Fears of a “Summer Pause” Prove Ephemeral

Many analysts, pundits and prognosticators were sounding alarms about “cautious consumers” and “threats to continued economic growth” after the Census Bureau reported on August 13 that both retail sales and the broader category of retail and food services sales in July were almost exactly what they had been in June. In other words, both categories were flat from month to month. Even more depressing, June was confirmed to have only increased 0.2 percent from May.

Those of us with more experience and greater knowledge of the volatility of these series cautioned against making snap judgments. We recommended waiting for the next release before becoming concerned about consumer spending, which makes up by far the largest share of GDP (68.5 percent of nominal GDP in 2013). The retail and food services part is about half of total personal consumption expenditures.

As is nearly always the case, this advice proved sound when we read the Census Bureau release of September 12. As the chart shows, not only did retail and food services sales set a new record of $444.7 billion in August, seasonally adjusted, but also both June and July were revised to be much larger than previously reported.

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July sales are now $ 441.8 billion on a seasonally adjusted basis, up 0.3 percent from June, rather than the originally reported $439.8 billion or 0.0 percent. June is now reported up 0.4 percent rather than 0.2 percent to a total of $440.3 billion rather than $439.6 billion, seasonally adjusted.

For the first eight months of 2014, total retail and food services sales were $3.46 trillion, up 3.7 percent from the same period in 2013. The biggest gain was at auto and other motor vehicle dealers, where sales were 8.0 percent ahead of the first eight months of 2013.

There are several reasons for this. One is that the average age of the 253 million vehicles we own (the “fleet”) is the highest ever, about 11.4 years. Another is that consumers have record levels of income and near-record levels of employment. A third is that banks, car dealers and credit unions are all competing to finance vehicle purchases at very good terms, including low rates, relaxed credit standards and maturities as long as eight years to keep monthly payments down. A fourth reason is that some measures of consumer confidence, while far from record levels, are at the highest point since the recession ended in June 2009.

Nonstore retailers (think catalog and internet stales) are up 6.5 percent from the first eight months of 2013 to $300.9 billion. That amount is 71.3 percent of the total for general merchandise stores ($421.6 billion) and nearly triple the $101.9 billion at department stores, where sales are off 2.5 percent from the first eight months of 2013.

We should see a record holiday shopping season in 2014. That will keep retailers smiling and contribute to several more quarters of real GDP growth above 3.0 percent at a seasonally adjusted annual rate, which is now the consensus for the first time in this expansion. That will be very good news if the economy follows that forecast. We’ve all been waiting impatiently for the US economy to break out of the subpar 2.1 percent a year growth path it’s been stuck in for the five years since the recession ended.

Dr. James F. Smith

Chief Economist

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The Rational Investor… or Not?

This is the last post in a series of six blog entries focused on topics that might be of interest to the Millennial generation. If you would like to see our attempt at making these subject matters entertaining, visit our YouTube page to see a video version of this article.

 

So here’s the setup: you have two large pizzas. One is cut into four pieces, the other is cut into eight pieces. Would you rather have one piece from the former, or two pieces from the latter? If you asked a hungry four-year-old that question, he’d probably be totally confused because you used the words “former” and “latter.” But then he’d go for the 2 pieces because in his mind, two pieces are more than one. Of course, anyone with a basic knowledge of fractions knows this is a trick question, because it’s the same amount.

Let’s imagine now that the pizzas are companies, and the pieces are shares of stock in those companies. You have $1000 to invest. Company A’s stock price is $50, and company B’s stock price is $100. Assuming that there are no trading costs, you can purchase 20 shares of company A and 10 shares of company B. All else equal, which would you buy? Answer: it doesn’t matter – your investment in either company is the same. You’d be surprised at how many people would choose company A because you get “more” shares of stock or because they think the shares are a better “value” by virtue of having a lower price per share. The thing you have to realize is this – a company can issue any number of shares it wants to. If the price per share is $100 they can issue a 2-for-1 split, and now you’ll have 2 shares worth $50 each for every one you had before. Your total dollar investment in the company doesn’t change, though.

We all want to believe we are rational and that emotions are only something that affect other people, but it just isn’t true. We all have made mistakes like the investor in the example above and that’s why behavioral finance is one of the fastest-growing branches of psychology. This is just one example of common investor misconceptions but there are many more – click on the link above for a lighthearted look at a few that we see from time to time. Remember to always discuss your investment decisions with your advisor, so that he or she can lead you in the direction of the logical and unbiased choice.

Sarah DerGarabedian, CFA
Portfolio Manager

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Interest Rates and How They Impact You

This is the fifth post in a series of six blog entries focused on topics that might be of interest to the Millennial generation.

Today I’m going to touch on the exciting topic of interest rates. Okay, let’s be honest, most of us consider the subject boring and highly technical at best, and pure financial torture at worst. But hear me out. I’d like to explain why interest rates are in fact pretty fascinating, surprisingly straightforward, and worth learning about. The truth is that interest rates can have a massive impact on your current and future financial situation.

So what are interest rates? And how do they affect your financial well-being? If you think about it, everything in our modern society has a cost. You pay for a good meal at a nice restaurant, there’s a charge for staying at a hotel, and an education certainly isn’t free. The same holds true for money. It has a cost and that cost is interest rates. In order to get your hands on some money, say for a car loan, a mortgage, even groceries, you pay for that money in the form of an interest rate. When you have a good credit history, i.e. you consistently pay back other people’s money in a timely manner, you’re considered a good credit risk and it becomes cheaper for you to borrow money in the future. In other words, the interest rate you’ll get charged on loans will be lower than the average person. This is a good thing for your financial well-being. On the flip side, if you are even occasionally late on a credit card, car loan, or any other debt payment, you become a less desirable credit risk and the rate at which you’re charged to borrow money in the future goes up. In other words, the interest rate on the next loan you take out will be higher and you’ll pay out more money over the course of the loan, all else being equal.

You may have heard about the compounding power of interest and how it can help you significantly grow your wealth. This is a very true financial tenant when it comes to investing your money. However, this same principle also works against you when you step into the role of a borrower. As an example, consider that the median price of a home in 2013 was about $200,000. Now assume you take out a 30-year fixed mortgage to purchase a home. You’ve worked hard and have 10% in cash to put down. This leaves you with a $180,000 mortgage. Going interest rates for borrowers with good credit are around 4.25%. Even though these are still historically low rates, at 4.25% you can expect to pay approximately $138,960 in interest alone over the life of the loan! That’s in addition to the $200,000 cost of the house. Now let’s pretend that your credit is a little below average, making you a slightly higher-risk in the eyes of a bank. You’re still able to secure a loan, but the bank wants to charge you a 5.00% interest rate in order to compensate for the risk they take on by lending to you. At a 5.00% rate, you can expect to pay $167,760 in interest over the course of the loan, or almost $30,000 more than you would pay with a better credit score. That is some serious money.

On top of the impact interest rates have on our personal investments and debt payments they also affect our spending and saving behavior. Imagine that your bank was offering a savings account with a 10% interest rate. All else being equal, would you be more or less inclined to save? That’s right. Most people would choose to direct more of their personal income towards savings when interest rates are higher. If millions of people were forgoing spending in favor of savings, this would have a significant effect on the overall economy. Interest rates matter. What about high interest rates when you’re the borrower? As we saw above, even a small increase in an interest rate can lead to much larger debt payments. Generally speaking then, higher interest rates tend to depress credit growth and in the end can muddle economic activity as consumers take out fewer loans.

As you can see, interest rates can have a very direct and often significant effect on our personal financial situation, not to mention our saving and spending patterns, and the broader economy. Although we’ve only skimmed the surface, suffice it to say that interest rates are worth understanding, if for no other reason than to help you make smarter decisions with your money.

Carrie Tallman, CFA
Director of Research

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Renting vs. Buying

This is the fourth post in a series of six blog entries focused on topics that might be of interest to the Millennial generation.

In my experience, one of the largest financial decisions clients struggle with is the decision to rent or purchase their residence. There is not necessarily a right or wrong answer, and every individual’s situation is different. However, there are some scenarios that may help guide you in making the right choice.

Let’s start with buying. Here are five factors that may make it more beneficial to purchase:

  1. You like the idea of “forced savings” – as you pay your mortgage your balance owed is reduced. Building this equity in your home will create a form of savings for you. Since the value of the home is locked in, you can’t squander it away on dining out or shopping. You realize the savings once you decide to sell it.
  2. You think the tax incentives are attractive – when you file your taxes, you will be able to deduct mortgage interest. Property taxes will also add a nice deduction. If you do any energy-efficient improvements, you could be eligible to deduct those expenses. Another bonus is that depending on your situation, any capital gain from the future sale of your home is free from federal income tax.
  3. You want stable payments– typically your mortgage payment will never change, while rent is more susceptible to rise with inflation. Purchasing may be right for you if you are looking for a stable cost of living.
  4. You dislike the restraints placed by your landlord – often when renting you must get everything approved. If you want to paint, rip up the carpet and put down hardwoods, take out a wall or have a dog, then owning probably makes more sense. Home ownership allows you to customize a space and really have a place that you can call home.
  5. You value a second-income stream – by owning a home, there is potential to create additional income by renting part of it out. If you have an extra bedroom, finished basement, or a garage for storage, it’s possible to rent to friends, family or others to help cover your mortgage payment.
  6. Bonus – quite possibly the biggest bonus of all is you will be debt free in retirement with no mortgage payment. You will always have the expense of a rent payment if you continue renting.

But guess what… buying may not be right for everyone. It’s important to remember that there is more to owning a home than just a mortgage payment. Between maintenance, fees, and taxes, the costs can add up. And other factors may contribute to make it an unwise choice for some people to purchase. Here are five factors that may make it more beneficial to continue renting:

  1. You plan on moving – home ownership is not a short-term investment. If you think that you may be moving for any reason within the next 3-5 years, it’s wise to continue to rent. Once you are settled, revisit the topic!
  2. You don’t have good job stability – of course you can never be 100% certain if your job is stable, but the possibility of your income going down could greatly impact the type of home you can afford. If you expect to quit your job, or anticipate being let go, hold off on a home purchase until there is a bit more certainty about the future.
  3. You just aren’t that handy around the house – as a renter, you don’t have to worry about maintenance issues. If the pipes burst (something that the author can relate to), then the landlord is responsible for repairs. For a homeowner, it’s 100% on you. It’s up to the owner to paint, shovel the drive when it snows, and fix the garbage disposal when it’s broken. If you aren’t ready for the hassle or expense involved with being the fixer-upper, then perhaps home ownership just isn’t for you.
  4. You have a low credit score – having a solid credit score is vital in purchasing a home. While it may not prevent you from getting a mortgage, it could drastically affect the interest rate that you receive. If you have a score below 700 it would probably be best for you to rent while paying off debt and building up your credit.
  5. You don’t have money for a down payment – if you don’t have any cash squirreled away for a down payment, it may not be the time to purchase. If you don’t have a 20% down payment you will have to pay PMI (private mortgage insurance) which will increase cost of monthly payment. Use this time to save and budget before taking the plunge.

These are some of the basic pros and cons of renting vs. buying. Since every situation is different, it’s always best to speak with a financial advisor about the circumstances surrounding your own decision matrix.

With correct planning and consideration, we’re sure that you will come to the best decision for you!

Ashley Woodring, CFP® Financial Advisor

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Roth vs. Traditional IRA – Do You Know the Difference?

This is the third post in a series of six blog entries focused on topics that might be of interest to the Millennial generation. If you would like to see our attempt at making these subject matters entertaining, visit our YouTube page to see a video version of this article.

 

“Roth IRA” and “traditional IRA” – these are terms that are bandied about willy-nilly by financial advisors and others in the business. You’ve often wondered what the difference is but haven’t asked, because you feel like you should know already. You nod along, meaning to Google it when you get home but of course you forget as soon as you step through the door and directly into a pile of something your loving pet left for you to clean up. Allow me to help! With the IRA definitions, I mean – not the mess. That’s all you.

First, the similarities – both are types of retirement accounts that allow the investments within them to grow without requiring you to pay taxes on any realized gains. So if you buy a stock for $500 and sell it for $1000, you don’t have to pay capital gains taxes on the $500 you made. Awesome, right? Another bonus – you don’t have to pay taxes on any dividend or interest income that you earn within either type of IRA. In a regular brokerage account you would have to pay taxes on realized gains, dividends, and interest income, which would cut into your portfolio return.

So what are the differences? Both traditional and Roth IRAs feature tax advantages on either contributions or withdrawals, but not both. A traditional IRA allows you to make tax-deductible contributions (so the funds you put in there are not being taxed as income). However, when you withdraw the money after age 59 ½, it will be taxed as ordinary income at your marginal tax rate.

Conversely, contributions to a Roth IRA are not tax-deductible (so this is income that has already been taxed). But when you withdraw the money (assuming you’ve had the account for at least 5 years and are older than 59 ½) it’s all tax-free! That’s why traditional IRAs are called “tax-deferred” accounts and Roth IRAs are called “tax-exempt” accounts.

Now, as with anything the IRS gets its hands on, there are all kinds of rules, guidelines, exceptions and so forth when it comes to how much a person can contribute to either type of account, how much is tax-deductible, what types of early withdrawals are allowed without a penalty, etc. Rest assured that all of this information is available on the internet, so I will spare you the details. Better yet, call your financial advisor and ask him or her how the rules affect your unique situation. There are so many different scenarios that, if I were to attempt to address them all, it would completely defeat the purpose of this blog, which is to simply explain the main difference between a Roth and a traditional IRA.

Because your situation is unique, you should talk to your financial advisor about the different account types and which ones are best for you. But now, when you hear phrases like “tax-deferred” or “tax-exempt,” “Roth” and “traditional IRA,” you can nod along knowledgeably.

Sarah DerGarabedian, CFA Portfolio Manager

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Student Loans vs. Saving

This is the second post in a series of six blog entries focused on topics that might be of interest to the Millennial generation. If you would like to see our attempt at making these subject matters entertaining, visit our YouTube page to see a video version of this article.

 

You’ve recently graduated from college and you have a load of student debt. It can be overwhelming. You think it will take forever to pay it off. To make matters worse, you know you are supposed to be saving for retirement but you feel like you can’t because you need to pay off your student loans first.

To make the best financial decision it is important to remove the psychological barriers that often accompany the ‘saving versus paying down debt’ trade-off. The millennial generation is particularly opposed to debt – more so than older generations, so they tend to pay their student loans off before they start saving. Unfortunately, this could be the wrong choice.

The long run average of large company stocks is 11.3% (1950-2013). If your student loans are at an 8% interest rate, you would be better off investing money over and above your minimum loan payment if you have the risk tolerance for investing the money in equities.

Maybe an 11.3% return sounds unrealistic. It’s common for this historical return to seem disconnected from the present. A common psychological condition causes us to take recent past experiences and extrapolate them into the future, creating a false sense of predictive ability on what the future holds. If the good times are rolling, they will always roll. If we are in crisis, we will be in crisis for the foreseeable future. But the truth is that things change. Our economy is cyclical in nature and that’s why we use long-term historical observations to make long-term decisions.

Even with the worst recession since the Great Depression the average return of large company stocks in the 10-year period from 2004 -2013 was 7.4%. And while that’s not huge, you may be willing to take the chance that we won’t soon see a repeat of the worst stock market period in history. Those loans will get paid off eventually and you’ll have more money in retirement simply by saving more and saving earlier.

Don’t forget about your employer match on your 401k. If you have a 401k match, by all means take it! Even if your student loan interest rate is 12%, you’d be better off (after paying the minimum) putting enough money into your 401k to get the free money. That’s a 100% return, guaranteed.

Harli Palme, CFA, CFP®
Partner

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7 Reasons to Consider a Prenup

This is the first in a series of six blog entries focused on topics that might be of interest to the Millennial generation. If you would like to see our attempt at making these subject matters entertaining, visit our YouTube page to see a video version of this article.

I believe Kanye West said it best when he said, “We want prenup!”

There is nothing that can kill the romance of upcoming nuptials more quickly than your partner asking you to sign a prenuptial agreement (aka prenup). But do you know what can really kill the romance? Divorce! Perhaps you are thinking, “our relationship is going to last… we’d never get a divorce.” Well let’s face it, I don’t think anyone goes into a marriage thinking that in 5-10 years they are going to split. Other people may think that the agreement is only for the rich… this is actually a misconception. While it’s true, a prenuptial agreement may not be right for everyone, the following are a few scenarios in which it will make a lot of sense:

1: One partner earns the majority of the income. If you know going into a marriage that one person will be the primary “bread winner,” a prenup can be used to determine the amount of alimony that will need to be paid upon a divorce.

2. What about the partner that doesn’t make a lot of money? The prenup can also be used to make sure that the partner who is less financially set is protected in the event of a divorce.

3. For the spouse with substantial assets. If you own a home or other substantial assets prior to a marriage, you can use a prenup toestablish that those assets that came with you, will leave with you.

4. For the stay-at-home parent: This will obviously affect your income. If it is decided prior to marriage that one parent will stay at home with the children, a prenup can be used to make sure that each parent shares in the responsibility of taking care of the children financially.

5. One partner has a significant amount of debt. A prenup can establish who will be responsible for paying off debt in the event of a divorce. This can prevent you from getting straddled with debt that the other spouse created prior to marriage.

6. Children from a previous marriage. When entering into another marriage you need to make sure that you kids are protected from another divorce. This can ensure that in the event of your death/divorce that assets that should be going to your children won’t go to your disgruntled spouse.

7. You own a business. It is possible that in the event of a divorce your spouse will end up owning part of the business. Your partner will then go from being an unwanted spouse, to an unwanted business partner. Establishing that the business is off limits in a prenup can prevent this from happening.

It’s understandable that many couples don’t even want to entertain the idea of a prenuptial agreement. The important thing to remember is that this is a document used to protect all parties. Communicate openly and listen to the concerns of your partner. Even if you do live “happily ever after,” there will always be a peace of mind involved with foresight and deliberate planning.

Ashley Woodring, CFP®

Financial Advisor

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