May Newsletter – Fiscal Debt and Investment Returns

Written May 3rd, 2012 by Jonathan Ericksen
Tags: 401k tips, BeManaged Newsletter, retirement
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Investment Returns and Overall Account Growth

Your contribution level critical to a successful retirement

The Employee Benefit Research Institute’s latest survey of 401(k) valuations looks at account growth by age and tenure (number of years participating in the plan). From January 1, 2011 through January 31, 2012, account values of newcomers under the age of 35 have risen in value by 58%. On the other side of the spectrum, those who are over 55 years old and have been in the plan at least twenty years saw account increases near 16%.

When you have an opportunity, compare your January 1, 2011 balance to your current balance and see if your growth is in line with your peers. If you are falling a little short, it might be a good time to revisit your contribution level!

“Illinois residents, whose income taxes rose by a record last year to help close a budget deficit, are paying the price again for the state’s fiscal mismanagement. With its pile of unpaid bills growing about 30% this year, the weakest pension-funding ratio among states and falling federal aid, Illinois and its municipalities are paying a penalty above AAA debt that’s twice their five-year average. Illinois plans to issue $1.8 billion of debt as soon as next week…”

April 24 – Bloomberg (Tim Jones and Brian Chappatta)

Excessive Levels of Debt and Future Economic Growth

The Effect of “Crowding Out”

Borrowing from tomorrow’s taxpayers to get economic results today would be fine so long as the results mitigate the negative consequences imposed on the future. Robust productivity and steady employment growth are the keys to long-term economic success.

In the long run, however, excessive borrowing can lead to an extended period of slow economic growth. The accrued debt load on society acts as a parasite diverting capital away from productive assets towards paying down principal and interest on accumulated debt.

The table below illustrates the effect excessive government spending has caused on economic growth worldwide in recent years. For an interesting case study, look no further than Japan, which has a debt to GDP ratio of roughly 220%, stagnant population growth, and has experienced two decades of meager economic growth (tradingeconimics.com).

As large amounts of credit are forced through one body (for example, the U.S. Treasury) private market participants are “crowded out” – the supply of credit is reduced which eventually drives up the cost of private sector borrowing. Central bank policy is accommodating current U.S. fiscal policy by expanding the monetary base (reference “Monetary Base” April BeManaged newsletter). As a result, we have been able to get away with excessive government borrowing without the negative effects of crowding out… at least for now.

Future economic growth is absolutely critical to support corporate earnings and, subsequently, stock prices and retirement account balances. Muted economic growth resulting from short-sighted monetary and fiscal policies will eventually translate into lower long term rates of return for financial assets.

In the aftermath of the 2001 terrorist attacks, the Federal Reserve increased bank reserve balances to $67 billion from a level below $10 billion to assure market liquidity. Those balances were quickly withdrawn, and we returned to normal levels by the end of the following week.

During the 2008 financial crisis, the Federal Reserve added over $800 billion in reserves in just over three months. Reserve balances have continued to increase – as of the end of April, over $1.5 trillion sits in Federal Reserve Banks as required or excess reserves.

“Tuesday Never Comes”

“The global economy is floating on an ocean of credit, and a good thing too as our cartoon friend Wimpy reminds us. Without it, he would be a hungry puppy by next Tuesday and nearly seven billion world citizens would be worse off if barter, and not credit, was the oil that lubricated trade…

Not suddenly, but over time, gradually higher rates of inflation should be the result of QE policies and zero bound yields that were initiated in late 2008 and which will likely continue for years to come. We are hooked on cheap credit just as Wimpy was hooked on Friday’s burgers.”

-William Gross, “Tuesday Never Comes”, www.pimco.com

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Beware of Confirmation Bias – And its Assault on Your 401k

Written May 3rd, 2012 by Jonathan Ericksen
Tags: 401k tips, investment behavior
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There is a useful analogy that relates the observation a goldfish makes when looking through the rounded glass of his fish bowl and us – the human. As we might suspect, a goldfish observing the outside world through the lens of a glass bowl would see things differently than you or I.

To the goldfish, the mechanics of the world might appear in a constant state of illusion as a result of the curvature of his glass house. The goldfish, though, having spent his entire life behind a glass screen, is likely unaware that his vision is obscured by glass simply because he is ignorant to anything else. A ball rolling on the floor in a curved line represents his reality even though the ball, in a humans reality, rolls in a straight line.

If this fish were of the scholarly type, he might catalogue and formulate a mathematical framework that describes his observations. As you might recall from your high school science class: this is what Sir Isaac Newton did when he observed that famous apple falling from the tree. The fish’s laws of motion, if written properly, would be accurate so long as every observation of outside objects were made through the lens of the fish bowl. However, if we applied these laws of motion written by the fish to observations made outside of the fishbowl, the math would break down as we observe balls rolling in straight lines, not curved lines.

Now, assuming you’re still with me, I’m going to make the connection between a goldfish looking through his fishbowl and us humans.

It’s important to remember, like the goldfish, that we humans observe and participate in this world through our own “fishbowl”. We rely on our senses and intuition to navigate this world. Sometimes, though, our intuition fails us and instead we participate in this world behind a screen of our own folly and consequently make irrational decisions. Thus, our senses and intuition act as our own glass lens and can sometimes obscure what would otherwise be rational choices.

I’m going to introduce you to a natural tendency that happens within us humans known as the “confirmation bias” or “confirmatory bias”. I will first explain what this tendency is followed by its potential impact on your retirement savings. Finally, I’ll give you a few tips on how to combat this tendency as you work towards meeting your retirement goals.

Confirmation Bias: A tendency for us to place a greater emphasis on information that agrees with our original beliefs while prematurely dismissing evidence that does not. In other words, we naturally ignore facts that don’t agree with our ideas and favor facts that do; we often do this without knowing it even takes place!

Suppose you entered a debate among your peers as to which restaurant provides the best service. For the sake of argument lets pretend a family member of yours owns restaurant “A”, while restaurant “B” is owned by an anonymous group. Lets say your friends all agree that restaurant “B” provides better service while supplying the appropriate evidence to support their claims. Now you, having a favorable bias towards restaurant “A” (because it’s owned by close family members), will provide evidence of “better” service from restaurant “A” to counter their argument. Now lets say a third party evaluated the evidence provided by you and your peers and came to the conclusion that the evidence in support of restaurant “B” was more definite and indisputable than the evidence in favor of restaurant “A”.

The confirmation bias says that you, having a prior opinion, will have a more difficult time accepting evidence that does not agree with your original belief even if the evidence is more conclusive and rational. This disregard for opposing facts happens under the radar of your conscious mind – the caveat being you are unaware this is happening.

The implications of the confirmation bias upon your retirement investing can be very dangerous. As you might suspect, when someone develops an original idea or belief, it can be difficult for them to change his or her mind about those original ideas even in the face of new and conclusive evidence. The confirmation bias if prevalent in many topics - even so in the world of personal finance.

Investment Example: Lets say you thought the appropriate mix of assets within your retirement account included a heavy emphasis on stocks. Perhaps you thought stocks were cheaply valued and as a result executed a strategy aimed at raising your equity exposure. Suppose, then, you were given a cogent analysis from a caring friend that suggests stocks might be too expensive and adding equity exposure to your portfolio is too risky. According to the confirmation bias, and to no fault of your own, you may (or may not) find yourself ignoring this evidence simply because it does not support your original belief.

What should we do as investors?

Increase Awareness – The best line of defense against undesired outcomes in life is often simple awareness. Educating yourself on topics like this can help safeguard against the problems they elicit.
Take opposing evidence more seriously. Try to look at new evidence as if you have no original opinion. This may be difficult but practicing it might help you discover the rational and best option.
Seek professional, fiduciary advice - The more opinions you hear, the more accurate your decisions. This, of course, includes opinions from those with opposing beliefs. Speak to an investment professional and ask for his or her opinion. And remember, if it disagrees with your opinion, try to falsify it with evidence of your own. Do not disregard it simply because it is not the answer you want to hear.

Want more on this topic? Click here to learn about a study conducted by Stanford University that gives evidence for this unusual occurrence.

Advisors – An Analogy to Understanding A Fiduciary Vs. A Non-Fiduciary Advisor

Written April 11th, 2012 by Jonathan Ericksen
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Those who guide individuals on their personal financial decisions generally fall under two categories: those who manage assets acting as a Fiduciary and those who advise clients acting as a Non-Fiduciary. The greatest distinction between these two groups is the incentives behind their guidance. I’ll help clarify what we mean by an analogy.

First, the specifics. Federal law mandates that those acting as fiduciary advisors are required to adhere to the following standards:

Act with undivided loyalty and good faith
Avoid taking part in any activities that result in a possible conflict of interest
Disclose any possible conflicts of interest that might arise during the management process
Provide full disclosure regarding any advice they may offer

Advisors who act as non-fiduciaries are those who generally earn compensation through commissions from the sale of investment products, life insurance programs or the sale of stocks (stock brokers). Because titles for non-fiduciaries are unregulated, they are free to avoid titles such as broker or insurance agent, and instead are free to adopt titles such as investment advisors, financial planners, or financial consultants. Additionally, these advisors are not regulated by the federal law and its requirements mentioned above.

It is important that investors understand the difference between these two categories and address this when seeking investment advice. Although it is possible for non-fiduciary consultants to provide honest advice, we must never forget they’re generally compensated by the sale of a product and not your financial well-being. This, by nature, provides a favored bias towards particular investment products by non fiduciary consultants that may not be in the clients best interest.

There is a useful analogy HighTower Advisors came up with to help understand the difference between a fiduciary and a non-fiduciary: “you wouldn’t expect your butcher to give objective dietary advice … If you want advice about what to eat, you go to a dietician, and by analogy when you want financial advice, you go to a fiduciary.”

In the analogy, the butcher is acting as a non-fiduciary by advising you on the best diet. As we might suspect, the butcher would probably include a favored bias towards eating cows – and preferably his cows . However, the dietician, acting as a fiduciary, while advising you to include some meat in your diet, would likely encourage you to consume food from other sources as well. The dietician is compensated based upon the continued health of you – the client – where the butcher is compensated upon the sale of his product.

If ever there is a lesson to learn from the world of socio-economics, it’s that incentives matter. If you are interested in running a smooth business or organization, remember that putting the proper incentives in the right places induce the best outcomes. It’s important that we apply this understanding to the world of financial advisors.

April Newsletter: An Exceptional Quarter and the Monetary Base

Written April 5th, 2012 by Jonathan Ericksen
Tags: 401k tips, BeManaged Newsletter
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Headlines Tout Largest First Quarter Gains in Years!

What Happens Next?

How can we not be excited! The S&P 500 rose 12.6% over the first three months of this year, the best start since 1998. Foreign stocks rode along, with an 11% gain since December 31st.

Over the last 40 years, the record hints that there is more good news ahead. Let us look at what happened in the seven years when first quarter market gains exceeded 10%:

Only in 1987 did the full year returns fall below the returns in the first quarter. Investors were overwhelmingly rewarded by sticking with equities during those years.

Of course, we are concerned with longer term returns for retirement accounts, so here are the five year returns for periods starting with those years:

During six of those seven five year periods, investors enjoyed double digits compound rates of return. A consistent presence in the equity markets would have provided dramatic progress toward a successful financial retirement. Is there something different during last five year period we should pay attention to?

Starting points matter! The average price investors have been willing to pay for earnings historically is $20.52 for every dollar of earnings (20.52x). Notice that the first six periods (all positive return periods) started below that average, while the only negative return period started above the average level.

In fact, with the increases we saw in the first quarter of 2012, the current P/E ratio is over 24x. Only in the 1990s, an era of inflated prices did any of these periods end above this level.

Unless we want to bet that the dot.com era is back, we have to believe the odds are not in the favor of outsized returns over the next few years. Caution remains warranted.

The Monetary Base

To Infinity and Beyond……

The U.S. Federal Reserve, along with several other central banks around the world, has adopted an aggressive monetary expansion policy in recent years to stimulate consumer demand. This is done by adding additional money (cash) to the markets in the hopes of stimulating spending. More money, equals more spending, which equals more demand, which then produces productivity growth, or so the theory goes. The graph below highlights the change in the supply of U.S. dollars for the past decade. Note the magnitude of this growth as it relates to the earlier years of normal economic expansion.

As investors we must understand that more money does not necessarily equal more wealth. There is a significant risk that growth in wealth in the coming years will flounder because of an increase in consumer and commodity prices – better known as inflation. Drastic rises in the money supply has been a precursor to rapid inflation in the past – look no further than the hyper inflation period in Germany post WWI. If inflation outpaces real growth in wages, the U.S. economy has stagnated even though appearing to do well in terms of growth in asset prices. Remember, price and wealth are independent of each other: an increase in prices does not mean an increase in wealth.

Traditionally, ownership of equities and equity funds offer a hedge against inflation, as long as inflation remains within a reasonable range. We know, for example, that inflation rates that exceed 4% often impact the ability of companies to maintain the profit margins necessary to support stock prices. The normal progression from significant increases in the monetary base to significant increases in the cost of living gives us cause for concern.

Investors with longer time horizons have the ability to assume greater exposure to assets of ownership as a hedge against the potential effects of normal levels of inflation. However, true wealth expansion (the increase of your purchasing power) is often not achieved when monetary policy is out of control.

The Pulse of Commerce

The Ceridian Pulse of Commerce Index, provided by the UCLA Anderson School of Management, measures the amount of diesel consumed by the road trucking industry. The index monitors movement of produce, raw materials, and finished goods.

The index posted a .7% increase for the month of February from January. However, the index is showing signs of stress in the economic recovery. The first quarter of 2012 is on track to show a reduction in over-the-road commerce from the fourth quarter of 2011. The index will have to post a gain of 4% in March to equal the fourth quarter volume of commerce.

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Video – Illustrating the Difference – Brokers vs. Fiduciary

Written March 26th, 2012 by Chad Griffeth, AIF
Tags: 401k fiduciary, 401k tips, Fiduciary Adviser
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Over the past few years, I have become a big fan of whiteboard illustrations that simplify concepts which can be challenging to understand. The video below by HighTower Whiteboard Animation does a great job of simplifying the confusion over the difference between brokers and a fiduciary in a nice little analogy.

Can’t view? Click here to view on YouTube

March Newsletter – Earnings Estimates Dropping

Written March 5th, 2012 by Jonathan Ericksen
Tags: 401k tips, BeManaged Newsletter
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February Market Returns

Good news for aggressive investors

Aggressive investors were rewarded in the month of February with the Dow Jones Aggressive benchmark returning 4.63% on investor capital. The S&P 500 index, the broadest and most comprehensive measure of U.S. equities, returned 4.32%. International investors did equally a well with the Morgan Stanley Capital International index returning 5.74% for investors in the month of February.

The Now: Among other things, the apparent resolution to Greece’s debt problem seems to have propped up equities around the world. However, we are skeptical these solutions will yield long term growth in value. It will be many years before the outcome in Europe is truly understood and realized.

The Future: Tensions in the Middle East will continue adding pressure to oil prices. As oil prices rise, so too does the price we pay at the pump. If tensions continue escalating, we may see prices on a national average reaching $5 per gallon of gasoline. These developments may add price volatility in the equity markets for the months ahead.

Earnings Estimates Dropping

Negative momentum ignored by market……so far

Analyst guesstimates of earnings for the first quarter of this year have fallen 10% from the peak estimate made in early July. This decline is largely ignored in today’s financial press, yet trends like this are often an indication of future market direction.

* Source: Howard Silverblatt, Standard and Poor’s (www.marketattributes.standardandpoors.com)

The Apple Effect

Largest U.S. firm may be creating a skewed picture of reality

Apple Inc. – the maker of everyone’s favorite consumer electronic gadgets. If you haven’t noticed, the Cupertino based Apple Inc. is now the largest company in the United States with a total market capitalization hovering around half a trillion dollars. To help put this in perspective, Apple is now larger than Google, Intel and Amazon combined!

As Americans, we celebrate the success of companies like Apple; however, as investors we must be weary of its effect on the market’s overall performance. In a recent article published in the Wall Street Journal, authors Jonathan Cheng and Brendan Intindola highlight the affect Apple is currently having on the major market indexes. For example:

• The S&P 500’s (the U.S.’s 500 largest public companies by market capitalization) earnings are on track to post a year-over-year rise of 6.8% growth in the fourth quarter of 2011. However, factor out Apple, and the year-over-year rise in earnings falls to a meager 2.8%, according to UBS.

• Year-over-year growth in profit margins (the percentage of every dollar a company makes in profit after subtracting expenses and taxes) in the S&P 500 was 0.05% in the fourth quarter of 2011. Remove Apple from the equation, and we’re left with a decline of 0.22%.

Although you might argue that Apple’s success is a positive sign of economic health, after all, the wealth created by Apple is returning to its shareholders. However, it’s important to remember that Apple’s success does not represent a broader market trend. Instead, it represents a company that has been exceptionally successful in an exceptionally difficult environment.

The Current State of Private Investment

Gross private domestic investment provides us with a snapshot of investment spending outside of the government sector. The inflation adjusted peak for this measure occurred in the first quarter of 2006 ($2.26 trillion).

This measure fell to $1.39 trillion in the second quarter of 2009, and has partially recovered to $1.87 trillion in the fourth quarter of 2011. Still, that level is 18% below the 2006 highs.

Private domestic investment represents less than 14% of our total gross domestic product currently; well below the most recent peak (17.2%) reached in 2005 and 2006.

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February Newsletter – Considering Risk When Evaluating Your Investment Options

Written February 13th, 2012 by Chad Griffeth, AIF
Tags: 401k tips, BeManaged Newsletter
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Adding Measures of Risk to Your Fund Evaluation

Picking your funds based solely on performance is a common mistake

Return numbers are the most readily accessible pieces of information available to you as an investor. As a result, it is too easy to make fund choices for your 401(k) based on those returns. The level of risk you assume in your portfolio based on fund choices is critical. Unfortunately that information is much more difficult to find and understand.

Morningstar, Inc. (www.morningstar.com) offers a free resource to find risk information on publicly traded mutual funds. If you navigate to the “Ratings and Risk” tab for a fund you are interested in, you can find measures of fund “volatility”. For example, you can see how a fund performs during periods when markets increase in value (Upside Capture) and when markets decline (Downside Capture).

Let’s look at the Upside/Downside statistics for Baron Growth, currently classified as a mid-cap growth fund. The top section of the snapshot below shows the behavior of Baron Growth’s returns versus the S&P 500. For example, over the last ten years, Baron Growth’s upside measure is 114.61 (the S&P 500 in this example would be 100). So, Baron Growth has tended to outperform the S&P 500 by 14.61% during up markets. Conversely, when the S&P 500 drops, Baron Growth tends to drop less than the market over the ten year period.

The bottom section provides you with the same measures for mid-cap growth funds versus the S&P 500 in general. This gives you a chance to see how other funds with similar investment strategies perform against the S&P 500.

If you find funds that perform better than the markets on the upside (a number above 100 on the top line) and the downside (a number below 100 on the bottom line), the fund may be a good addition to your portfolio “recipe”.

“What incentive does a bank have to buy two-year Treasuries at 20 basis points when they can park overnight reserves with the Fed at 25? What incentives do investment managers or even individual investors have to take price risk with a five-, 10- or 30-year Treasury when there are multiples of downside price risk compared to appreciation? At 75 basis points, a five-year Treasury can only rationally appreciate by two more points, but theoretically can go down by an unlimited amount.” - Bill Gross, PIMCO Investment Outlook, February 2012

My $3.99 Ground Beef is on Sale!!!

Now I only have to pay $5.95………

Buying stocks is no different from buying any other product – you perceive a value to you, then you look at the price tag. If the price seems fair, you buy. If the price is lower than you thought, you might buy a few extra. If the price is too high, you hold off and wait for a better time.

As simple as that sounds, investors often decide to buy no matter the price. Rumors spread of better economic times or solutions to fiscal problems. Maybe the “everybody else is buying” syndrome kicks in – or the desire to find higher returns “somewhere, anywhere” takes over.

Your retirement dollars are too valuable to follow the herd. Long-term returns are generally enhanced when patience is exercised. We are confident that the patience we exercise in client portfolios will ultimately be rewarded.

Treasury May Let Investors Pay to Lend to US

……..and you thought hamburgers were expensive

The U.S. Department of Treasury, according to recent reports, may allow investors the option of bidding for future Treasury issues with a negative yield.

From the minutes of the latest meeting of the Treasury Borrowing Advisory Committee:

“There was a lengthy discussion regarding the bid-to-cover ratios at recent Treasury bill auctions. It was broadly agreed that flooring interest rates at zero, or capping issuance proceeds at par, was prohibiting proper market function. The Committee unanimously recommended that the Treasury Department allow for negative yield auction results as soon as logistically practical. “

What does this all mean? Well, in the near future, you may have the option of giving the US government $10,000, and they will hold it for you for 90 days, and then give you back something less than $10,000.

The goal is to force investors into riskier asset classes in an effort to continue the price inflation we are seeing in most investment categories.

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The Surprising Paradox of Choice in 401k Plans

Written February 1st, 2012 by Jonathan Ericksen
Tags: 401k education, 401k tips
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You may have heard about experimental studies that aim to capture the human experience when provided a large variety of options. Consumers today are often bombarded with a very high number of choices when they enter shopping malls, department stores, restaurants, mobile phone stores, etc. It is likely we have all experienced a certain level of paralysis when forced to choose a wine flavor from a menu containing 37 different wine choices. That overwhelming feeling we get when we are introduced to a vast array of choices can bring about discomfort and is ultimately unfavorable.

There seems to have been an accepted dogma among marketers in the past that a greater variety of choice leads to a better customer experience. When waiters place menus at the dinner table with 22 different entrees as opposed to 6, they might think they are doing you a favor by giving you the chance to choose the “perfect” option among several others. However, it’s becoming increasingly clear that perhaps, as humans, we may be better off with only 6 options as opposed to 22. When faced with 22 different options, we may experience a level of anxiety as we jockey between whether we’re in the mood for the filet mignon or the flank steak as opposed to whether or not we’re in the mood for a steak or instead some pasta -an easier choice, no doubt!

Although some may disagree with this notion that a greater number of choices is not beneficial to the consumer, it appears that on an aggregate level, a greater number of choices does reduce customer and user experience and in this case, participation. An interesting study conducted by Psycho-Economist Sheena Lyengar, along with her team of researchers from the Columbia Business School, suggests that greater consumer choices leads to less participation in retirement savings plans. In the study, Sheena and her team surveyed nearly 1 million Americans participating in 650 different retirement plans with regards to their decisions to save for retirement. What they found was a negative correlation between the participation rate among retirees and the amount of funds being offered. In other words, participation rates among consumers being offered 3 funds was in the mid 70’s percentile, while those plans offering nearly 60 funds saw participation rates drop the 60th percentile.

Sheena and her team found that as more choices are made available to the consumer (and perhaps you could relate to this) three things happen:

Folks procrastinate even when it goes against their best self-interest
They’re more likely to make worse choices (worse medical choices, financial choices, et cetera)
They’re more likely to make choices that leave them less satisfied

It is important we recognize this as not a sign to give up and forgo saving when faced with an overwhelming amount of choices, but instead as a cue to seek professional help from those offering responsible advice. We live in an age where we are routinely subjected to a large number of options. It is important we recognize this as a possible threat to our well-being and make the appropriate steps to improve the outcome. The old adage that knowledge is power can yet again yield some value as your awareness to this situation should help with future decisions. Understanding that it’s natural to feel overwhelmed when choosing the optimal location for retirement funds should encourage you to take an offensive stance and make the appropriate steps to remedy your anxiety.

Click here to view Sheena’s presentation.

A Mountain Climber’s Perspective on Risk

Written January 18th, 2012 by Jonathan Ericksen
Tags: investment recipe, personal finance, retirement
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Imagine you’re a mountaineer about to scale the face of El Capitan in Yosemite National Park. As you hike to the bottom of the face your level of risk to injury is relatively low. You might trip and fall on your hike but any injury is nonetheless negligible. In this situation, your exposure to downside risk is low while your upside potential is high.

As you begin your ascent the amount of downside risk you assume increases with each pull of the hand and push of your leg. As you near the top, you find yourself in a position with an incredible amount of downside risk with limited additional upside potential. Should you slip and fall, risk becomes a reality and you would no doubt be affected by the consequences.

As investors, we all understand that assuming a certain amount of “risk” within our portfolios is largely beneficial in the long run. We understand that increased exposure to risk combines additional volatility in the short run (risk) with greater returns in the long run (reward).

Risk is a fundamental element to our business model. We spend an exceptional amount of time thinking about risk and what implications it has for your assets. We bring this topic of risk up as a means to inform clients regarding our current understanding on the amount of risk in the market place for financial assets and why the level of risk is perceived to be where it is.

Short Term versus Long Term Returns

Stocks behave much differently in the short run then they do in the long run. Stocks in the short run are largely driven by human emotion. Short term reactions to business headlines, market rumors, etc. drive monthly, quarterly, or even yearly returns.

Long term total stock returns are the function of two items, corporate dividends and market price changes. Economic growth leads to increased corporate sales, leading to increased corporate profits and corporate dividends. Market price direction is highly dependent on the height of the mountain and your distance from the peak.

Let’s think about our mountain climber as we look at the graph at the bottom left. For a forty plus year period of time, from 1950 through the end of 1993, our mountains never went higher than the top of the red bar. At levels slightly above $25 for every $1 of corporate earnings, investors reached the peak, and the only way to head was down. After 1993, we decided the mountains should be much higher. At one point, our climber went as high as $50 for every $1 of earnings.

We looked at five year total rates of return for the S&P500. Prior to 1994, less than 2% of those five year returns were negative. From 1994 to the present, negative returns were experienced 33% of the time!

We believe we have returned to the lower (and safer) set of mountains we climbed pre-1994. However, we have climbed near the peak of those mountains, and as a result, we see limited upside potential and significant downside risk as we head into 2012.

BeManaged Year End Newsletter – 2011 Was a Treacherous Ride to Nowhere

Written January 18th, 2012 by Chad Griffeth, AIF
Tags: 401k tips, BeManaged Newsletter
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Conservative Investors Rewarded in 2011
A treacherous ride to nowhere

Pretend for a moment you pulled off your best Rip Van Winkle imitation and slept through 2011. You pick up a “Year in Review” newspaper, and find out:

A number of European countries (Portugal, Italy, Greece, Spain) are close to defaulting on their debt.
The United States ran up another $1+ trillion in debt and lost its’ AAA credit rating.
Over 13 million Americans remain unemployed. Another 8 ½ million are working only part time because they cannot find full time work.

You would have to believe your investments took a beating. Yet, you open up your retirement plan statement and find out things weren’t quite as bad as you expected.

Nobody made a bundle of money last year. If you owned mostly stocks, and mainly foreign stocks, you lost 4% or more. Conversely, if you emphasized bonds and cash in your assets, you managed to eke out a small gain (1% – 2%) – not enough to meet your long term needs, but enough to protect your principal in anticipation of better times ahead.

We were pleased to see that corporate earnings and dividend payments increased significantly last year. Earnings and dividends provide the basis for long term rates of return that can meet your retirement needs.

On the negative side, we went from historically low interest rates at the beginning of the year to ridiculously low levels today. Savers and retirees are unable to find income producing investments without accepting significant risk.

We remain extremely concerned with subpar growth in our nation’s level of output. If our shift to lower growth rates (which began almost a decade ago), is more permanent than we thought, even conservative projections of 5% long term rates of return will be called into question.

We discuss our thoughts for the next year on the following pages. We enter 2012 the same way we entered 2011, with a very cautious outlook.

Investment Professionals Weigh In on Market Outlook

The CFA Institute recently published their 2012 Global Market Sentiment Survey. The report analyzes responses to a November, 2011 survey of over 58,000 CFA Institute members across the globe. Among the findings:

The current global financial crisis has severely impacted market trust and confidence. Almost 80% of U.S. respondents expect this low level of confidence to last at least three more years
52% of survey participants expect the sovereign debt crisis to get worse in 2012
Mis-selling of financial products by advisers is perceived to be the most serious issue facing global markets

Globally, 59% of respondents predict that asset classes other than equities will be the top performers in 2012. The majority of U.S. respondents (56%), however, believe the equity markets will outperform other asset classes.
The full Global Market Sentiment Survey for 2012 can be found at the CFA Institute website (www.cfainstitute.org).

2011 Market Returns Mixed
Foreign stocks suffered significant declines

It was indeed a wild ride for the equity markets in 2011. The S&P 500 ended at almost exactly the same price it began the year – its only return came from the 2.11% dividend paid by S&P 500 companies. Monthly returns ranged from a decline of 7.0% in September (completing five straight months of negative market returns), to an increase of 10.9% in October.

Stock markets worldwide generated negative returns for the first time in three years. Investors who utilize both domestic and foreign stock funds have lost money over the last five years. Fortunately, bond funds have generated 6.5% gains annually since 2006, and cash has helped with a 1.4% compound return.

The average market strategist interviewed by Barron’s at the beginning of 2011 predicted a gain of 11% for the markets last year. Also, they collectively predicted that stocks would outperform bonds, especially U.S. Treasuries.
The 2012 survey predicts a market gain of 11.5%. Two of the ten strategists are predicting flat to down markets, unlike 2011, where almost all predicted gains.

Worldwide Sovereign Debt at Unmanageable Levels
Time to laugh at ourselves…if only it were funny

Other incredible statistics from usdebtclock.org:

Total Federal/State/Local spending has exceeded $7.0 trillion dollars. That represents 46.7% of US Gross Domestic Product.
Total US Debt (households, businesses, governments and financial institutions) has reached $56.5 trillion ($683,522 debt per family).
US Unfunded Liabilities (promises made for Social Security, prescription drugs and Medicare, now exceeds $117 trillion, more than $1 million for each taxpayer.
Hayman Capital Management provides a concise view of the debt situation for the rest of the world :
Total global credit market debt has grown at a compound rate of 11% since 2002. Global real gross domestic product has grown only 4% during that same period.
Total credit market debt is currently 310% of GDP (US Debt to GDP just surpassed 100% for the first time).

According to Hayman, “Throughout history, whenever total credit market debt breached 200% of GDP, it was commonly due to deficit spending fueled by borrowing as nations prepared for and fought wars. To the victor went the spoils (and debt pay-downs) and to the loser went defeat and default.”

We are fixated on worldwide debt levels for one important reason: As more and more resources are pulled from future production and consumption capacity, lower long term potential growth rates are reduced. For example, if we use a standard financial calculation like a dividend discount valuation model , we see the following results:

On January 18th, the World Bank cut its global growth forecast by the most in three years. The world economy will grow 2.5 percent this year, down from a June estimate of 3.6 percent, the Washington-based institution said. The euro area may contract 0.3 percent, compared with a previous estimate of a 1.8 percent gain. The U.S. growth outlook was cut to 2.2 percent from 2.9 percent.
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1. Hayman Capital Management, L.P November 30, 2011 Newsletter
2. The formula for the dividend discount valuation model:
(Dividend Payout)/(Required Rate of Return-(GDP Growth+Inflation))