Stock Market at a 4-year High… Again…

23 08 2012

While it has been an unusually long pause between market updates this time, I can assure you that we were not asleep at the wheel. In this instance, no news was good news, as the stock market has maintained its generally upward trend for the past several months with only moderate volatility for us to endure.

As of this writing, the United States stock market is approaching the high of 13279 on the DOW and 1419 on the S&P500 that it had previously reached on May 1st of this year, before the 10% correction that we went through during June and July. Since then, we have had generally uninteresting economic news on the domestic front, no real political unrest that has given us pause, and the Europeans continue to struggle through massive debt issues and one of the worst recessions that region of the world has had to face in several decades.

It can be easy to fall into the trap of thinking that “something good” must actually happen for the stock markets to go up. This is actually not the case. Given the fact that bond markets have gone up continually over the last several years, the current prices of bonds are so high, that most investors have begun to realize that future returns of the bond market are likely to be disappointing. We are beginning to see a shift of capital from what is historically an asset of moderate risk and return (bonds) to an asset class that historically has been riskier – but is currently acknowledged to be undervalued (stocks – especially blue chips).

As a result – nothing spectacular is happening in the economy to move us measurably forward, but as money shifts from bonds to stocks (or from sideline cash to stocks) – the price of stocks will tend to move up simply as a result of supply and demand. In other words – beause more and more investors are dissatisfied with the expected returns from bonds in the forseeable future – stocks seem like a more attractive alternative, especially for long-term investors. The current owners of the stocks must be convinced to sell them – and this “convincing” is done by investors paying higher and higher prices for the stocks over time.

Approaching a new or previous high is not without danger, however. Those who have invested for a while also understand that when the market approaches a previous high mark, it may fail to break through – almost as if an invisible lid has been placed upon the market itself. Sometimes, even in bull markets, the market must pull back and “take a new run” at the “lid” to break through. Currently the market does not have a great deal of momentum; while investors are buying stocks, they are not doing so with enough gusto or wild abandon for us to be convinced that a breakthrough will occur. So… a potential correction may be in store for us.

As we have mentioned before, we are of the belief that the stock market will likely remain in a “trading range” for several years – with a slight slant to the upside (just enough to make investing worthwhile, I suspect) but not a roaring bull market that we enjoyed after the last recession. Instead, we are likely to enjoy several months of upmarkets, followed by several months of downmarkets… squeaking out 7 to 8% returns on an annualized basis, and paying for it with a good bit of volatility and lack of market direction. Dividends will likely play a significant role in creating portfolio growth. We have adjusted portfolios to try to maximize investor returns (within risk tolerance) for this scenario, and continue to admonish patience.

Most experts believe that we are unlikely to see any real economic or fiscal news between now and the election. While it is possible that world events may cause unrest, or that some good news may come out of Europe that bolsters markets for a while, in general it seems that most institutional investors are in a “wait and see” mood. Market movements, however, can give some insight into likely election results. A strong stock market during an election year has historically increased Presidential approval ratings and would likely increase the chance of the current President being reelected. If, on the other hand, the market should falter between now and November, incumbent approval ratings are likely to decline, thus increasing the odds of the Romney/Ryan ticket being successful on election day.

Jon Castle

This blog is for informational purposes only.  This is neither an offer to purchase nor sell any securities.  All investing involves the potential of loss – including invested principal.  Indices quoted are general barometers of security price movement.  You cannot invest directly in an index.  All information is obtained from sources deemed reliable but not guaranteed.  Past performance is not a guarantee of future performance.  No tax or legal advice is given nor intended.

Investment advisory services provided by Paragon Wealth Strategies, LLC, a registered investment advisor.

10245 Centurion Pkwy. N. Ste 105, Jacksonville FL 32256   (904) 861-0093  Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements


The Market feels a bit… “Toppy.”

5 03 2012

Jonathan N. Castle, CFP®, ChFC®

Where does the time go?  It is already nearly the end of February and it seems like 2012 is speeding along faster than last year!  So far this year, the financial markets have been reasonably good to all of us, with the S&P 500 up about 8.5%, the Dow up 6.6%, and the NASDAQ up an eye-popping 13.9% as of this writing.

The Dow Jones Industrial Index has broken through the psychological barrier of 13,000 – the highest it has been since March of 2008 a few times now.  In fact, the markets have been remarkably – almost eerily – calm for the last 3 months, quietly marching upward, shrugging off the occasional bad news (such as the Greek bailout nearly unwinding last week and the ever increasing tension over oil in the mideast) with little more than an occasional flinch. 

As we have said for the past 8 months, we remain cautiously optimistic.  “Moderately Bullish” is a term that I have used in the past.  Based upon historical behavior of Secular Bear Markets, we expect that over the next 3 years or so, we will see substantial ups (and downs) in the markets with a slight overall uptrend.  

As it pertains to the current rally, we believe this leg of the rally is probably due for a drawback of some kind.  The next chart shows our reasoning for this.  When the market approaches a point where it had difficulty breaking through previously (such as the Dow’s 13,000 level), this is known as “resistance.”  Typically, as a market index approaches a resistance level, it generally will pause, draw back, and then, IF the level is to be broken, will punch through that level to achieve new highs.  Similar to a person drawing back before breaking through a door, the market will generally draw back before “breaking out” to a new level.  As we are at that resistance level now, a drawback would be a natural – even necessary – part of a normal market rally. 

Despite the recent market rally, we do not feel it is time to break out any party hats on a new sustained bull market just yet.  There are a number of reasons to remain cautious about the markets:

  • According to the Investment Company Institute – the total inflows (new money) going into equity (stock) mutual funds from February 1st through February 15th was a little over 4.6 Billion Dollars.  While this seems like a lot, compared to the inflows to bond funds, which netted 15.2 Billion – it was just a trickle.  Clearly, investors are not ready to assume lots of stock market risk just yet, and the recent rally did not have the market breadth that would indicate the start of a new bull market.
  • The price of oil is going up.  Part of the reason is that US refineries shut down every May to retool to EPA requirements, so oil nearly always rises during this part of the year.  However – increased tensions in the mideast are also driving oil prices higher.  Higher oil prices mean slower economic growth.  As businesses must pay more for energy, they spend less on payrolls and other things which drive growth.
  • Europe’s financial situation is still quite a mess.  While it seems that the European Union is working feverishly to keep from imploding – and they may well succeed – the fact is that Europe is already mired in what appears to be a deep recession.  This will have a global impact, slowing growth in emerging markets as well as within the United States.
  • Our National Debt is a significant problem – and only getting worse.
  • We are in an election year, so significant economic policy will likely not be passed until next year.  Given the uncertain outcome of the 2012 elections, it is anyone’s guess as to whether any new policies will be helpful or harmful.
  • The Bush tax cuts are set to expire this year.  This expectation is curbing business spending.
  • And the list goes on… given the recency of the 2008 market crash, investors are not yet hungry enough for returns to take additional risks and dive head first into the markets. 

However – there are numerous reasons to be bullish as well.  Institutional investors are slowly beginning to see the opportunity in stocks – and have publicly stated their plans to acquire more stocks in their portfolios over the next several years in preparation for a future bull market.  Some reasons to own stocks – and to expect the market will go up are: 

  • Stock valuations are more attractive than they have been in decades.  Based upon the price of stocks compared to company earnings, stocks are cheap.  In the past, investors who loaded up on stocks at current valuation levels were handsomely rewarded over the next 10 years.  Institutions know this – and their demand for stocks during this period may well keep the market afloat.
  • We are seeing a new “flurry” of IPO’s (Initial Public Offerings).  New companies – such as Facebook – offering publicly traded stock for the first time.  Historically, when there are a lot of IPO’s, the market does well.
  • We are seeing a significant increase in companies buying back their own stock.  Not only does this activity boost the stock market – but it is also an indication of what company insiders think of the future prospects of their companies.  Who would spend good money to buy their own company stock – unless they believed the company woud do well?
  • Corporations are hoarding more cash than ever.  While initially this might seem a bad sign – it is a an indicator of the huge potential that exists.  Eventually, this cash will be deployed.  When it is – there is enough of it to have an enormous impact upon virtually all parts of the economy.
  • Currently, the dividend yield on the Dow Jones is a very attractive 3.07%.  So, hypothetically if the market only goes up 5%, an investor who owned the Dow Jones would reap over 8% in total return.  It is only a matter of time before return-starved pension funds, institutions, and corporations currently investing in Treasuries earning less than 3% begin to move money to other assets to seek greater returns.  When this begins, the market has the potential to move up very quickly.

This balance between bullish and bearish factors is a normal part of the recovery process, but makes for a challenging investment environment. In summary, we remain cautiously bullish, with an expectation for occasional market corrections which may exceed 20% or more.  Likely, it will feel like taking three steps forward, only to take two steps back.  However, we feel that reasonable gains are available with the correct strategy.  The most successful investors that we have worked with have carefully chosen their risk tolerance, and then invested in portfolios scientifically designed around that risk tolerance – and remained focused on the long term.  

This blog post is not personal investment, financial, or tax advice.  Please consult your financial professional for personal, specific information.  Indexes mentioned are a general barometer of the stock or bond market they represent.  You cannot invest directly in an index.  Past performance is no guarantee of future results.   

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services offered by Paragon Wealth Strategies LLC, a registered investment adviser. 

Should I Still Invest in a Crappy Economy?

20 09 2011

By Jon Castle, CFP®, ChFC®

It does not seem to matter who the potential investor is – whether they are already retired, are nearing retirement, or are a younger person with quite a bit of time until retirement… the question is often the same.  With interest rates being so low… with the markets unpredictible and volatile – what should I do?  The questions aren’t even really so straight forward as, “why should I invest my money now,” or “should I pay off debt first,” or even any of the other questions that, as a financial advisor for more than 15 years now, I’m used to getting.  The questions I am hearing now seem to have taken on the tone of confusion, despair, and a lack of direction, versus the questions I used to get such as “how should I invest,” or”what type of account – a Roth or a traditional IRA – should I have?”

Yesterday, when talking to a rather successful, nearly retired client on the telephone, she mentioned that she feels that she always has to take two steps backward for every three steps forward, and ideally, she would rather not see her account fluctuate at all once she retires next year.  “Isn’t there just something we can do with our money to earn a steady 6-8% or so with no risk?”  Unfortunately, the answer is NO.  While there might be many product salesmen out there who will try to convince you otherwise – the answer is still NO.   If there were -then all the institutions and large organizations in the world, who spend millions and millions of dollars trying to find or design such assets would have already found them.  A classic example of people and institutions trying to get outsized returns with no perceived risk is the recent mortgage debacle, and we saw how that turned out.

So – back to the original question – With the Economy on shaky footing (to say the least) and with the markets being… unusually volatile, to put it lightly – what should I do?

To answer this question, I had to turn to the history books, tenured academic research, and even some new research – but I think I found the answer.  Do EXACTLY what you have been told to do throughout the years.  Live below your means – save a portion of your income (assuming you are working and saving for retirement) and invest in a fully diversified portfolio designed specifically for your risk tolerance.  In fact – it is having the GUTS to invest during times like these that separate the winners from the… folks who wish they had as much money as the winners.

Last year, Dimensional Fund Advisors tapped into the database held at the Center for Research in Security Prices (CRSP) at the University of Chicago – the nexus of more Nobel-Prize winning research in economics than any other institution on the planet – to identify IF there was a direct correlation between a poor economy (as defined by low GDP) and poor investor returns.  In other words – SHOULD I STILL INVEST IN A CRAPPY ECONOMY?”

The Dimensional Study started by taking all of the world’s developed economies, examining their annual GDP growth from 1971 – 2008, and dividing them into two groups – High Growth, or Low Growth – for each year.  Clearly, much of what we hear on the news is about GDP growth – is our economy growing or not?  The higher the economic growth, the better – as this means reductions in unemployment, increases in personal wages, and, generally, a feeling of well-being, versus the cloud of general malaise that seems to have decended upon the world as of late.

Once the economies were divided into High Growth and Low Growth – the performance of their stock market indices was compared to their GDP Growth.  The question:  Does a poor economy (low GDP Growth) accurately predict poor investor returns?  The question was not – can an investor perform poorly during low-growth times (of course, we know that is possible) – but is there a clear and determinable correlation between a bad economy and a bad investor experience?

Oddly enough – the answer is NO.

                              AVG GDP                      AVG RETURN              Risk (Std Dev)

High Growth               0.92                             12.90%                          23.07

Low Growth               -4.02                            13.52%                          23.04

The data for Emerging Markets was similar, but quite honestly, the data for Emerging Markets only went back to 2001, and I felt this was just too short a time period to draw any reasonable conclusions.

When I first saw the data, I thought… well… this might be a sales pitch just to keep investors invested… we are still looking back only as far as 1971.  What about other periods of lousy growth?  And what about for the US in particular?  I wanted to check the data myself.  So, I delved into the CRSP database myself, using the French and Fama indices that go back as far as 1926, and to the Bureau of Economic Analysis (BEA.GOV) and compared hypothetical investor returns to the GDP growth (or lack thereof) during the 1970’s and during the Great Depression.

One particular period of interest to me was the years from 1972 to 1982.  Yes, this was after 1971, but I wanted to look at it further and in more depth from a portfolio manager perspective instead of just looking at the stock market.  How did it feel?  Remember the oil embargo?  Our defeat in Vietnam? The Cold War?  Carter’s “Misery Index?”  Double Digit Inflation?  During this period of time, the average GDP Growth was only 2.7% – well below the historical average of 3.4%.

The second period of interest was the period of the Great Depression.  Now the Great Depression itself lasted from 1929 to 1941 – but for this particular exercise, I wanted to look at the period starting about 2 and a half years AFTER the crash – starting with the summer of 1932 until the attack on Pearl Harbor, or December 1941 – the long, grinding years of the Depression.  During that period of time, our average GDP Growth was only 2.0% – the longest and weakest period of below-average growth on record for the United States.

My question was – how could today’s investors, using a properly designed, diversified portfolio,  have done during that time?  Were these two periods of time – arguably the worst periods (economically) in the past hundred years – a bad time to be invested?

Assume a relatively simple, domestic portfolio:  T-Bills (15%), 5-Year Treasuries (15%), US Large Stocks (11%), US Large Value, or underpriced, dividend paying stocks (21%), US Small Value Stocks (18%), US Small Stocks (10%), and Very Small, or Micro-Cap Stocks (10%).

Looking at the indices only (remember – there were VERY few mutual funds at the time of the Depression, and certainly no ETF’s,) we can get an idea of how an investor might have done.  The following numbers do NOT account for any fees, commissions, taxes, etc – but we can still draw conclusions.

From the period of 1932 – 1941, the above, simple, diversified portfolio (indices only) would have achieved an AVERAGE ANNUAL return of… wait for it… 19.29%!!  In fact one dollar invested as described above in the summer of 1932 would have grown to about $4.50 by December of 1941.  During the Great Depression!!

From the period of 1972 to 1982, the above, simple, diversified portfolio (indices only) would have achieve an AVERAGE ANNUAL return of… 14.82%!!  One dollar invested as described above in December of 1972 would have grown to about $3.49 by December of 1982.  During the Carter Years and the Misery Index!!

Were there periods of volatility, market corrections, and even stagnation in the investor’s portfolio?  Absolutely – in particular, a sharp market correction in 1936 would have scared out many undisciplined investors, and a particularly unpleasant 18 month bear market from 1973-1974 would have tested investor mettle.  But the facts remain – a fully diversified, properly balanced investor would have been able to achieve significant returns during those times.  In fact – there are a number of economic theories that suggest that investors who have the GUTS to invest (and remain invested) during these uncertain times are the ones who enjoy the GREATEST rewards.  These are the riskiest, most emotionally draining times to invest – as a result, the Capital Markets reward those investors more readily and more predictibly than the comparatively “timid” investors who only remain invested during the “good” times.

Today, the Fed and the International Monetary Fund (IMF) are projecting the US economy’s GDP growth to be about 2.7% for the next two years.  The media harps daily on the miserable shape of our economy, and politicians are using the economy as opportunities to further their agendas.  These are things that we must endure as a people, or change with our votes.

However – it is critical to SEPARATE our concerns about the economy – from our own INVESTMENT POLICY.  The two are NOT necessarily correlated.  A miserable economy – historically – does NOT mean miserable returns for an investor who is disciplined, creates a sound, diversified, low-cost investment STRATEGY with strict risk controls, and then implements it with courage and discipline.  In fact – it is EXACTLY these types of investors who have historically been the winners over the long term.


This blog article does not constitute legal, tax, or personal financial advice.  Please consult your own financial professional for personal, specific information.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.

Why has everyone suddenly become fearful?

29 06 2011

Jonathan N. Castle, CFP®, ChFC

The economy was in recovery; the bulls were stampeding through Wall Street, and for a few short months we had a general feeling that maybe – just maybe – all would be well with the economic world.  Then things seemed to fall apart – first we had a Tsunami and a potential nuclear disaster in Japan; then President Mubarek of Egypt was ousted, and then we started dropping bombs on Lybia.  To top it off, Greece will probably go bankrupt – if not soon, then certainly at some point in the future, and everyone in the US is wondering if that will be our own future if our brilliant congressional leaders can’t quit their squabbling and decide one way or another on our own budget deficit.  Do we simply raise our own debt ceiling, allowing our government to put us deeper in debt, do we default on some of our debt, or do we cut deeply into some highly sensitive entitlement programs to try and balance the budget?  QE2 is ending, so the Federal gravy train of free money is coming to an end, right?  To top it off, the market has been floundering around – falling one day and rising the next with no clear direction, reminding us of the ever present danger of a sustained bear market that may push all of our retirements back a few more years.

So what happened?  What should you do?

Well – since everyone’s situation is different, I’ll start off with some assumptions.  In my experience, individuals who are generally successful investors have the following characteristics, so I am going to assume that if you are reading this – then you have met the following criteria.  If not – then disregard anything and everything I say.

1)  You have an investment PHILOSOPHY (i.e., set of guiding beliefs and a repeatable strategy) that you believe in enough to stick to through the long term.  You are aware that events that effect financial markets continually happen and are often unpredictible – therefore, your investment PHILOSOPHY provides you guidance on how you build your investment portfolio, and does not change from day to day.  You are also aware that, contrary to what Wall Street and the mass media (which is in their pocket, by the way) constantly advocate – “buy when the market is going to go up, sell when it is going to go down,” is NOT an investment PHILOSOPHY.  It is an investment FANTASY.

2)  You have carefully measured your risk tolerance.  This means that you know EXACTLY how much your portfolio can drop before you even THINK about making any changes to your overall strategy.

3)  You have carefully designed your portfolio to match your risk tolerance.  In other words – if your risk tolerance is such that you can bear a drop of up to 10% in your portfolio – but no more – then you are aware that the market typically will drop 20% or more every 3.5 years, on average.  Therefore – you have designed your portfolio so that 50% or less of your account would be effected by such a drop.  So- if the overall stock market drops 20% – but only about half of your portfolio is in the stock market – with the rest of the portfolio in cash, CD’s, and perhaps short-term bonds  – then you can reasonably assume that a 10% drop in your portfolio would be a likely outcome of such a correction – and would be bearable.  Keep in mind that during extended recessions or financial crises (such as occurred in 2008) that these parameters are often exceeded.  The 2001 crash, on the other hand – did not effect properly diversified portfolios as much.  Point being – you have structured YOUR portfolio to match YOUR risk tolerance.

Assuming all of the above – then my general advice, assuming that you have some time until you need ALL of your portfolio – would be to do nothing.  Nonthing at all!  Sometimes we have to scream out, “Don’t just DO SOMETHING – Stand there!!”

As far as all the other stuff going on, here is my take on current events.  Granted – I cannot foresee the future – no one can – but from looking into things and trying to keep everything within a historical perspective, here’s what I think is going on.

1)  The market first.  The markets are quite efficient.  With probably more than 100 million investors, analysts, gurus, institutions, etc. all playing in the market and trying to get the most profit for the least amount of risk – the markets as a whole factor in a great deal of information in a short period of time.  I believe that the potential outcomes of both a default by Greece, and the end of QE2 are already factored into the current prices of stocks and bonds – for the most part.  None of this information was kept a secret; markets have known for nearly a year about the end of QE2, and honestly – Greece’s entire economy is about the size of Rhode Island’s.  The threat to the EU is certainly there – but more on a political front than as a potential for a global financial meltdown.  I expect very little response from the overall market to either the end of QE2 or a Greek default.  In fact, I believe that Greece WILL default – but in stages.

2)  Again, on the markets.  The economy is in recovery, but this occurs in stages.  Honestly I don’t understand all the wailing and gnashing of teeth – but I suppose that’s what drives in the revenue to the squawkers in the Media.  Remember those old rocket ships that had multiple stages – first the big rocket engine with all the fire shooting out of it, then a smaller booster rocket, and then another, and finally the little spaceship on the top of the rocket fires its engines and it goes off into outer space or to the moon?  Well, every time the rocket ended one stage, the engine would quit – there would be a pause – and then when the next engine would kick on the rocket would continue on its way.  We didn’t see all the media freaking out at every pause… squawking about how the rocket was going to fall back to the ground just because the first engine quit.  We don’t all jump out of our cars and start worrying that our car is broken everytime we shift from one gear to another… a marathon runner knows he can’t sprint for the full 26 miles… so why all the wailing and chicken littling every time there is a bit of bad news or a new report that wasn’t quite as good as the last one?  Economic recoveries take time.  This was the GREAT RECESSION, after all – over a decade in the making, so it stands to reason that it will likely take a decade or more to fix.

3)  There are a ton of reasons to believe that the stock market – and the economy – will continue to head in the right direction – upward.  First – the general index of leading economic indicators is still positive.  Yes, some of the coincident indicators have slowed down, but generally, they are still well ahead of recession territory.  Secondly, employment is still growing.  Yes, we’ve had a slow month or two of new hiring numbers – but employment is still growing.  And the number of temporary workers that have been hired is up to levels not seen since 2009, and companies typically hire temps before perms.

4)  Economic slowdowns (operational pauses) are absolutely normal after a run-up like we saw since last year.  This “pause” gives corporations time to think about their next moves – expansions, hiring, starting new projects, new marketing campaigns, etc.  Corporations have also been hoarding cash; it is only a matter of time before these corporate reserves are put to work in new growth opportunities and innovations.

5)  Stock buybacks are at an historic high right now.  Based upon P/E ratios, stocks are the cheapest they’ve been in 26 years (this from Bloomberg).  The Bush tax cuts are still in effect, corporate profits are higher than ever – and there is currently approximately 2 trillion dollars sitting in cash and on the sidelines ready to be deployed into the markets.  This all makes for a powder keg of bullish opportunity.

Ultimately, no one can see the future.  But I do believe that we as humans typically worry too much.  Supposedly about 95% of the things that we worry about never happen.  So, in this case – assuming all the above – my suggestion is that we just stand back and see where the markets take us.  I’m betting that place is up significantly from where we are now.


This blog post is for informational purposes only.  All investing involves the potential of loss – including invested principal.  Indices quoted are general barometers of security price movement.  You cannot invest directly in an index.  Past performance is not a guarantee of future performance.  This message is NOT personal investment advice and should not be taken as such, nor is it a recommendation to buy or sell any security.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services offered by Paragon Wealth Strategies LLC, a registered investment advisor.

High Unemployment… Debt Crisis… Inflation… Tsunami… why does the market keep going up?

5 05 2011

By Jon Castle, CFP®, ChFC®

Many times, while working with clients, we get the question,  “WHY are you generally bullish on the market?  All the news I hear is BAD.  How can you possibly think the market is going to keep going up?”

I will get around to answering this question – but bear with me a moment as I wax philosophical.  It has been my experience in working with individual investors saving and working toward retirement – that the most successful investors develop an investment philosophy – a set of guiding principles and beliefs that shape an investor’s decision making process.  This set of principles essentially guides the investor during the darkest times so they can remain disciplined during times of economic and market volatility.

“I think the market is going to go up – so I want to be invested NOW – but not if it goes down,” is NOT an investment philosophy!  An investment philosophy guides an investor’s decisions consistently, based upon their fundamental beliefs about the way markets work.  For example, MY own investment philosophy (not necessarily the right one – just what I happen to believe) can be summed up as follows:

1)  Capitalism – perhaps best described as “Pay Upon Results,” ultimately drives the financial markets.  It creates the impetus for new developments and for entrepreneurs to take risks, to create new businesses or opportunities, to hire people to do work, to think up new goods and services that people will buy.  Without capitalism, there is no opportunity for reward, so no one will take undue risk – and the economy will languish as it did in the old Soviet Union.  Sometimes capitalism gets a little out of control… and can be cruel… thus the need for prudent regulation.  However, it is the best economic system invented so far and is amazingly efficient.

2)  Capital Markets work.  With all of the competition to outdo the other guy – millions upon millions of investors seeking the highest reward for the lowest possible risk creates an environment of extreme efficiency in our Capital Markets.  Just about all known information – and the probabilities of all imagined outcomes- about any particular stock or bond – is very quickly factored into that security’s price.  Any “surprise” information that can significantly give one investor an advantage over another is factored into the price very quickly – usually within seconds of that information becoming public knowledge.  Therefore – most of the time – doing tons of research about any particular stock or bond is a waste of time because the market prices the information faster than you (or a mutual fund manager, hedge fund manager, or other money managers) can do the research.

3)  I do believe that there are those few who have the “gift” and have been able to outperform the general market by some margin.  However, this “gift” is usually fleeting  – numerous studies show if someone has outperformed the market in the past – the odds of them continuing to outperform in the future are miniscule.  More often than not, managers who outperformed merely increased the risk within the portfolio, and pay for that risk later in under-performance.  Picking a money manager (or a mutual fund) who will outperform the market – in advance – is extremely unlikely.

4)  Successful investors focus on what they CAN control instead of what they cannot.  We cannot control fund manager performance.  We cannot control the Fed’s actions, nor can we control the markets.  However, we CAN control costs, the structure of our portfolio, and our own behavior.  So, in general, better and more predictable performance can be achieved by capturing the movement of the entire market and its various sectors – through the use of lower-cost ETF’s, index funds, and institutional “total market” funds – than through individual stock picking, trying to hop in and out of the market based upon tips or media input –  or by using more expensive mutual funds where managers try to beat the market while enduring higher risks, tax inefficiencies, and trading costs.

5)  Above all – manage risk.  If the market gets bumpy and shakes you loose from your philosophy – you have failed.  Likely, you took too much risk and will probably never recoup that risk by reaping the rewards the market has historically given those who structure their portfolios so they can ride out the market’s bumps.  Risk tolerance is best described as the amount of money in your account you can watch disappear (through market fluctuation) without changing your philosophy.  If the market drops 20% – but you freak out if your account drops 10% – then you need to structure your account so it will most likely only drop 9% when the market drops 20%, instead of gambling on when the market will go up and when it won’t.  More often than not your gamble will be wrong.

OK, so that was my investment philosophy in a nutshell.  Now – back to the original question.

With all the bad news – why does the market keep going up?  Aren’t we just setting ourselves up for another disaster?   Personally, I think not.  I could be wrong, but I believe my logic is sound.

First – much of the “bad” news is sensationalized.  Right now, as I write this, the media is just about going bonkers trying to get the Obama administration to release photos of the dead Osama Bin Laden.  Now let’s think about this for a minute.  What real purpose would that serve?  Suppose the photos ARE released:

1)  He isn’t any less dead with the pictures than without.

2)  Pictures can be faked.  People (and countries) who don’t believe he is dead, will believe the pictures are faked.

3)  People who believe he is dead will still believe he is dead.

4)  If the photos are released, the media would get more people either watching their shows, reading their magazines, or logging into their websites to see the pictures.  This would sell more magazines (with the photos), and allow them to charge more money for advertising in those magazines, sell more web banners, and charge higher rates for their commercials!

AHA!  The net worldwide effect of the administration releasing the photos would likely be – the MEDIA MAKES MORE MONEY!!!!  Hmm…

So… let’s apply this logic to the stock market and the economy.  What if the media were absolutely unbiased and did not sensationalize anything?

Responsible Media:  “The preponderance of the data shows that the economy is slowly recovering.  Unemployment is slowly going down.  Generally, economic activity is increasing while housing still continues to lag.  Corporate earnings are healthy and corporations are sitting on mountains of cash which they will likely continue to invest over the next 5 years in new production, jobs, advertising, commerce, or in the stock market.  The Federal Reserve will likely, very slowly, reduce the amount of stimulus in the economy to try to control inflation – but must do it carefully in order not to derail the economic recovery.  (They know this, by the way, since they all have PhD’s in economics and finance).  The dollar is weakening a bit – but a weakening dollar can be good for America because it creates jobs at home (versus being sent overseas) and it allows us to sell American goods overseas more competitively.”  (REPEAT EVERY DAY OVER AND OVER with tiny adjustments… )

BOOOOORRRRRIIINNNNGGGG!  After about the third day, no one would watch that show anymore!  And of course, that show and its network would make no money in advertising.

Now – compare that with OUR MEDIA:

1) “Tsumani causes Nuclear Disaster!!!!  Will this cause a global stock market crash?!?”

2)  “Osama Bin Laden Killed.  EXPECT TERRORIST ATTACKS which may cause a global stock market crash!!!!”

3)  “Initial unemployment claims increased by 0.005% last month!!! Is the economic recovery DOOMED?”

4)  Fed to reduce Quantitative Easing.  Is the economic recovery DOOMED?!?!

5)  Fed did Quantitative Easing which boosted the economy.  Oh, No, we’ve got DEBT!  Is the economic recovery DOOMED?!?!

You get the picture.

 The simple reason the market keeps going up is this:  Investors seek investments which give the highest reward for every unit of risk.  Currently, cash is paying virtually nothing.  Bonds are trading at the highest prices (and lowest yields) in most of our lifetimes – so very little new money is moving into bonds.  There is a TON of cash sitting on the sidelines – and it has to go somewhere.  Slowly, it is making its way to the stock market.  The stock “Market” is driven by supply and demand.  As demand increases, the prices go up to reflect that demand.  Expect occasional bumps as unforeseen events unfold – but in general, our economy is expanding and is likely to continue to recover over the next several years.  The stock market is a “leading” indicator of the economy (investors invest for the future, not for the now), so it will generally rise BEFORE recoveries and will generally fall BEFORE recessions.  This is not new – it is basic economics.

It can be helpful to remember that the stock market NEEDS some uncertainty to do well.  Only when there is cash sitting on the sidelines (as a result of worry or uncertainty) can the markets continue to go up.  It is this very “worry cash” that gets the fed into the markets over time, which, in turn, drives the markets up.  OF COURSE investing is risky – why in the world would there be any significant reward without any risk??  The problem is – once everyone FEELS great about the market – once the last investor FEELS great about the economy and goes “ALL IN,” – then there is no additional cash left on the sidelines.  Thus – there is no further demand to continue to drive the market up.  THAT is when we need to really worry… that event occurred in March of 2000 – at the very height of the tech bubble… when all was well, the economy was booming… monkeys with dart boards could outperform professional money managers… and we all know what happened next.

Disclaimer:  This blog article is not personal tax advice.  Please consult your tax professional for personal, specific tax information.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.

The 8%+ Solution*. Seriously??

8 03 2011

  by Michelle Ash, CFP(R), CDFA(TM)

 This past Friday evening, February 26th, I went to my local bank’s ATM to make an evening deposit.  It was about 8pm, it was dark outside, and clearly the bank itself had been closed for hours.  As I was waiting for the machine door to open to accept my envelope, a piece of paper folded up and taped to the ATM machine caught my eye.  It’s headline read,


“Finally, A Safe, Sensible Alternative to Money-Losing IRAs: The 8%+ Solution*”.

Being a financial advisor, and firm owner, this naturally caught my eye.  The paper was taped with one small piece of tape and was clearly meant to be taken by a curious passer-by, so I decided I’d take it.  Down below the headline, the 8 x 10 sheet continued to espouse all the almost-too-good-to-be-true features of this investment strategy, and then the contact information for the advisor who could be contacted about the investment; who is not affiliated with the bank, by the way.

You know what they say about things that seem too good to be true, right?

They usually are, and the same thing is true here as well.  Technically speaking, the author of the flyer did not make any inaccurate statements or tell absolute falsehoods.  However, as a fellow financial professional, I would tell you that he did make all sorts of misleading statements that appear to be intentially designed to cause a consumer to believe one thing – while the truth is actually another. 

Let’s look at some examples:

1. The footnote of the title, “The 8%+ Solution*” says “*8% is the highest income guarantee in the industry; actual accumulation amount could be greater.  **If you add an initial optional bonus of 8%, your first-year earnings could be at least 16%. Product is guaranteed and insured by an A rated insurance carrier. Minimum deposit is $5,000.”

Other examples:

“Want a retirement account that compounds at 8% a year guaranteed- no matter what happens in the market? (But it could be much more!)”

“Would you like a financial vehicle that will guarantee you income for the rest of your life? (And you can pass it on to your family!)”

To the left is a picture of the flyer.  I include it because it’s just got so many wonderful-sounding details.






Sounds fabulous, doesn’t it?  So, now let’s talk about the rest of the story.



First of all, what product is this advisor talking about?  Answer:  an equity-indexed annuity with a guaranteed income rider.  Now, that’s a mouthful of words that, unless you’re in the financial industry, probably sounds like I just spouted off in Greek instead of English.

So let’s break that down.  I’m going to try and keep this relatively simple, since this is a blog and not a white paper.  And trust me, you could write quite a lot to really give an explanation of these things.

Equity-indexed annuity: is an annuity product wherein your invested principal’s safety is guaranteed, and has a minimum guaranteed return (usually around 2%).  “Your” money is never invested directly in the stock market like it may be with a variable annuity or a mutual fund.  Instead, the insurance company invests your dollars in very safe vehicles like government treasuries, and then uses the interest from those to buy calls on a stock market index.  If the calls make money from the stock market going up, your account gets credited with a portion of the earnings.  If the calls don’t make money, your principal was never at risk so it’s still safe.

Guaranteed income rider:  There are several types of these, but this one is most likely a “GMWB” – a Guaranteed Minimum Withdrawal Benefit – an optional rider that can be purchased for an extra annual fee and “attached to” the base annuity contract.  In jest, sometimes we refer to this as “magic money”.  Think of it like this:  when you buy an annuity with this optional guaranteed income feature, your annuity actually has two values.  The first value is your account value – the one that represents your ACTUAL money in the account.  This is the money that you could actually take out if you decided to withdraw your money or cancel the contract (minus possible surrender fees, but that’s a different issue).

The second value your annuity has is the “magic money” guaranteed income bucket.   THIS value is the one that gets the “guaranteed” 8%  growth – NOT your account value.  The ONLY way to access this value is in one of two ways – either 1) by turning this “magic money” bucket into an income stream similar to a monthly pension, or 2) by taking a preset amount in the form of withdrawals over your lifetime – such as taking 5% annually off of the “magic money” bucket.

Still confused?  That’s common, so let’s do a simple example, using option number 2 (the GMWB option).

Let’s say I have $100,000 that I put in one of these contracts.  It has a guaranteed interest rate of 2%, but the opportunity to earn more if the stock market goes up.  I also buy (and pay for via internal costs) a guaranteed income rider with an 8% guarantee.

Now, let’s say that I hold the annuity contract for 10 years.  During that 10 years the stock market does really poorly, similar to the years 2000 – 2010, not even surpassing my 2% minimum guarantee.

My ACTUAL account with the 2% minimum guarantee grows to $121,899.  This is the money I could take out if I want (assuming all surrender charges are zero).

OR, instead, I can use my guaranteed income rider, which, with its 8% guarantee has grown my “magic money” to $215,892.  The amount of annual withdrawals I can make will be based on my age and published in the contract.  Let’s hypothetically say I’m age 70,  and because the insurance company has calculated my mortality, I may be able to withdraw annual amounts of 5% of my “magic money”.  If you multiply 5% by the “magic money” value of $215,892, you get an annual withdrawal of $10,794 – for life.  If I take more money out – it “blows up” the contract and my “magic money” pot will be severely penalized in some fashion, depending upon the individual company and contract.  At no time can I get the $215,892 at any one time – although, if I live for longer than 20 more years, I may get more than that amount – in annual withdrawals.

Still confused?  At this point, most people are.  Honestly – the vast majority of financial advisors and financial journalists do not understand these products – so misrepresentations tend to abound.

And so here’s the real crux of my issue with this advisor’s flyer:  these products are very, very complex.  If you take some of their different features individually in isolation and discuss them, they sound great.  You might even think that everyone should want one.  However, the real key to success is understanding how all of the features work TOGETHER.  Only then can a buyer have a true understanding of the pros and cons of the product.

At the end of the day, am I saying equity indexed annuities with guaranteed income riders are bad?  No.  Neither am I saying they are good.  They are just a tool.  Much in the same way that a carpenter probably doesn’t look in his toolbox and decide his hammer is “bad”, I am not looking at this annuity as “bad” or “good”.  Like the hammer, it’s just a tool.  A hammer may be great for pounding in nails to hang a picture, but I probably don’t want to use it to sand fine furniture.

The real problem I have with the flyer I found taped to my bank’s ATM machine is that advisors representing the financial industry are supposed to a) understand their products, b) represent them accurately, and c) only recommend them to individuals for whom they are suitable.  These are the mandates that state insurance commissioners, FINRA (the Financial Industry Regulatory Authority), and SEC (Securities Exchange Commission) oversee to try and prevent consumer abuses.

In my opinion, this advisor seriously misrepresented a product to try and make sales, and by doing so, he made our industry look bad by his misrepresentations.  I take serious issue with this.  And I bet the Florida Insurance Commissioner will too.


All investing involves the potential of loss – including invested principal.  Indices are general barometers of security price movement.  You cannot invest directly in an index.  Past performance is not a guarantee of future performance.  This message is NOT personal investment advice and should not be taken as such, nor is it a recommendation to buy or sell any security or insurance product.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Imvestment advisory services offered by Paragon Wealth Strategies LLC, a registered investment advisor.