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 1. If you would prefer to opt out of these communications, please reply with the word “cancel” in the title of the email and we will take you off of our distribution list for newsletters. 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.
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