Is Index Investing Really a Bubble?

Is Index Investing Really a Bubble?

Back in September, Bloomberg published an article about index investing that made a few waves.  If you read the book or watched the movie “The Big Short”, you might remember Michael Burry.  He’s the former doctor turned hedge fund manager who lives in Silicon Valley (and rocks out to death metal in his office while pondering investment strategy).

The article made waves because Burry claims that index investing is a massive bubble.  Comparing index funds to CDOs (collateralized debt obligations), Burry’s perspective stoked fear in the hearts of more than a few investors.  Here’s the guy who correctly identified one of the biggest bubbles and upcoming crashes of all time.  And he’s saying that index investing could be a bubble too?  Maybe the simplicity we’ve enjoyed of investing in index funds was really a big mistake.  What if he’s right?

Don’t run for the hills just yet.  There’s been some great discussion of whether the argument is fair (here, here, and here, for example).  Here’s my take on whether index investing really is a bubble.

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I Keep Hearing We're Nearing a Recession. Are We Nearing a Recession?

I Keep Hearing We’re Nearing a Recession. Are We Nearing a Recession?

There’s been more than a few news headlines recently claiming that we’re on the verge of an economic recession.  For many business owners and investors the word recession is a lot like Voldemort.  It’s so evil and scary that you’re not even supposed to say it.  “Recession” evokes fears of falling stock prices, unemployment, and scarcity.

So what exactly is a recession?  And should we treat them with the same respect that Harry Potter treats Lord Voldemort?

Recessions are technically two or more consecutive quarters where national gross domestic product contracts.  Gross domestic product (GDP) is sum of all the goods and services a country produces.  It’s the broadest and most common way to measure economic activity and the strength of the economy.  Growing GDP is a good sign, falling GDP is a bad sign.  This is what US GDP growth has looked like since 1930.  Lots of major swings between 1930 and 1950, and relatively steady since about 1985.  Note that by that time the US dollar was the world’s reserve currency, we were off the gold standard, and interest rates had started to stabilize after stagflation in the 1970s.

I Keep Hearing We're Nearing a Recession. Are We Nearing a Recession?

Now on to why you should care.  The more goods and services a country produces, the better off its citizens are financially.  There’s more wealth being created, more jobs available, and usually faster rising wages.  For businesses this means that your customers have more stable employment and more discretionary income to buy your products.

In a recession GDP contracts.  There’s less economic activity.  From a business’s perspective your customers have fewer jobs, lower wages, and less discretionary income.  Revenue dries up, and you may be forced to lay employees off yourself.  Times are tough.

From an investor’s perspective, recessions are tough on asset prices.  The value of your stock holdings, including index funds, depends on the market’s expectation of future cash flows & profitability.  Recessions are tough on cash flow, tough on profitability, and tough on stock prices.  Recessions often coincide with bear markets.

So where are we now?  Are we actually nearing a recession, or is the rhetoric we’re hearing on the news just propaganda?  I’m no economist, but I do have some background and stay informed as part of my day job.  Here’s my take on whether we’re nearing a recession.

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Q3 2019 Market Update

Market Update: Q3 2019

I’ve written and published quarterly market updates religiously since launching Three Oaks Capital Management back in 2014.  At first I had physical newsletters printed out on six thick pages of card stock, and mailed them out to clients and other contacts.  Shortly afterward I began adding the commentary to www.3oakscapital.com, and started calling the distribution “Investment Insights”.  A few years after that I abandoned the print version, and distributed the commentary solely through the blog.

Writing a market update at all is starting to become less common in the financial planning community.  Many of my peers, colleagues, and friends prefer NOT to publish or distribute market updates at all, as they believe it diverts their clients’ attention away from long term & consistent strategies.

The market updates I’ve written have evolved quite a bit over the years, but they’ve received a good amount of positive feedback all along.  Clients like to know my take on the markets, and feel comfortable knowing that I have my eye on them.  Other readers and contacts seem to enjoy the content too.

This quarter I am making a minor change to the format of Investment Insights.  While I plan to continue producing them, starting this quarter all new editions will live on Above the Canopy as opposed to Three Oaks Capital’s blog.  We have other changes to the blog, format, and site forthcoming, and this change makes the most long term sense.  (Hint: there is a podcast on the way).  But from here on out, you’ll find market updates on this site as opposed to Three Oaks Capital’s.

Speaking of this quarter’s edition, we have a number of items to touch on.  First, the Federal Reserve reduced short term interest rates in both of their third quarter meetings.  There continues to be a lot of trade uncertainty globally, inflation remains low, and there continues to be some weakness in global economic growth.  This is the first time the fed’s reduced rates in ten years – the last time being December of 2008, when it cut rates from a range of 75 – 100 basis points to 0 – 25.

Elsewhere, US equities had another strong quarter, value shares outpaced growth in the small cap space, and the yield curve in US rates inverted for three days in August.  Read on for more details.

 

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Value vs. Growth Investing: Will Value Ever Come Back?

Value vs. Growth: Will Value Ever Come Back?

Returns from growth investing have substantially greater than those from value investing over the last decade.  Looking back over the last 100 years or so, this isn’t the norm.  Will value ever come back, or is growth here to stay?  This post will examine the history, along with both sides of the argument.

 

So What Is a Value or Growth Stock, Exactly?

The investing world likes to categorize stocks in a number of different ways.  Geography and size are two of the most popular methods.  Another way is value vs. growth.  Value stocks tend to be older, more established companies with “cash cow” type businesses.  They don’t typically create exciting new technologies that might set the world on fire, but they have stable revenue and profit streams, and often distribute a portion of their earnings back to shareholders through a dividend.  Think of companies like GE, Exxon Mobile, or Home Depot.

Growth companies operate a little differently.  They typically reinvest 100% of their earnings back into the company to fuel future growth, rather than pay dividends to shareholders.  They often have new products, services, or technologies that are spreading around the world like wildfire.  Your FANG stocks are great examples of typical growth companies: Facebook, Amazon, Netflix, and Google.  All have new technologies, services, or models that are taking the world by storm.

From an investment point of view, the reason you might buy a value stock is completely different than why you might buy a growth stock.  In a value investment, you’re purchasing company shares because you think they’re worth more than the current market price.  “Undervalued” is a common term you’ll hear in a value investment strategy.  Metrics you might track to make this determination are price to earnings ratio, price to book ratio, or dividend yield.

Current share prices don’t matter as much in growth investments.  In a growth investment you’re not buying a stock because you think it’s cheap; you’re buying it because you think the company will continue growing at an above average rate.  Look at companies like Amazon.  They’re terribly expensive on a valuation basis, but that doesn’t deter investors in the least.  The company is growing so rapidly that the expensive valuation simply doesn’t matter to those buying shares.  Metrics you might track here are earnings growth rate, EBITDA (earnings before interest, taxes, depreciation & amortization), or momentum.

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A Review of the CalSavers Retirement Savings Program

A Review of the CalSavers Retirement Savings Program

If you’ve been following the California legislative process at all, or if you own a business that employs people in California, you may have heard of the CalSavers Retirement Savings Program.  In 2016, Governor Jerry Brown signed Bill 1234, requiring development of a workplace retirement savings program for private sector workers without access to one.  The resulting program is known as CalSavers.

Basically, the program forces employers with more than 5 employees to defer a portion of their employees’ paychecks into a state run Roth IRA.  These contributions are invested in default target date retirement funds, unless the employee directs their investments otherwise.  Employees may also opt out entirely, if they choose.

The benefit of such a program is easy access to a retirement savings account.  Employees could contribute to one on their own, of course, but that would require opening an account at a brokerage firm & making investment decisions.  CalSavers greases the wheels by providing a “done for you” program that employees are defaulted into.

The positive spin here is that the program will certainly result in more retirement savings for many thousands of employees.  The negative side of the story comes from the business community.  Businesses without retirement plans will be forced to take the time to open a plan, enroll their employees, and deposit their contributions.

CalSavers isn’t at all unprecedented.  At this point 21 states have enacted similar legislation.  The law is taking a good amount of “heat” though.  Several industry groups are suing the state treasurer in an attempt to derail the rule.  Some plaintiffs don’t care for the state government telling them what to do, while others in the financial industry probably see the program as a competitive threat.

Whatever your take on the matter, businesses will be required to comply beginning in June of 2020 as the law stands today.  This post will provide a quick overview of the program, including its benefits and shortcomings.

 

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How to Evaluate Real Estate Investments

How to Evaluate a Real Estate Investment

The concept of acquiring rental properties as a means to build passive income has become exceptionally popular recently.  In fact, it’s difficult to peruse the internet for content on personal finance without bumping into videos/podcasts/blogs/courses on how to build passive income through real estate investing.

My take on real estate investing is that it can indeed be a wonderful complement to your investment portfolio.  But the conditions need to be just right.  And given how quickly housing prices have risen since the depths of the financial crisis in 2009, the circumstances today are rarely compelling.

As you can imagine, this is a conversation I have with clients frequently.  Some have an existing property we need to evaluate.  Others fall in love with the idea of putting in sweat equity now & building an empire of properties that kick off income over time.  This sounds nice in theory, but in my experience rarely pencils out.  (At least of the opportunities I’ve seen recently in California & Oregon).

This post will explore how to evaluate real estate investing opportunities.  We’ll cover cash flow, return on investment, and go through a real life scenario of a property I pulled from Zillow.com.

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72(t) Distributions: The Ultimate Guide to Early Retirement

72t Distributions: The Ultimate Guide to Early Retirement

What’s the most common piece of retirement advice you’ve ever heard?  I bet it has something to do with tax advantaged retirement savings.  Most people are inundated with voices telling them to start saving early and take advantage of tax deferrals.  It’s solid advice.  Saving tax deferred money through IRAs, 401(k) plans, and other retirement vehicles is a wonderful way to grow your wealth over time.

The downside?  Those pesky withdrawal penalties.  The IRS will typically ding you 10% if you withdraw from these accounts before turning 59 1/2.  This can pose a problem if you’re considering an early retirement.  Fortunately there are a few loopholes.  eight of them, in fact:

  1. Roll withdrawals into another IRA or qualified account within 60 days
  2. Use withdrawals to pay qualified higher education expenses
  3. Take withdrawals due to disability
  4. Take withdrawals due to death
  5. Use withdrawals for a qualified first-time home purchase up to a lifetime max of $10,000
  6. Use withdrawals to pay medical expenses in excess of 7.5% of adjusted gross income
  7. As an unemployed person, take withdrawals for the payment of health insurance premiums
  8. Take substantially equal periodic payments pursuant to rule 72t

For those of you interested in an early retirement, the final loophole is likely the most interesting to you.

According to rule 72t, you may take withdrawals from your qualified retirement accounts and IRAs free of penalty, IF you take them in “substantially equal period payments”.

This post explores how.

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Case Study: Retiring With $1,000,000

Case Study: Retiring With $1,000,000

Those of you who know me know that I’m a massive baseball fan.  And when it comes to famous quotes from baseball players, one person comes to mind more than any other: Yogi Berra.

Yogi Berra was a long time catcher for the Yankees and had an incredible hall of fame career.  He was equally known for his head-scratching quotes, which the world has affectionately termed “Yogi-isms.”  Yogi didn’t comment often on financial topics, but he does have one quote that applies nicely to retirement planning:

“A nickel ain’t worth a dime anymore.”

When we think about retirement planning, many people consider $1,000,000 as kind of a “golden threshold.”  They think of a million dollars as the minimum nest egg they’ll need in order to retire comfortably.  But as Yogi pointed out, being a millionaire doesn’t amount to what it used to.

So is it even possible to retire with $1,000,000 these days?

Let’s find out.  In this post we’ll explore a hypothetical couple named John and Jane.  They’ve saved $1,000,000 and want to retire, which is a very common situation for many Americans.

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A Beginner's Guide to Cash Balance Plans

A Beginner’s Guide to Cash Balance Plans

In my financial planning practice I work with a good number of business owners who want to make aggressive contributions to their tax deferred retirement accounts.  This helps put them on strong footing for retirement, but also provides a generous tax deduction.  While the 401k plan is the primary retirement plan most business owners are familiar with, a cash balance plans is one I often recommend in addition.  In fact, cash balance plans can actually allow for far greater contributions & tax advantages.

A cash balance plan could be a good fit if you’d like to contribute over $50,000 per year to a tax advantaged retirement plan.  They don’t come without their nuances though.  This guide will explain how cash balance plans work and whether they might be a good fit for you.

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