Money Matters Newsletter:
April 28, 2015
Better Options for Income Investors
The Investment View from Prescott, Arizona
As I state elsewhere in this newsletter, interest rates are going even lower than they have been and getting good income will become a greater and greater challenge for investors. Let’s take a quick look at various income investments and see where the best combination of risk and reward lies.
I will use a hypothetical $500,000 portfolio in these examples.
1. CDs. The majority of CDs are issued for six months, and according to Bankrate.com the average rate across the country for 6 month CDs is .16%, meaning your income would be a whopping $800 per year on your $500,000 savings.
You may be able to shop and find higher rates, as .16% was the nation’s average, but beware of the banks that pay the highest rates as they are often those closest to default and offer higher rates because they really need the money.
You pay a lot for the luxury of FDIC insurance since these low rates are what is left after the bank pays the FDIC. And each year your savings buys a little less as inflation keeps prices creeping higher. Your reward with CDs is not money, but certainty. Your risk is loss of purchasing power after taxes and inflation.
2. Treasury Bonds. Treasuries with a 10 year maturity offer 1.92% annual yields as of this writing on April 24, 2015. This is much better than CD rates, but Treasuries also have market risk. If interest rates were to suddenly go back to their historical norm of 6%, the resale price of Treasuries would drop by about 1/3. Your $500,000 bond could lose $166,000 if sold. That is serious risk from something with a reputation for safety.
Of course you could hold it to maturity and be guaranteed to get your full $500,000 back, but the same inflation that would drive the price down would also drive down the remaining purchasing power over 10 years. Your reward with Treasuries is higher interest than with CDs, but with significant risk of loss of principal if the bond is sold prior to maturity, or in purchasing power.
3. Annuities. Rates offered on annuities are also dropping. Annuity salesmen offer juicy Guaranteed Minimum Income riders of different sorts that obscure the true
earnings power of an annuity. Two things should be kept in mind with regards to these products:
One is that the annual “calculation amount” advertised for the income guarantees, often 6% or so, is not money you can really spend. It is an accounting mechanism only. You usually have to wait a number of years to get income, and when you do your principal usually is eroded because you are spending your own money along with a little interest. This calculated erosion of principal is a real drawback of annuities.
The second concern is that annuity companies competing with highest-rate offers may have miscalculated on how low interest rates would be and how long they would stay that way. If they promise you 6% and can only earn 2% they will lose money. They might be able to continue losing money for a year or even a few years, but how long do you think they can hold out? How lucky do you feel?
Insurance companies have only their own money to fall back on. State guaranty funds for insurance companies have only enough money to pay off a tiny fraction of your investment if defaults become wide spread. The reward with annuities may be higher than CDs or Treasuries, but there is significant default risk with them, too. Just because it has been some years since a rash of insurance company defaults hit doesn’t mean it won’t happen again. The only question is when.
4. Dividend Paying Stocks. For many years stock dividends were much lower than bond interest, but over the past few years more and more companies have been raising their dividends at the same time as bond and CD rates plummeted. Quite a few companies are now paying dividends higher than CDs, Treasuries and Annuities.
The stocks in my Flexible Income* portfolios are currently producing 6.11% annual income. Considering that both stock dividends and principal values can grow over time, right now, stocks clearly give the best income and the best protection from inflation.
Stocks do have market risk, although dividend paying stocks tend to be less volatile than growth stocks. What has really changed in the risk equation over the past few years is that bonds now carry market risk roughly equal to dividend paying stocks, but those stocks pay dividends at 2 or 3 times the interest rate on 10 Year Treasury bonds. And with me managing the risk for you, this becomes a great risk/reward tradeoff.
And with stocks you have instant access to your principal, unlike Annuities with their crippling exit fees. Since the only thing that is certain with investments is that things can change, this liquidity is a very valuable commodity that allows your portfolio to Adapt to Changing Markets®.
Juggling Days
These days you may find any one of three different ladies running the front office at HCM. Operations Manager, Yvette Romero Zurita, backs us up on the phones from her office in Fresno, but the faces you see here in the Prescott office are those of Sheri Congdon, Mary O’Neill and Laurel Fitzhugh.
Sheri has been with Hepburn Capital for 11 years, and if you think Sheri’s is a professional voice when you hear her on the phone, you are absolutely right. Sheri was a Ford Agency model and did professional voiceovers in her work there.
I often tell Sheri she should write a book because her adventures have been so many and so varied: a flight attendant in the early days when air travel was still special, her continuing friendship with Jazz legend Herbie Hancock, running an architectural firm and many, many other chapters.
Sheri produced this newsletter and helps keep us organized. Sheri is so organized in fact, she runs a side business helping folks like yourself organizing paperwork, offices and homes. Call her if you need that kind of help.
And thank you Sheri for making my life easier.
A Slice of Life
Growing up on da Sout’ Side of Chicago I have a special spot in my heart for good Chicago style hot dogs, Italian Sausage and Italian Beef sandwiches. Last week I had business in Phoenix and stumbled across a hot dog place straight out of the 1950’s, called Dazzo’s Dog House, at 62nd Ave and Glendale just west of Grand Avenue.
If you like Vienna all beef hot dogs with poppy seed buns and celery salt topping, or Italian Sausage with just the right seasoning, Dazzo’s is worth going out of your way for.
Go Cubs!
How Are The Markets Doing?
Coming to a Bank Near You, Soon!
The big news last week was the Nasdaq stock index finally breaking out to new price highs. Sounds good, right? But most news reports overlook the fact that the price point that was exceeded occurred 15 years ago. That means it took 15 years for some buy and hold investors to just break even!
The stock market rally that has been with us for several years is still underway, but there are signs that it is running out of gas. Economic news is glum. New home sales are down, joblessness is higher than expected and manufacturing is slowing down, not picking up. Those are troubling signs of weakness.
The poor price action of the Dow Jones Transportation Index further underscores the idea that the economy is weakening.
Transportation stocks, trucking, shipping, railroads and airlines carry raw materials to factories and finished goods to market. When transports aren’t doing as much business it suggests that manufacturers and retailers are doing less business, too. When transports aren’t doing well, despite big savings on fuel costs, something is wrong.
The market may be playing its old game of “bad news is good news,” with the idea being that a weak economy will keep the Federal Reserve from raising interest rates.
Strong business activity creates greater demand for loans driving up the price of money being loaned, with interest rates being the price of money. Low interest rates are another sign of weak economies.
Interest rates went negative in Europe earlier this year. Negative interest rates occur when you loan $1.00 knowing you get back only $.99 and are guaranteed to lose a percent or so, but that is OK with you because the borrower guarantees you’ll get the other 99% of your money back at maturity. In other words, you’d rather take your chances with the borrower (often a government that can print money) more than you would the economy. This scenario is just about the worst indictment of a business climate as you will ever see, and it is coming to a bank near you soon.
On April 23rd Bloomberg reported that JP Morgan Chase recently sent a letter to some of its large depositors telling them that rates were going negative. Beginning May 1st it will charge certain large customers a “balance sheet utilization fee” of 1 percent per year on deposits. That amounts to a negative interest rate on deposits.
Think about how weird this is. No one wants money. You have to pay them to take it!
We don’t have inflation at the moment. The latest Consumer Price Index shows that inflation has been negative for the 12 months ending March 2015, coming in at -.1%. That is called deflation.
Money becoming worth less and less is a hallmark of inflation. Yet now we have scenarios where you have to pay someone to take your money from you but we don’t have inflation in the normal sense. This is sure a crazy world.
What should we expect from the markets due to this conundrum? No one knows for sure, but this sure seems that we are approaching some sort of tipping point in the economy and the markets. Something’s got to give! As usual, with my daily market scans I stand ready to see these changes as they begin to actually affect the investment markets, and then Adapt to Changing Markets® by changing the strategies to fit the circumstance.
What’s Going On In Your Portfolio?
I have made some adjustments to both our Flexible Income* and Shock Absorber Growth* portfolios this past month.
The oil markets have stabilized after the price of oil dropped by over half from July to January of this year. Oil has a history of sharp drops that bottom out after about six months, so I think most of the risk in oil is over. I have added stocks of high dividend energy companies to both portfolios since I expect some growth from here, as well as income.
Real estate stocks that powered us to strong gains in the 4th quarter of 2014 have lost their momentum this year. Two were sold out of the income portfolios this month while they still showed gains. Two other real estate stocks experienced declines in February but have since stabilized. I am trying to be patient with them since they both pay good dividends while we wait.
I added an Emerging Markets Bond* fund to the income portfolios this month, another high dividend producer.
Infosys, a leader in our Future Technologies* portfolio had lost its upward momentum, and finally had a significant price breakdown on Friday, so it has been sold.
I added gold to the growth portfolio because it appeared to be starting a recovery. It is a situation where it could decline 5% before I would exit, but if the recovery is genuine the potential gain could be ten times that much. That is a good risk/reward trade off.
Our shock absorber hedge is used to manage the higher market risk in the Shock Absorber Growth* portfolios, especially the go-go Future Tech* stocks. I entered April with a very small hedge as the market’s momentum was up with no reason to ride the brakes. Two weeks ago, as the stock markets approached points from which they had turned south from a couple of times already this year, I increased the hedge to a more normal amount.
Despite the headlines of “New Highs” for the stock markets, the S&P 500 Index** has made very little gain over the past two months. It is called “resistance” when a market has trouble breaking through old price highs. Until we are through this area of resistance, I’m going to keep our Shock Absorbers in place.
And Barron’s had a Bear on its cover last Saturday. Hmm…
College Classes Coming In June
My Yavapai College Class, Fundamentals of Investing for Retirement will begin on Wednesday June 10th, running from 3:00-5:00 p.m., for 3 weeks
This class has been the most popular investing class at YC, running for 25 years straight. I try to keep the classes lively, and the most fun has been when friends wanting to learn brought other friends and the social level is high. If you know someone who has complained about their finances or who has financial decisions to make, suggest this class to them. Telling your friends about me is one of the nicest things you can do.
Mark your calendars, and call 717-7755 to register for course # SU15-118. Tuition is $65.
Scottsdale Office
If it is more convenient to meet with Will in Scottsdale, please call the office to schedule your appointment.
928-778-4000
Our Spotlight Strategy
With ourFlexible Income Srategy we strive to provide high total return consistent with Capital Preservation.
Your money will be invested in bond mutual funds and exchange traded funds (ETFs), including inverse and leveraged funds, currency funds, including precious metals that may be used as currencies and equity-income investments whose price trend is up. If the price cycles down, holdings are replaced with new investments that are going up, repeating as needed. Growth stocks are not used.
Mental Floss
To sharpen scissors, simply cut through sandpaper.
Electronic Delivery Snag Identified
For several months we have been wrestling with the question of why clients who signed up for electronic delivery of proxies and investment reports kept getting them in hard copy form, with some of you getting two copies of each. We finally figured it out a week or so ago.
The vendor who sends these notices out was still receiving National Financial account numbers even though we stopped using NFS as a custodian last year. Your requests on Trust Company of America’s site were being honored, but the National Financial list kept generating paper.
Now that we have identified the problem, it should clear up. However, companies sending out annual reports and proxies begin planning way ahead of time for the printing and mailing, so it is possible it will take a month or so for the tide of paper to completely recede.
I appreciate your patience while we tracked down this problem.
Now I have to go apologize to some trees!
If you would like a current copy of our Privacy Policy or our SEC Form ADV, Part 2, you can find them at our website at www.hepburncapital.com/images/PrivacyPolicy.pdf or www.hepburncapital.com/PR/form-adv.pdf respectively.
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Performance and activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** Indexes are unmanaged lists of stocks considered representative of a broad stock market segment. Investors cannot invest directly in an Index.
Flexible Income
Adaptive Balance
Adaptive Growth
Shock Absorber Growth
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.
In all investing, past performance cannot assure future results, and as such, our efforts are not guaranteed. Losses can occur. All strategies offered by Hepburn Capital Management, LLC adapt to changes in the markets by changing the investments they hold, therefore, comparisons to broad stock market indexes such as the unmanaged indexes mentioned may not be appropriate. Sometimes client accounts are invested in stocks or markets not included in these indexes. Past performance does not guarantee future results. Investment return and principal value will vary so that when redeemed, an investor’s account values may be worth more or less than when purchased. Mutual fund shares and other investments used in our managed accounts are not insured by the FDIC or any other agency, are not obligations of or guaranteed by any financial institution and involve investment risk, including possible loss of principal. Advisory services offered through Hepburn Capital Management, LLC, an Arizona Registered Investment Advisor. Adviser will not transact business unless properly registered and licensed in the potential client’s state of residence.
Copyright (C) 2015 William T. Hepburn. All rights reserved.
