because, buy low sell high, right?

Well, we’re herd animals and we rationalize staying with something even if part of us tells us it’s wrong when everyone else is doing it. But now as we enter the second week with a new president who, love him or hate him, seems to embody the very idea of volatility, something tells me sooner or later the last straw will fall.

They say every prognosticator is eventually right. I don’t consider myself to be one, but if I’m now rationalizing, I suppose I just don’t think I’d be doing my job if I didn’t tell my clients how concerned I am about the level of risk to their 401(k)s and brokerage accounts. I really don’t want to be right about this.  But every week I see people that have all, or the vast majority of their money in broad market funds that they think are “diversified” and “pretty conservative.”

If you haven’t been paying attention, thanks to the massive increase in the money supply, the stock, bond, and real estate markets have all gone up to very high levels. These three asset classes have been positively correlated since the crisis (and before), so owning funds that invest in them offers very little in the way of diversification. Commodities and natural resources are the only asset class that is not highly priced, which is not a good indicator for the other three.

Politicians have been rationalizing policies that favor the industries and companies that heap favor upon them, and continue rolling the debt snowball bigger and bigger. Investors rationalize plowing money into their 401(k) funds, partly because they don’t know what else to do, but also because they don’t want to fall out of step.

There is another way. But you must be willing to consider that what everyone else is doing may not be right for you. And stop rationalizing.


The Interest Rate Roller Coaster

150305_INV_KEEPCALMFor almost forty years, the interest rate roller coaster has been going downhill. But digging underground tunnels, metaphorically speaking, or charging depositors, instead of paying them to hold their money can only last so long. So for the last few years, the roller coaster ride has been up and down, and now up again.

After their recent policy meeting, the Federal Reserve announced that they would raise their federal-funds rate by a quarter percentage point to between 0.50% and 0.75%. And a lot of people I talk with think this announcement marked the beginning of the most recent climb upward for the roller coaster. But upon closer examination, it becomes clear that rates (as measured by Ten Year Treasury yields), began rising in July.

The Ten Year Treasury bond has been around since the late 1700’s. Here’s an interesting chart on that. The yield on this historic implement of our nation’s financial structure hit its lowest point ever this past July at 1.37%. Prior to that, the lowest point was 1.46% in 2013. In between, the yield doubled to just over 3% on fears over the impact of the end of quantitative easing from the Fed (the taper tantrum). It seems maybe we’ve been rolling up and down at the bottom for a few years but it also seems to follow that we might be headed upward on a big climb right about now. You can almost hear the clicks of the roll-back chain.

The financial media talking heads seem to think we’ve seen the bottom and proposals to spend a trillion dollars on infrastructure and cut taxes will create more inflationary pressure.

My opinion? I think we’ve had plenty of inflation all this time. Remember, inflation is not rising prices. Rising prices are a symptom of inflation. At its core, inflation is the decreasing value of our currency. And the glut of supply central banks have created has caused inflation, evidenced by higher than ever stock and bond prices, real estate values to a slightly lesser or more isolated degree, and consumption items the owners of these assets want or need, like the most expensive schools, and the best health care. I think the Fed is raising rates under the cover of bond market speculation of increased inflationary pressure to give themselves some leverage for the next crisis. Because they have very little of it after almost seven years of unprecedented stimulus.

But I don’t claim to know if the low point we saw this past summer was really the bottom. When the bubble bursts again, odds are good the herd will plow back into US Government Bonds in search of safety, which could drive yields back down again. That reminds me. It’s also critically important for investors to understand that the bond market herd controls the interest rate markets, not the Fed. Obviously, the Fed has significant influence, but the herd is bigger than the Fed. If the herd is spooked, the Fed will get trampled.

It’s also interesting to note that the stock market is still rising (at least certain sectors are), even though rates are rising. Much has been said about the post crisis bull market in stock prices being built on low interest rates and stimulus from the Fed. Just how far the bull market in stocks can run when the bull market in bonds appears to be fading remains to be seen.

While I rant about the Fed and the big banks all the time here, this is, after all, a personal finance blog. So iif I were to tie this all back to some personal finance insight, it would be this: with rates rising, but still very near two hundred plus year lows, I want to be a long-term borrower, not a long-term lender.

I think history will be very cruel to long term lenders of this period.

For years, savers have been dying for higher interest rates as their deposits lose value. But the lending institutions will postpone increasing deposit rates until it’s explicitly clear the roller coaster is on a sustained upward climb. And all the cash the Fed gave the banks in exchange for their bad debt during the last crisis will make it easier for them to delay even a little longer. This will increase temptation to buy long term CDs and other similar instruments to gain a still anemic, but slightly higher, yield. If the roller coaster is in fact on a long term up climb, this will have been a bad decision, because it amounts to being a long-term lender, to the bank.

Some borrowers have taken advantage of the low rate environment we’ve had and loaded up on long term debt, but some folks I talk to are reluctant borrowers. They follow the emotional pull to try and eliminate debt, which isn’t all bad, of course. Debt used to fuel over consumption is unhealthy, and often disastrous. But debt used in a thoughtful and comprehensive long term saving and investment strategy is a very powerful tool. I see lots of people making extra mortgage payments and refinancing from thirty year to fifteen year mortgages. Even when they don’t have adequate cash reserves, or have all or most of, whatever personal wealth they’ve managed to build in a qualified plan. With rates as low as they still are, I want to lock in for as long a term as I possibly can so I can direct surplus cash flow to capital assets that will offer some potential for mitigating further inflation risk, or to build (short term), cash to mitigate the risk of a deflationary trend caused by bubbles bursting.

Time will tell if we’ve just witnessed the end of the longest and greatest bull market in bonds the world has ever seen, or if this is just another small hill on the roller coaster ride before another dip. What we do know is rates are still very, very low, and hedging one’s long term bets would be wise. Because sooner or later, the ride comes to an end, and if you aren’t properly buckled, you’ll be one of the many that gets hurt.