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

Gen Y, Say Yes to Stocks!

It started with anecdotal evidence: a conversation with a co-worker about a group of professionals he spoke to about their 401k. The wiser (by which I mean older) folks were asking about the outlook for the economy and how they could maximize their 401k contributions. But the young man in the group, who was in his early 30s, expressed complete contempt for the stock market.  All of his money, he said, was in cash. Then a client of mine who is nearing retirement called me just to tell me about a dinner he went to where the topic of investing came up.  He was shocked at how vehement the young people at the table were about not investing in stocks due to their risk.

Since then I’ve read about a growing body of evidence coming from surveys and other research that suggests that the younger generations are too conservative in their investments. Gen Y is saving but not investing aggressively enough. The problem is that they distrust financial institutions (we don’t count) and believe another financial meltdown is all but imminent.

Gen Y, we don’t blame you. You were in your teens on Sept. 11, 2001, which had to have rocked whatever concept of stability you had. By the time you were old enough to know what the stock market was, the technology-driven crash of 2001-2002 was causing strife in budding 401k plans. And just when you were starting to dream about home ownership the housing market was spiraling out of control in 2008-2010. Many of you watched your parents go through extreme financial duress during this time period, something you were well old enough to understand.

It’s no wonder that Generation Y is too conservative. Your generation doesn’t have the benefit of personally experiencing the roaring 80s and 90s to boost your confidence about the markets. You don’t know who Crockett and Tubbs are. Looking at historical stock returns on paper just isn’t the same as living through it. And it’s hard to understand why men ever wore over-sized shoulder pads, but they did. Even the last five (amazing) years of positive stock markets seems like mere payback for the horror of 2008-2009. Despite this, we have to remember that stocks have historically provided the highest long-term return. No matter what your steadfast beliefs are about the future of the economy, it probably carries no more predictive capacity than the next differing opinion. That’s why we look to history as a guide, rather than trying to guess the future.

When you look at stock volatility over long time frames, it isn’t nearly as risky as the day-to-day movement would have you believe. In the last 87 years large company stocks’ annual returns ranged from -43% in the worst year to +54% in the best. That’s quite a spread! But those same stocks in any given 20 year period (starting on any given day in any year) averaged returns in a range of +3% in the worst 20-year period to nearly +18% in the best 20-year period. That includes the Great Depression and the market crashes of this century. That’s a lot easier to swallow. You have a long time before liquidating your accounts for retirement – probably more than 30 years, so you should be taking a longer term view.

And let’s not forget about inflation. That cash that’s in your 401k is doing less than nothing for you. Long run inflation is around 3%. If you are getting a 0% return on your cash, that is actually -3% in real dollars, guaranteed.

Saving money isn’t good enough. Millennials need to invest with a little more oomph. Yes, diligently putting away $500 a month for 30 years is hard work and no one wants to see their money shrink. But consider this: if you get a modest 4% average return on those savings, you will have $347,000 in retirement; if you double that return to 8% an amazing thing happens: $745,000. Taking risk means a lot of ups and downs along the way, but potentially twice the money in the end. If you can go cliff-jumping with your friends, you can buy stocks, right? (No? Was that just my friends?)

There is no reward without risk, to be sure. Any investment plan should be done with the full comprehension of the volatility, range of outcomes and potential for return. There certainly is risk in losing money in the stock market over short and intermediate time periods. However, those losses only become permanent if you sell out during periods of decline. It seems all but certain that an all-cash/fixed income portfolio is doomed to growth too slow to possibly reach any long-term financial goals.

 

Harli L. Palme, CFA, CFP®

A Gen-exer who believes all of the above applies to her generation too, except the part about over-sized shoulder pads.

Paralysis from Analysis

This month, I celebrate my 500th year at Parsec.  OK – it is really 22 years, but sometimes it feels like 500 years.

During that time, I have been involved in a lot of highly technical projects.  With one project in particular, I was really stressed out about the details.  I analyzed every piece of data so much that I made little progress.  Bill Hansen, one of our Managing Partners, said I suffered from “paralysis from analysis.”  After some reflection, I realized he was right.  At some point, I had to let go and realize nothing would ever be perfect.

In my lengthy career here, I have seen the effect of “paralysis from analysis.”  Some investors may be reluctant to act based upon the endless stream of information available now.  One can flip on the TV at any hour and hear the opinions of investment commentators.  Peruse the Internet, and one can find a vast amount of data about the stock market and the economy.  With so much information and contradictory opinions, it is easy to sit on the sidelines and do nothing.

In some cases, inaction can be as devastating as making the wrong choice.  Consider this scenario.  On March 9, 2009, the S&P 500 hit bottom.  A lot of people panicked and sold all holdings, leaving the proceeds in cash.  Five years later, the index was up 205.84 percent or 22.6 percent annualized (total return).

At the bottom point, there were probably a few people on TV who claimed the end was near.  One could probably find endless charts and articles foretelling great doom to come.  If an investor was paralyzed by this data overload, sat on the sidelines, and did not invest during that five-year period, he or she could have missed an opportunity to recover from deep losses.

What should a person do?  For starters, it helps to leave emotion out of the decision as much as possible.  Then, develop an investment plan that will not lead to sleepless nights.  The real test will come when the market has wild swings – either up or down.  One must commit to the plan and not deviate based upon the mood of the moment.  It is fine to alter the plan if goals or needs have changed, of course.

We at Parsec try to help our clients develop these plans and weather the inevitable market fluctuations.  Communication is a key factor in success.  We encourage our clients to tell us their goals, their changing life situations, or anything that is relevant to staying on target.

So, let’s switch off the talk shows, put down the business magazine, and take a nice walk.  Let’s try to enjoy life instead of obsess over every little detail.

Cristy Freeman, AAMS®
Senior Operations Associate

Portfolio Construction: The Way We See It – Part 1

In this ever changing world we live in, there are “advisors” everywhere. Flip on the TV, pull up a news app on your mobile device, or even the national paper. I came across a gem a few weeks ago from the NY Times archives.

SUNDAY, June 5, 1994; Picking Stocks by the Stars

Published: June 5, 1994

For those who missed the recent conference on “Astrology and the Stock Market” in Manhattan (about 40 people attended), here are some tips from several of the hot sessions:

The Art of Timing: Combining Astrological Indicators — Graham Bates, London financial astrologer. “I’m worried and confused about the eclipses in November. I don’t know what they’re going to do, but I know they’ll be important.”

Stocks, Planets and Solar Cycles — Richard Mogey, executive director of the Foundation for the Study of Cycles. “There’s a 23 percent gain the fifth year of every decade because of the Jupiter-Saturn cycle. I’d expect the same in 1995.”

The Cosmic ‘Inner Winner!’ — Paul Farrell, author of “Think Astrology and Grow Rich.” “When Uranus and Neptune go into Aquarius, I look toward information and technology.”

Beyond Cycles: Using Interpretive Astrology to Identify Key Turning Points in Markets — Charles Harvey, president of the Astrological Association of Great Britain. “When there is a new moon in the eighth house, Placidus system, in New York, there is always a major change in interest rates. That happens July 8.”

Want something more specific? Henry Weingarten, who heads the Astrologers Fund (the conference sponsor), predicts, “Novell will be at 30 next May.” But, “If it hits 35 before then, I’m out.”

There will always be very smart individuals that develop complex theories of why and how the markets work. This is part of human nature and our innate desire to understand how our world works. This is why we have departments in government and universities dedicated to studying human behavior. Our investment approach at Parsec is incredibly simple. We accept that markets behave irrationally in the short term. We feel that it would be a breach of our fiduciary duty to attempt to predict short term market movements.

Fiduciary duty is extremely important to us. This duty is a very old idea, which was defined here in America with Harvard College v. Amory in 1830. The decision of this case scolded the trustees and instructed them of their duty to manage the trust as they would manage their own affairs. This is known as the “Prudent Person Rule.” Here at Parsec, when evaluating an investment, we ask ourselves first is this in the best interest of our client and secondly would we invest in this particular security.

Be on the lookout for further posts on this topic.

How much is that Doggie in the Window?

According to a recent announcement from the American Pet Products Association, Americans spent $55.7 billion last year on their pets. That’s billion, not million. An article at Time.com (http://time.com/#23451/pets-dogs-cats-spending-americans/) cleverly noted that the figure is $10 billion more than Germany spends on its defense budget.

I admit I am one of these people. My little rescue dog hit the lottery when she came to live with me. She has seven dog beds, if you include her car seat (yes, car seat). She owns more jackets than I do, although they are all for function, not fashion. She has multiple, color-coordinated harnesses, collars, and leashes so that she need never feel ashamed about how she looks. When we go on vacation, she has as much luggage as I do. Yes, she is spoiled rotten.

I am not alone. Bill Geist of the “CBS Sunday Morning” program tells a hilarious story about his “free” rescue dog: http://www.cbsnews.com/news/even-cat-people-fall-in-puppy-love/.  Sometimes, the unexpected costs can really add up.

In our industry, I see a number of fees that some people pay for investments: high commission rates for certain products, either on the front or back end of the transaction; frequent, unnecessary trade costs from a practice called “churning;” and expensive investment counsel fees. Before long, that simple purchase of 100 shares of ABC Widget Works has cost a fortune in added fees.

When you are evaluating an investment advisor, consider how the person earns his or her money. Does he receive a commission for his or her investment recommendations? Is he or she directly affiliated with a broker? Does he or she charge an additional investment counsel fee? While he or she may promise a great gross return on investment, the net return after all of those fees may be no better than what you would find with a simple savings account.

At Parsec, we do not receive commissions for any of the investment products we recommend – no commission from the trade, no commission for recommending a certain security, nothing. In addition, when we recommend mutual funds, we look for funds that do not carry significant internal fees.

We are not beholden to a particular broker. We have four brokers who we like to recommend, based upon client needs.

We do charge an investment counsel fee that we think is reasonable to industry standards. When you sign a service agreement, you see upfront what your fee schedule will be. On a quarterly basis, you receive a reports package that includes information about net-of-fee investment performance, current holdings, et cetera. We are also here to help with planning – everything from college savings to retirement to estate. We like to think service goes beyond placing a trade. Our clients pay us to act as a partner in planning their future.

Everything in life – from owning a home to adopting a rescue dog – has the potential for unexpected costs. How you invest your money, though, should be a little more straightforward. With a little research in advance, you can evaluate whether or not fees charged for service are reasonable and affordable.

Now, if you will excuse me, I need to order organic food for my doggie. And maybe I will pick up a bottle of shampoo. She told me she is tired of smelling like a bowl of oatmeal.

Cristy Freeman, AAMS
Senior Operations Associate

Happy 5th Anniversary, Bull Market!

That’s right, it’s the Wood Anniversary for the market, which hit bottom on March 9, 2009. Since then, it has come roaring back – the S&P 500 is up 174% for the 5-year period (that’s price change only, not total return). Not too shabby.

The WSJ has a nice article here showing the anniversary in five charts. According to one of the charts, this rally is the second-best since WWII (beaten only by the S&P’s 228% gain from 10/82 through 10/87). The article’s author thinks there is still room to go in the market recovery, saying that investors’ confidence in the rally will continue to fuel stock market inflows.

No one knows what the future will bring where the market is concerned, but the present is a far cry from five years ago. Happy Friday, happy bull market anniversary, and here’s to five more years!

Sarah DerGarabedian, CFA
Portfolio Manager

Where is My Money?

It seems there are always stories in the news about the latest scheme that has defrauded many people. Seeking a big return, people give their hard-earned dollars to criminals. The big return is never realized. All the money is lost.

With all the bad guys in our industry, I can understand how someone would look at Parsec with a skeptical eye. I am not going to discuss our performance returns or market strategies in this post. I want to discuss something a little more basic that everyone should consider when interviewing a potential investment advisor: “Where is my money?”

In some cases, the victim gives the criminal money to buy investments. In turn, the fraudsters provide the victim with a statement showing assets purchased with that money. It may contain the names of easily recognizable companies. Without an actual stock certificate behind that piece of paper, the statement is worthless.

At Parsec, we do not take custody of your assets. The assets are held at an independent broker, in your name. We recommend Charles Schwab, Fidelity, and T.D. Ameritrade, all brokers whose names you probably recognize. You will receive a quarterly statement from us that contains performance statistics and other information. You also receive a monthly statement from the independent broker so you know exactly what you own in each investment account.

Furthermore, we do not have the authority to move those assets to an unlike-registered account without your consent. You must sign a letter or form to authorize the movement of securities to unlike-registered accounts, which adds another layer of security.

When assets are held at a broker and registered to you, an independent source tells you what you own. There are no “phantom” assets. Also, giving someone the ability to move assets to accounts not registered in your name can be dangerous if in the wrong hands.

When you select an investment advisor, I hope you will ask this very basic question. You worked hard to accumulate what you have. Don’t let an unscrupulous person take it away from you.

Cristy Freeman, AAMS
Senior Operations Associate

The Best Man for the Job is…a Woman?

I was pleased to read yet another article supporting the importance of women in portfolio management. The article (found here) cited a recently released report which found that an index of hedge funds managed by women outperformed the HFRI Global Hedge fund Index over a 6.5-year period. During that time, the female-managed fund index rose 6%, while the HFRI declined 1.1%. Of course, the sample size was relatively small, as only about 125 of the 10,000+ hedge funds have female portfolio managers. Still, the data seem to support the notion of gender diversity in investment management. There have been many articles written about how men and women differ in their approach to investing, indicating that women investors on average have a performance edge on men.

Many theories abound as to why this might be the case. Some of the most popular theories are that women tend to be more risk-averse (less testosterone) and are therefore less likely to take risky bets that don’t pay off. Another theory is that women lack “over-confidence” leading them to trade less, which has shown to contribute to outperformance. This particular article also suggested that these women hedge fund managers took a longer-term view compared to their male counterparts, which paid off over the time period in question.

Fortunately, Parsec is ahead of the curve when it comes to gender diversity in the investment management arena. Three of our five CFA charterholders are women, and are active members of our Investment Policy Committee. We don’t really know the reasons behind the findings in these studies, but some of the theories described above make sense to us. At Parsec, we don’t see this as a gender issue, just good investing. Our philosophy has always been one with a long-term view that eschews market timing and excessive risk-taking. While this approach doesn’t guarantee outperformance, it is a prudent way to invest for retirement, and we do know the research supports that.

Sarah DerGarabedian, CFA
Portfolio Manager

Time is Running Out!

When we were kids, it seemed to take FOREVER for Christmas to get here.  After Thanksgiving, you knew it was close but oh so far!  Nowadays, it seems as if December just flies by.  We have so much to do!  How do we get it all done?

In the midst of the holiday chaos, let’s take a moment to handle charitable donations.  Your favorite non-profit organization appreciates anything you can do for them. 

You still have time to make a donation.  You must make cash donations by December 31 to count them toward the 2013 tax year. 

If you want to donate securities, call us the second you read this blog post.  Time is running out to ensure processing of these types of donations by December 31.

Also, if you have old clothes, furniture, or other items to donate, you should deliver the items to the charity by December 31.  (Some charities even offer pick-up service.)  Make a detailed list of the items you donated.  If something is particularly valuable, it would be a good idea to snap a picture.  You would have proof, if you are ever audited, of the item’s condition.

It is possible to get everything done on time.  As I mentioned, charities need our support.  Just take a deep breath, make a list, and do one thing at a time.  If you planned to make a donation, just add them to the “to do” list.

We hope everyone has a safe holiday season and a healthy, happy new year.

Cristy Freeman, AAMS
Senior Operations Associate

Investing Like a Psychopath (or at least like a Vulcan)

I recently read an article by Morgan Housel about the detrimental effect emotions and memories have on investing behavior (you can read it here). Not surprisingly, people tend to recall bad memories more easily than good ones, and seek to avoid experiencing those emotions again. When such behavior interferes with investing, you get something called loss aversion. Housel explains it like this:

“The market falls 50% in 2008 and early 2009. That hurts. Then it rallies 130% over the next few years, recouping all of your losses and then some. This feels OK, but not nearly good enough to ease the shock you felt from the 50% crash, which was emotional and memorable. You remember the crash much more vividly than the ensuing rally, and you change your portfolio to make sure you never suffer through a crash again. You buy bonds, hold a lot of cash, and swear off stocks for good. We’ve seen quite a bit of this behavior over the last few years. And we know it comes at the expense of long-term performance.”

A study conducted on people whose brains suppress emotion (due to the presence of a lesion on the brain) found that they did not suffer from loss aversion, and were able to make rational decisions that resulted in a higher payoff. One of the study’s authors referred to these people as “functional psychopaths” since their choices were unaffected by emotions (personally, I think “Vulcan” would have been a bit less insulting, but perhaps this guy is the only scientist on the planet unfamiliar with Star Trek).

In addition, “our memories of emotional experiences tend to get rearranged and distorted, so much so that some of what we remember never actually occurred.” (I think the author must be acquainted with some of my extended family members – I am all too familiar with this phenomenon.) So what is an investor to do? Housel provides the same advice as that given to dieters – keep a journal. It’s easy to say you’ll be a rational investor (or a healthy eater) but far more difficult in practice. The best way to remain accountable is to keep an accurate history, refer to it, and learn from it.

Live long and prosper.

Sarah DerGarabedian, CFA
Portfolio Manager