While growing up in the 1970’s, we heard (what we thought at the time were apocryphal) stories of Chicagoans visiting Europe and revealing the name of their hometown. “Oh,” the story had a suddenly interested European saying, “Chicago! Bang Bang!”
After reading this article in the Economist, we don’t expect Chicago’s reputation overseas is on the rise. As the late pol Paddy Bauler is purported to have said, “Chicago ain’t ready for reform.”
TCI continues to focus its equity portfolio on quality stocks both in the U.S. and around the globe. There are two reasons. First, value is better in these securities assuming the economic situation in the world will revert to something like normal over the next 7 years. Second, quality is the best place to be based on the uncertain economic and political environment present in Europe and the U.S.
The managers of the Morgan Stanley Global Franchise Fund (MSFAX) point out that the equity markets had good cause for celebration based on the European Central Bank (ECB) providing more than $750 billion in funding to the European financial system in December. This funding lessened the risk of a severe liquidity crisis during 2012. The ECB will offer another round of funding on February 29th and the demand is expected to be even greater.
The managers point that it would be a mistake to relax because the long term structural and political issues within the Euro-zone are yet to be resolved comprehensively. Clearly the same thing could be said about the U.S.
When stock prices slid last summer and early fall, we found ourselves to be, strangely enough, happy. Value investors – which we are – appreciate an opportunity to buy assets on the cheap. The slide afforded us the chance to do so, albeit in small increments as prices fell only moderately below fair value.
A strong October 2011 and January 2012 have ended the discount sale. Equities across the board range from fairly priced to somewhat expensive. This is a less enviable position for investors, because it means lower expected returns. It also means a smaller margin of safety – the prices of expensive assets have further to fall than those of cheap assets.
This puts us in an uncomfortable, itchy place. We would love to hold an outsized portion of cash, but cash yields approach zero. Bonds are terribly expensive, so they’re not an option for overweighting. We hold a fair sized position in alternative investments precisely because of that.
Our long-term goal for the average client is to earn 5% plus inflation (as measured by CPI.) At times like this, we must mind the risk that accompanies expensive markets. You will find us cautious, concerned investors for the time being.
At TCI, one concept we talk about a lot is ‘real return’— defined as the return on an investment less inflation as measured by the Consumer Price Index. Real return comes up in two different ways. First, TCI uses real return in financial plans. The secret here is that an investor who can live off the real return of his portfolio can receive a ‘raise’ each year equal to the rate of inflation and still see his or her portfolio retain its purchasing power.
The second place TCI uses real return is in investment portfolios. How can the investor earn this return? Since time began (at least my time) investment advisors have recommended portfolios of 60% stocks and 40% bonds. The expected real return is 6.0% for stocks and 2.5% for bonds for a portfolio total of 4.6%. The investor’s job is to accumulate enough money to be able to live off 4.6% real.
All these nice, neat numbers are wonderful but only occur when stocks and bonds are fairly valued. The percent of the time this is true is about equal to the percent of the time a stopped clock shows the correct time. So what does TCI do?
First, we adjust the financial plan to a real return based on today’s stock and bond valuations. Second, we adjust TCI portfolios to overweight those asset classes priced to provide the best real return available and underweight overpriced asset classes. Third, we evaluate our success in earning real returns over a complete market cycle—from market peak to market peak or trough to trough.
I walked into my office on a Monday morning many years ago to a blinking red light.
After getting my coffee, I picked up the phone to retrieve a voice mail message, stamped at 5:27 the same morning.
“Bill, this is (I will call her Jane). My mother died at 5:10 this morning. I will be coming in at 9 o’clock to see you. Where’s my money?”
Mom had been in a nursing home for several years before passing away peacefully at age 94.
At first, I was struck not by Jane’s eagerness to get to my office (we had been dealing with her for years) as much as the realization that mine was the first call after learning that her mother died, before any of her siblings or family.
Jane arrived fifteen minutes early, waiting while my colleagues and I gathered in the conference room. I escorted her in, then had the distinct pleasure of informing her that her mother saw her for exactly who she was: An angry, vengeful, vindictive woman. And just as she thought (and lamented to us at every turn through the years), Jane was not included in her mother’s estate.
And no, we did not say those exact words to her. We were professional and fulfilled our fiduciary duty, though believe me I wanted to dance a jig on the table after she left for the final time.
I think she snatched a few pens and mints on the way out.
Jane had two sisters, each of whom inherited some money. They were both nice people and expected nothing given Mom’s advanced age.
Money doesn’t change people, it just exposes them.
This is the time of year advisors get out the crystal ball and try to predict which way the markets will go.
But it’s also an important time to review, with your loved ones, your estate and financial plans. For me it’s personal.
In the past six months we have dealt with the death of both of my in-laws, one from cancer, the other from a stroke while suffering from dementia.
They were successful doctors who lived a comfortable lifestyle and did basic planning. Very basic, meaning my wife and her sister were left in many instances to make decisions based on what they thought their parents wanted.
I am often approached by prospective clients whose “investment problem” is first and foremost a planning problem requiring us to take a step back. In this sense quality financial advisors are like doctors, unable to make a full diagnosis without first examining the patient.
Investing without an effective estate and financial plan is akin to hunting while blindfolded. You might hit a few birds, but in our business what you get is never as important as what you get to keep. Taxes matter, planning matters.
At TCI we talk about clients being able to make “one call” to a trusted advisor who has all of your information safely in one place. Every family should have a quality legal advisor, a quality tax advisor and a quality financial advisor, ideally in touch with and on the same page with each other.
Talk to your loved ones, but go beyond “where the documents are.” Let them know your intentions about everything from end of life wishes to where your passwords and keys are kept.
I had a client years ago who was terminally ill with cancer. She was a traveler, often alone, and did so even as her one year life expectancy stretched past five years.
I remember her telling me about a trip to Israel during a period of intense conflict despite travel warnings. As she put it, “Who cares about a bomb when you only have six months to live?”
She lasted over six years, and the service, which she planned months in advance, was a fitting tribute.
Do your loved ones a favor with one final gift, the gift of familiarity, which will empower them.
And consider naming a corporate fiduciary to independently and objectively handle your affairs. We all have families, and what are families for if not to put the “fun” in dysfunction?
There are plenty of “Janes” in the world.
And plenty of people who, in the midst of a crisis, are exposed as one.
When we first bring on a new client, it is a busy time where we help them get the right plan in place so that they are on the right track to meet their financial goals. However, once the initial comprehensive plan is in place, we get into a nice rhythm of helping them continue to take the right action steps to fulfill their goals and monitor their plan. In nearly every case, it is at this point when our clients who have children ask, “What advice do you have that we can pass on to our children?”
I have collaborated with my colleagues and following are the top 10 strategic moves we would recommend that the “next generation” take.
Dear Next Generation,
The path to achieving financial success throughout one’s life and retiring in comfort is no mystery. In fact, it is a well worn path. Nothing on this list is new. The ability to meet your financial goals is really only a matter of choosing to follow a handful of key principles day after day, week after week, month after month, and year after year. The process is rather dull, but the results are extraordinary!
10. It is tempting to want to “keep up with the Joneses,” however the key to financial success is living within your means (i.e., your expenses are less than your income). Determine what your true priorities are in light of your current income and future goals and be realistic with your spending. The alternative is to vastly limit your options in the long run.
9. If you are not a financial professional, do not pretend to be one. Obtain a trusted advisor and let them do their job just as you would with a doctor or plumber. One way to increase your chances of finding a financial professional you can trust is to find a “fee only” (as opposed to a “fee-based” or “commission”) advisor so that the advisor’s compensation structure is most closely aligned with your best interest.
8. Ensure you are a go to person in your company based on your knowledge and work ethic. Regardless of your occupation, be sure to continuously invest time and money into yourself and your skill set. Some have suggested that you spend 3% of your annual income on conferences, classes, books, and other educational opportunities. Investing in yourself will not only help create job security, it has the potential to increase your income as well.
7. Obtain the right amount of health, disability, car, renters / homeowners, liability, and life insurance and no more. For example, once you have a child, a rule of thumb is to obtain 20 to 30 years of term insurance just in case.
6. If not earlier, before having your first child, be sure to sit down with an attorney who specializes in estate planning to create a will and any other documents specific to your situation (e.g., general durable power of attorney, healthcare power of attorney, living will, trust, etc.).
5. It is okay to use credit cards for convenience, but eliminate all credit card debt and pay off your balance every month. It is okay to have other debt such as student loans, a mortgage, and a car loan as long as it is carefully selected and you are still able to live within your means.
4. Keep an emergency fund that you can access quickly to cover 3 to 6 months of expenses.
3. Do not panic during a market sell off. Remember: “Buy low, sell high.” It is not “Buy low, abandon your long-term investment plan in a panic, and sell even lower to ensure your losses.” The best practice here is to create a sound investment plan with your advisor and stick with it.
2. Be sure to participate in your employer’s retirement plan (e.g., a 401k or 403b) if one exists. Your minimum contribution to this plan should be the amount necessary to take full advantage of your employer’s matching contribution. For example, if they will match 25% of your contribution up to 4% of your salary, contribute the full 4%. If you do not, you are passing up “free money” and an immediate 25% return.
1. Pay yourself first and invest this money. The minimum amount you should be saving and investing including contributions to your employer’s retirement plan is 10% of your gross income. If you would like to retire early or if you have other major goals, consider saving and investing 20% of your gross income. If you do not think you can save 10% today, then work towards this goal by investing half of all future raises and use the other half to increase your standard of living.
We wish you much happiness and financial success! If you have any questions, please let us know. We are here to help.
Sincerely,
John Duckworth and the rest of the team at Trust Company of Illinois
PS- These are general principles and we recommend that you meet with a trusted financial advisor to review your specific situation.
The evolutionary process hardwired humans with the ability to assess information quickly. Growls emanating from behind a bush = head the other direction. What suited us for survival, however, many times causes us to make counterproductive financial decisions. We are afflicted with numerous biases that cause us to overrule our rational selves. Our investment committee spends a fair amount of time contemplating these biases and evaluating our decison making process to make sure that we are not falling into traps set by our human behavior. Here are a few common behavioral biases that you may recognize in yourself (although it is our experience that they’re easier to recognize in others!):
Loss Aversion. Investors prefer an uncertain larger loss rather than realizing a certain smaller loss. This bias causes the investor to hold losing investments too long and to take increasing risks to try to gain back unrealized losses. To counter this bias, make sure to evaluate an investment on its expected return rather than by the price you paid for it.
Recency Bias. Recent events shade our forecast of the future. This bias causes investors to chase after last year’s hot investment and dump last year’s loser. The wise investor regularly consults the periodic table of investment returns to remind himself that past performance is not a reliable indicator of future results.
Availability Bias. The easier you can call something to mind, the more prevalent you judge it to be. Investors who clearly remember a bad experience investing in a particular asset class will tend to avoid that class in the future. Investors should comprehensively research and analyze potential investments to offset this bias.
Confirmation Bias. Investors tend to pay attention to information that supports their current outlook and to ignore information that contradicts it. To avoid this trap, make a concerted effort to read up on differing opinions.
These are just a few of the biases afflicting our fallen human condition. The successful investor uses a rules based decision making process and keeps track of investment decisions for later evaluation.