July 15, 2008
As I write to you this week, I am sitting on the front deck of our cabin on the shore of beautiful Lake Minnewaska, in Glenwood Minnesota, where I will be attending a wedding in a few hours. Peter’s Resort, where we are staying, is a throwback to the 1920s, and 1950’s when most of it was built. Faithfully maintained, its old cabins and rustic lodge bring back memories of childhood summers in the Northwoods of Wisconsin.
Have I written recently about how much I like technology? It allows a workaholic like me to relax and fight off under-achievement complexes at the same time. In a few minutes, I’ll press the “send” button and my work will travel to my office in Prescott, then Fairfield, Iowa for compliance review and back to Prescott for publishing on Tuesday.
Life is Good!!
Rough Times in The Market, Just Not For Us
The past few weeks have been among the roughest in recent memory for stock market investors. Not us, however.
The mortgage mess just keeps getting worse and worse for the banks, insurance companies and brokerage houses. The whole thing is weighing the stock market down, like a swimmer trying to carry a rock across the pond. A few strokes back to the surface, and back under again.
My list of 140+ market indicators that I review weekly is as negative as it can get, and has been for a month.
Many sentiment indicators are reporting record levels of bearishness. Everyone is expecting the worst. And when everyone expects something to happen in the markets, normally something else happens. Which makes me think that the worst is over – temporarily at least.
I’ve often stated that this is a crazy business. When sentiment indicators – polls of investors, investment newsletter writers, and investment managers indicate extreme bearishness, what that really means is that those folks have decided things are so bad they are out of the market. If an investor really thinks things are bad, they sell. This means they are no longer potential sellers, but have become potential buyers.
I like investing when potential buyers outweigh potential sellers. I like it a lot.
So as bad as things have been for investors recently, they are about to get very good for those with the foresight to get back in when the worst is over. I don’t know how long the uptrend I foresee will last, perhaps only weeks or months like the last one did, but I think it will be a very tradable rally.
Remember, the markets never go in a straight line for very long. They zig and zag. We have had a couple of months of down, now it’s time to zig our way back up for a while.
I still don’t think the stock market problems are completely over, and lower lows will be coming in the next year or two, but we have a well earned rest coming up.
Account updates
Fortunately Hepburn Capital clients have missed most of the recent problems.
Our growth models1 were net short for several weeks, making money as the market went down. A week or so ago, I thought the downtrend was over, and closed out our short holdings and moved to 100% money market funds. I had planned on waiting for an uptrend to establish itself and I’d move back into the markets as I did in March and April.
Man did I get fooled. Things turned back down and it was another ugly week for stock market investors. But not for us. Being 100% in cash at times like this is very comforting. We are making money slowly, and the purchasing power of our cash is growing steadily in terms of shares of stock or stock funds it will buy.
In golf we call that a good miss. A duffed shot that rolls up onto the green anyway.
Right now our growth models1 are in capital preservation mode.
Our Flexible-Income models1 are still marking time. Up slightly for the year, we are partially invested in a fund that goes up as the junk bond market goes down, and in a Mexican Peso fund that pays 5.75% while we hold it. If it goes up in value, that is even better. If it goes down more than a little, we will be out of there and looking for the next opportunity.
Target Date Funds: Useful Tool or Sales Gimmick?
Index funds gained popularity not because they were really that good, but because they were then in sync with the stock market’s major trend and looked good for a few years – until the S&P 5002 Index, the biggest one, lost almost half of its value from 2000-02.
The darling of the industry today is Target Date Funds. They are supposed to make saving for retirement easy by offering a pre-mixed portfolio of other mutual funds that get more conservative as the years pass. All an investor has to do is select a target retirement date and voila`! An instant retirement portfolio is created for you. One investment covers it all for you. Sound familiar?
No more need to visit that pesky broker. No need to hire a real money manager. And best of all, no more decisions to make. Nirvana for the average investor!
But do Target Date Funds work? And at what cost? As you may remember from Investing 101, bond prices fall as interest rates rise and vice-versa. And regular readers of this newsletter may remember that I have shown several times how inflation pressures are mounting. Inflation pushes interest rates up. So, if we are in a rising interest rate market, that spells trouble for bond funds.
As a professional money manager, I have to tell you that I think it is absolutely insane to blindly move investors into more bond funds as interest rates are creeping up. But this is exactly what Target Date Funds do, unthinkingly move investors to more and more bonds as time goes on.
Strategically this is a big, big flaw in Target Date Funds.
Target date funds are mutual funds that often invest in other mutual funds. A fund family will always use their own funds in the underlying mix they provide. Not the best funds in the category, their own funds. A little incestuous? I think so.
And how about fees? The Target date fund brings its own set of fees on top of the underlying fund fees. The average Target Date Fund includes a net expense of 1.23% (Source Morningstar, 3/31/2008). That is in addition to the expense of the underlying funds.
In my college class, I advise students to not focus on individual fees or what they are called because all that mumbo jumbo can drive you crazy. Sadly, hiding fees in the mutual fund and in insurance industries has become an art form. The great equalizer is to look at what effect the fees have on the bottom line. That is what you should watch.
If a firm really does a great job investing for you and delivers better returns after all expenses, why worry about what the expenses were. You made more money. Focus on the bottom line.
So how have Target Date Funds done? For supposedly “diversified” portfolios, pretty darned close to the S&P 500 Index.2
| Target Date | 1 mo | YTD | 1 yr | 3 yr | 5 yr |
| 2015-2029 | -6.55% | -9.26% | -10.28% | 4.39% | 6.47% |
| 2030+ | -8.21% | -11.70% | -13.66% | 4.79% | 7.65% |
| S&P 5002 | -8.15% | -13.07% | -15.49% | 3.85% | 7.05% |
It is striking how many Target Date Funds merely track the performance of the S&P 5002 which is not what most investors expect of them. Why the disappointing performance?
In my opinion they are ignoring the first rule of investing. And the rule is that there is a time to be invested and a time to be out of the market. Unthinking, formulaic investing will always stub its toe by not asking this question.
Some companies are adding conservative, moderate and aggressive versions of their Target Date Funds. But the flaw still exists. They are formula driven computer programs. There is no one to ask, “Is this a good time be invested? Or should I be in the safety of a money market fund instead?”
I guess that is why I am in this business. Because, that is the question I always start with.
Social Security: When to Wait
A frequent question I get when doing retirement planning with clients is, “should I take my Social Security at age 62 or wait?”
Everyone is tempted to take the money at the earliest opportunity. After all one bird in the hand is worth two in the bush. No one wants to be cheated by death, especially where money is concerned.
It is true that social security payments go up the longer you wait to take them. Last year one of my articles mentioned that you get the equivalent of earning 7% annual rate of return by waiting. Not bad considering the prospects in the stock market right now.
But what does that mean in terms of dollars per year? Here is a look at how the cumulative value of Social Security benefits changes depending upon when you start collecting them and how long you live.
There are many factors to consider when making the decision to take the money at the earliest opportunity or wait. Women live longer than men, so waiting often makes more sense for women.
Because a surviving spouse’s benefits can increase at the time of the other spouse’s death, the strategies can be complex.
A strategy that makes sense for many married couples is for the biggest breadwinner to delay taking benefits for as long as possible and for the smaller breadwinner to sign up at age 62. Results can vary depending upon age and earnings differences, but this example gives you a good place to start planning.
The More Things Change . . .
In my newsletter a few months back, I re-printed a hand-wringing article which read like it was written yesterday. As it turned out it was from Harper’s Weekly Magazine in 1857.
Recently, US News had an article about classic political lines. It seems they don’t change much either. The more recent ones you’d remember, but how about these classics:
“If I were two faced, would I be wearing this one?”
Abraham Lincoln, in 1858 to his debate opponent, Stephen Douglas.
“No man will ever bring out of the presidency the reputation which carries him into it.”
Thomas Jefferson, in a 1796 letter to Edward Rutledge, a member of the Electoral College.
The more things change . . .
1. The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. 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.
2. The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
Information in this newsletter is 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.
