Thoughts from the Lighthouse - Lighthouse Financial Planning, LLC

Thoughts from the Lighthouse (Aug. 2014)
An assessment of long term market valuation – The CAPE Index
(An informational note – no action required for Lighthouse Financial Clients.)
Lighthouse Financial does not believe that it is possible to predict future market
performance.
We believe that the best estimate of the value of a security (stock) is the current market
price. The father of this efficient market philosophy, Eugene Fama, was awarded the Nobel
Prize in Economics last fall.
This does not mean that there are not bubbles (over reactions
on the up side) in the market or over reactions on the downside. It simply means that we
cannot predict such events in any meaningful or actionable way.
Yet good minds continue to try to predict longer term valuations. One leader in this
arena, Robert Shiller shared the Nobel Prize in Economics with Eugene Fama last fall (along
with a third economist).
Shiller developed the CAPE index. CAPE tracks the current S&P (Standard and Poor’s
index of the 500 largest US companies by market capitalization (value)) and divides it by an
inflation adjusted average of ten years’ worth of earnings.
The CAPE is now hovering around
a value of about 25. The long term average is around 15 to 16. When the CAPE index is at
this level, returns over the next decade tend to be below average. However, its usefulness in
predicting short term changes in market valuations is poor and questioned by many good
academics.
What does all of this mean for Lighthouse Financial and its clients? Because of the
non-actionable nature of the above findings, we do not attempt to adjust our client’s
portfolios in response to changes in CAPE valuations. We leave such efforts to market timers
and tactical investors who believe that they can outguess the market’s response to event or
known information.
This, however, does not mean that we ignore the work of Shiller. One
reason we have a mantra of “no money in the market that you will need in the next five
plus/minus years” is because of the volatility of the markets and the work of Shiller and
others. For our retired or near retirement clients we are sensitive to the impact of market
performance, especially declines on their portfolio longevity – particularly in the early years of
retirement.
It is for this reason that we encourage our clients to work with us to monitor the
impact of early withdrawals from their portfolio and make needed adjustments as appear
necessary. We also design all of our clients’ portfolios to incorporate a diverse group of asset
classes (going well beyond the US large capitalization class). Theory says it is the structure
and diversity of the overall portfolio that is the primary determinant of future returns.
If you would like to discuss this subject further, including its impact on your specific
portfolio structure or retirement plans, please feel free to contact us.
An Advisor’s Value Added
(An informational marketing piece – no action required)
Lighthouse Financial believes that we add significant value for our clients. A value that
well exceeds our fees. We were therefore intrigued to see a report by Vanguard “ Putting a
value on your value: Quantifying Vanguard Advisor’s Alpha ”.
Vanguard estimates that Advisors can add about 3% for the ‘average’ client’s investment
experience by implementing their Advisor’s Alpha framework!
Vanguard attribute this to contributions from seven best practice areas in wealth
management – areas in which Lighthouse believes that it also adds value:
1.
2.
3.
4.
5.
6.
7.
Suitable asset allocation using broadly diversified funds/ETFs
Cost-effective implementation (expense ratios)
Rebalancing
Behavioral coaching
Asset location
Spending strategy (withdrawal order)
Total-return versus income investing
Now for some caveats. Vanguard’s results apply to their analyzed service framework. Results
will not be uniform over time – often being greatest in times of uncertainty and high
volatility. They are not all applicable to all investors, e.g., you might already be using costeffective (low expense) funds. Their estimated benefits have wide ranges. Results will not
show up as a line item on your statement – you will always be able to find a fund that did
better over any given time period. All investments involve risk of loss and there is no
guarantee that you will realize your goals using this or any other approach. And finally, as all
of our clients should know – If you cannot stay the course with our recommendations, you
may change at the worst possible time, make the worst possible changes, and negate much
of the benefits we will have worked so hard to achieve.
And now to add a brief marketing pitch. Astute readers will note that the seven practices
listed above do not include the broad range of financial planning services that we offer and
stress with our clients. We believe that your choice to rely on the Lighthouse to help guide
you in the financial arena offers significant additional value in a number of arenas. While the
value of being able to sleep better at night or knowing that you have a solid, objective
lighthouse to guide you through the storms that life throws at you cannot be quantified, we
believe they are significant. Further, for those of you allowing us to take advantage for you
of the fund offerings by Dimensional Fund advisors, we believe that you are gaining
additional long term expected benefits when you utilize or investment management services.
We have Vanguard’s permission to provide you with electronic or hard copies of their report
– let us know if you would like a copy. We would also be happy to discuss this with you in
more detail – just ask.
Eye on the news: “Brokers lure federal retirees from low-fee plan” (see:
Washington Post, page G3, Sunday, August 17, 2014)
(An important discussion for those with TSP accounts – call if you would like to discuss
further)
The theme of this article can be summed up by one of its quotes – John Turner is quoted as
saying: “It’s a scandal. They are trying to sell me an IRA clearly not in my interest. It’s in
their interest”. The article drove home its point by noting that most options offered to
retirees moving their Thrift Savings Plan (TSP) accounts to IRA’s were sold much higher fee
funds or in some cases inappropriate investments such as gold funds.
This article hit home because it is a subject that Lighthouse Financial has wrestled with. The
Federal TSP is clearly one of the best defined benefit (401(k)) types of plans offered in the
public or private sector both because of its fund offerings and its extraordinarily low
fees. The TSP fund fees cannot be matched in the private mutual fund/ETF market. The “G”
fund is not available or beatable on a risk/return basis in the private market. The TSP offers
some online educational material for its participants. As a plan subject to ERISA it offers a
high level of asset protection to its participants.
Yet, Lighthouse Financial, with its
commitment to always put its clients’ interests first, now generally recommends that its
investment management clients move their TSP to an IRA.
Lighthouse Financial’s recommendation to our clients to move their funds is driven primarily
by our belief that we can develop for our clients a portfolio structure whose expected
performance justify the extra costs and risks involved. This is because the TSP does not
include the diversity and type of funds that we would like to have our clients invested
in. This reality was acknowledged by a TSP official in the article who noted that “to fight
against defections, Thrift Savings officials are considering adding more investment options”.
To avoid having a financial incentive to encourage our clients to shift funds out of their TSP
accounts, Lighthouse Financial has developed a fee structure that treats captive assets, such
as those in the TSP, the same as assets that we can manage at TD Ameritrade. We seek to
make sure that our clients understand the lower asset protection levels offered by an
IRA. Our approach is also partly driven by constraints on withdrawal approaches imposed by
the TSP -- This and difficulties in rebalancing across the TSP and outside funds has led us to
drop an option of trying to just retain some funds in the TSP’s “G” fund.
We recognize
that our clients must pay our financial planning and or investment management fees on top
of individual fund fees for the investments we recommend, but believe this is justified based
on our overall value added (see above article). And as noted at the beginning of this
paragraph, we have tried to reduce any potential conflicts that might exist in our
recommendation in this arena.
We would be remiss if we did not include some caveats. First, our general recommendation
to our clients should not be interpreted as a general rebuttal to the Washington Post article –
unfortunately many of the pitches to Federal retirees to move their funds out of the TSP are
not in the retirees’ best interests and on the surface it appears that some do not even meet
the loser ‘suitability’ standard that brokers are subject too. Caveat Emptor! And finally any
investments involve risk of loss.
Please call or email Lighthouse Financial ([email protected]) if you would like to
discuss this subject further.
NOTES
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2. All investments involve risk of loss. The above articles are not meant as investment
or tax advice. We cannot guarantee the accuracy of the information provided as much
of it was drawn from other sources.