Sunday, November 30, 2008

The Root of the Problem

The Root of the Problem

Bert Whitehead, M.B.A., J.D.
© 2008

Five ‘up-days on the Dow’ gives us a chance to catch our breath and ponder: What is the root of the problem? Three considerations come to mind.

1) Mortgages made too easy to provide affordable housing has resulted in too many families having to go back to renting. The root problem in real estate is too many houses: population shifts and housing speculation has resulted in having more houses than we have people to live in them. The housing glut means that real estate will be depressed for at least a couple more years.

From an endogenous standpoint, that means if you have a vacant house, cut the price until you can sell it. The root of the continuing housing problem is that too many people don’t price their vacant houses realistically. The price has to go down to the point that it makes financial sense for investors to buy them and rent them out.

2) The root problem with the stock market is that investors have reacted with sheer panic to the liquidity problem (caused by too many non-performing mortgages). The primary valuation indicators show that the worldwide stock market is underpriced. Governments are acting in concert to add liquidity, which is a very complex undertaking. Mistakes have been made with the bailouts, but eventually they will get it right. FDR didn’t get it right to start with when he battled the Depression, but he did engender confidence in people that the problem was being addressed. Confidence in our leadership will suffocate rampant panic.

Expect the stock market to rebound before real estate. It’s not a given that the market increases over the past 5 trading days signal the end of the bear market. The market will turnaround before the economy starts to recover, and when the market does turn around it is likely to increase very rapidly. That’s why we don’t want you to panic and sell off your portfolio, especially now.

3) Being ‘rich’ means having enough money to buy and do whatever you want. Being ‘wealthy’ means being rich enough to take time to enjoy life. It doesn’t take a lot of money to be rich, and it is too easy to focus too much on ‘rich’ rather than ‘wealth.’ The current problems in our economy remind us how transient our stacks of money are, whereas wealth is within our control. The root problem of feeling poor is our own mindset.

Thanksgiving is a wonderful time in our culture to reflect we are indeed wealthy, even if we are not as rich as we could be.

Monday, October 27, 2008

How Bad Can It Get?

It’s time to get our heads out from under the covers and face our worst fears. The financial crisis is world-wide, and the U.S. is actually better off than most countries. Iceland is bankrupt, and others (including Russia) are teetering. What happens when a crisis turns into a complete collapse?

Keep in mind that the worst possible outcomes are short-term. We’ll take a look at those and then look at the reality of the long-term.

Short-term Possibilities:

Scenario #1: Complete Financial Collapse. Likelihood = 1% - 2%. This could rival the Great Depression scenes we see in old movies with bread lines, tent towns of homeless, etc. You’re not able to use your credit cards, or write checks. In the worst case, where faith in US dollar evaporates, bartering or using gold becomes the basis of commerce.

This extreme outcome could be produced in our current economy if one or two extremely destructive exogenous events occur in the next year or so. These traumatic events could be anything from a huge California earthquake, Al Qaeda usurping power in Saudi Arabia and strangling the world’s oil supply, or severe weather changes brought on by global warming, etc.

We have suggested that clients who are genuinely concerned about this worst-case scenario keep 1-2% of their portfolio in gold bullion.

Scenario #2: World-wide Deflation. Likelihood = 5-20%. Countries try to protect their economies using tariffs, which sets off retaliation in other countries so global commerce dries up. Shortages become a way of life. Widespread deprivation kindles violence, terrorism escalates, and a large scale war may loom.

Even in this case, the dollar would likely be the world’s safe haven. Decreasing prices enable those who have cash or U.S. Treasury bonds to survive and prosper.

Scenario #3: Recession Reaction. Likelihood – 15-35%. Panic sets off contraction in consumer spending which cascades through the economy. Classic recession response, including lay-offs, unemployment of 10-15% in US, higher in other countries. The Euro may be destabilized by conflicts in monetary policies of member nations. Cutbacks in inventories closes factories; bankruptcies increase. Portfolio Panic Reaction leads many people to take foolish risks.

We work closely with clients to manage their endogenous risks, rebalance portfolios accordingly, make sure that adequate liquidity is maintained.

Scenario #4: Volatility Eruption. Likelihood = 25-40%. We are likely experiencing this phase now. Market prices in securities, commodities, housing, etc. take huge swings in waves of panic trading. Investors retreat to the sidelines, so trading volumes vacillate. This is how the market finds price balance, by testing the extremes. This could be a relatively short phase followed by onset of recession which could be severe, or gradually recover as markets begin to bounce back.

This is most difficult time for investors. In today’s economies this scenario usually stirs government intervention in the markets. This brings the danger that the money supply is increased faster than productivity gains which can trigger spiraling inflation. Having a long-term fixed rate mortgage is the best protection against inflation. Survival in this phase requires clients to turn off the TV.

Scenario #5: Bounce Back. Likelihood = 15-35%. If governments are successful in shoring up confidence in their economies, and adequate liquidity is available in capital markets, stable commerce will again emerge. Housing prices will drop to the point where entrepreneurs can buy up excess inventory and rent out homes with a positive cash flow. New business formations provide most new employment opportunities.

The stock market is likely to start rebounding a year or so before this phase kicks in. Clients guided by Functional Asset Allocation, which we preach, will prosper in this stage since they will not have sold off their stock holdings. Those who have continued dollar-cost-averaging, (e.g. through their 401-k’s, etc.) will enjoy rapid accumulation in their portfolios.

Long-term Outlook. Likelihood – 98-99%. As this downturn is relatively severe, it may take another 2-3 years to substantially recover. Then we will enjoy approximately 5.5 years (on average) of prosperity, which we will soon take for granted. On the next downturn, we will be again surprised. We will go through though another down-cycle as we have for the past century. Again we will think that ‘it is different this time.’ A year or so into that downturn we will again anguish about “How Bad Can It Get?” Then I will send out this blog again, as I did seven years ago in Nov. 2001…

Sleep well tonight! Bert

© Bert Whitehead, M.B.A., J.D. 2008

Monday, October 13, 2008

What Are Your Options Now?

Last month we could take some solace comparing the current bear market to past recessions. Last week, though, was the worst week ever for stocks, dropping 22% over eight trading days. The market is down 36% YTD and the Dow is back where it was in 1998. Even though this recent drop is due to irrational panic, is it time to switch gears?

Before outlining your options, it is still important to keep some historical and global perspective. So far there have been steeper market declines during the 1972-1974 recession and during the 2000-2002 dot-com bust. We are not on the brink of another Great Depression, when the market lost 93% from 1929-1932. Unlike the past, this market cycle is global and the markets in Japan, Britain, Germany, Australia, Hong Kong, India, China and France are all down well over 40%.

Here are your basic options, followed by our commentary:

1) Buy more stocks all at once

2) Buy more little by little (dollar-cost-average)

3) Hold everything to see what happens

4) Hold market position but review and reallocate investments

5) Sell some/all stocks for now and keep in cash, or buy bonds

6) Sell everything and put it in gold or under the mattress.

1) If you are a Gambler, you could take extra cash, or take out a home-equity loan (now offered at 3.99% through Schwab), and put it in the market as fast as you can. This is basically ‘market-timing’ which is always a mistake in the long run, but gives you bragging rights if you are correct (otherwise don’t tell anyone). If you are driven to do this, only do it with a small amount of money (5% or less of your portfolio) and don’t sell your bond ladder to get the cash.

2) Taking extra cash, or using your current 401k contributions, to dollar-cost-average into the market is actually the best option. If you are young enough this is a once-in-a-lifetime opportunity to provide for your retirement so you won’t even need to worry about Social Security (which you may not get anyway).

3) If you are retired, or need some cash flow from your portfolio, holding on to what you have provides peace of mind (assuming you have a balanced portfolio with a 15 year bond ladder with Stripped Treasuries). It is tragic to see how many people are letting money ruin their lives now by watching the news all the time, talking to everybody about how awful it is, mired in angst about whether they should buy or what they should sell. In the long view this will have as much impact on your life as last year’s Super Bowl.

4) Hold but review and reallocate as needed is a great idea. Of course you pay us to help you with this strategy. so we are biased toward this option. We have let you know when major shifts are called for (e.g. sell muni bonds) and can help you execute these changes. We are now reviewing our current portfolio holdings to see if there are better money managers in various asset classes, and will advise you as appropriate. If you are feeling very anxious, it may be a subtle psychological clue that you should have a lower risk portfolio due to endogenous changes in your life (e.g. employment, health, business/real estate risk). If this fits you, please call us to see if your portfolio should be reallocated.

5) Sell! Put it in the bank or buy bonds. This is folly because you are letting your emotions dictate your investments. This is one of the stupid things some smart people are doing with their money. Not only do you have to decide when to sell, but also when do get back in to the market. So you live out the next couple of years on the edge of your seat watching the market. When it goes up, you jump back in, but then get whipsawed as it drops again. So you sell and take your loss. On the next uptick, you lie awake every night wondering if you should buy this time. Get a life!

6) Sell everything and buy gold or put it under your mattress. This is one of the stupid things that stupid people do with money. Sure, keep some cash or gold within reach (not more than 2% of your portfolio) to hedge against financial Armageddon if that is comforting, but it is not an investment strategy.

We hope this outline of your basic investment options will strike a chord with you, and confirm that you are on the right course for your particular situation. If it is unsettling, please email us so we can set up a time to discuss further.

PS The Cambridge strategy of using the 15 year Treasury bond ladder is impacting the industry. See this Oct. issue of Money Magazine:

© Bert Whitehead 2008

Bert Whitehead, MBA, JD

Tuesday, October 7, 2008

Time to Act!(?)

If you haven’t been stewing about the market, don’t bother to read this. If you have been losing sleep over the market’s ups and downs, we hope this will put it in perspective. We had a conversation this morning with over 75 members of the Alliance of Cambridge Advisors (ACA) across the country to discuss the situation and appropriate action clients could take.

As of this morning the Dow was down about 25% YTD, and the European Markets are down over 30% YTD. The impact of the bailout won’t be felt for at least a month, and we are likely to see significant market volatility at least until the end of the year.

To put this in historical perspective, the Dow dropped 25% in one day in 1987. In the last recession, from 2000-2002, the market was off 45% at the bottom in 2002. A number of clients jumped out of the market in 2002 because they couldn’t stand the thought of losing half of their portfolio.

Alas, once burned, twice shy = so they were hesitant to put money back in the market when it started to recover, worrying it would drop again. During 2003, the market soared over 30%, and by the time they got back in during 2004 they were never able to make up for the loss they experienced from jumping out.

This market presents both dangers and opportunities for investors. Below we review actions you might consider depending on your stage in the ACA Life Cycle, as well as specific advice if this market is now impacting your cash flow. We have included all of the stages, not just yours, because many clients like to share this information with their friends and family.

1) Foundation - ages 20-30: This is a great time to buy your starter home. You have to shop for foreclosures and short sales though, or you might buy a house you could buy for half the money next year. If more than 10% of the home sales in your area are foreclosures, they are driving the market price, so hold back, no matter how tempting it is to jump in. In the meantime, pay off your credit cards and accumulate cash. Keep contributing to your 401k, since you can borrow this money for a down payment if you have to.

2) Early Accumulation - ages 30-40: Since by now your net worth should be 1 to 3 times your annual income, and you have a home, save-save-save. Hold off on home upgrades and renovations until you have built up a cash reserve of at least 20% of your mortgage balance. Split your 401k contributions 50/50 between cash/stable value funds and equity mutual funds.

3) Rapid Accumulation - ages 40-55: Your net worth is now 3-10 times your annual income so invest aggressively in your equity mutual funds to bring them to at least 60% of your portfolio. This is a great time to buy stocks using Dollar-Cost-Averaging (i.e. buying some every month). Doing this now will guarantee you a great retirement, and you will look back in 10 years and be amazed at how low the prices were. However if you are in danger of losing your job, see the section below on “Cash Flow Problems.”

4) Financial Independence - ages 55-70: At this point you are still working but supplementing your income with investment earnings. This is a dangerous stage right now. You want to make sure you don’t deplete your investment portfolio!
Either work more to increase your income, or cut your living costs.

5) Conservation - ages 70-85: You are probably now retired and should have your ACA Bond Ladder complete. It is critical to make sure you continue to live within your means. Excess spending means your portfolio will be depleted to quickly. Keeping to your spending plan will assure we will be able to replace the rungs you are using from your ladder when the economy turns around.

6) Distribution - ages 85+: Many clients in this stage are distributing their largess. We suggest holding off on additional gifts to children or charities for 6-12 months. You want to gift your largess, but you don’t know what that will be until this financial crisis ends.

For a more complete discussion of these life stages, we would suggest re-reading chapter 7 of “Why Smart People Do Stupid Things With Money” by Bert Whitehead, MBA, JD, who founded ACA.

Cash Flow Problems? Special consideration should be given in situations where a client is laid off or their business is losing money. You should contact us before taking any action. However, here are the sources of cash we suggest in order:
a) Cash: conserve it, and if you have depleted your cash to below 4 months living expense, consider borrowing money on your home equity line of credit (banks only lend you money if you don’t need it, so don’t wait until then).
b) Bonds: sell bonds which are not in a qualified (i.e. pension) account.
c) Stocks/Mutual Funds: sell equities which are not in a qualified account. At this point it is likely you will have a very low taxable income this year. If the stocks are at a gain, you may not have to pay capital gains tax if you are in a 15% bracket. If there’s a loss, you can use $3000 each year after offsetting capital gains and carry forward the loss to future years.
d) If you are anticipating a negative taxable income, we may want to use the opportunity to convert IRA’s to Roths.
e) If things get this bad, you may have to consider cashing in Savings Bonds.
f) If you end up having to live on your credit cards, we should be doing bankruptcy planning with you.

The economic situation could worsen substantially, particularly if there are compounding exogenous events like terrorists setting off a Middle Eastern war which interrupts the world oil supply, or a severe California earthquake, or a global health plague. These however are very remote. There is nothing you can do about these possibilities.

It is more likely that your endogenous situation could change due to a disability, layoff, divorce, etc. In these cases we should rebalance your portfolio accordingly, so give us a call to set up an appointment.

Finally, if you find yourself often anxious about the world financial situation, do yourself a favor and stop watching TV news or listening to the radio. The media has been hyping this issue to increase ratings, and of could all the politicians are bellowing about it to get votes. Most of them don’t really know what to do about it and just rant. Stop listening!

Warren Buffet is a calm, collected buyer in this market; Jim Cramer is jumping up and telling people to sell now! Warren Buffet is one of the richest men in the world; Jim Cramer earns a living with his antics. Who do you want to emulate?

Bert Whitehead, MBA, JD

Monday, October 6, 2008

Getting Out of Egypt

The Red Sea hasn’t parted, but at least the bail-out gives us some boats. Our problem now is to realize that the leadership skills needed to get out of Egypt aren’t the same ones needed to get to the Promised Land.

It is expected that the congressional action will have a calming influence on the markets. The next few weeks will be telling. Markets are still likely to show some volatility, so just remember that roller-coaster rides are always scary, but only dangerous if you decide to jump out (especially when going downhill…).

We are continuing to monitor the situation and will keep you informed. The greatest danger in this situation is that it could be aggravated by other events. Major financial catastrophes usually are due to a ‘perfect storm’ of exogenous events. For example, the Great Depression is variously thought to have been caused by the Smoot-Hawley Tariff act (which caused global retaliation and crippled our exports), or the run-up in the stock market due to low margin requirements, or the government not stepping in to save the banking crisis. In my opinion, the Depression was due to all three happening at once, and then compounded by the severe drought of the 30’s.

Serious exogenous threats would surely aggravate the situation today, like a major Calif. earthquake, Mideastern war, terrorist disruption of oil supplies, etc. However these are improbable possibilities which we can’t do anything about, except complain and worry.

The real threats in this environment are endogenous threats which you may encounter, like losing your job, or emerging health issues, or problems in relationships or with children. These endogenous events can be exacerbated by the current financial situation. I believe that these are times when a professional fee-only financial advisor offers the most value and can provide you with peace of mind. If you are losing sleep due to this situation, please let us know. We can help you figure out a plan to find the Promised Land.

Bert Whitehead, MBA, JD

Friday, September 26, 2008

How Safe Are Money Market Funds?

As you may have heard, the Federal Reserve has said that it will guarantee investors have in money market funds (MM) for the next 12 months. This was prompted by one of the largest and oldest money market funds ‘breaking the buck’ = i.e. the net asset value of the fund dropped from $1.00 per share to $0.97 per share last week. In the past, MMs have diligently maintained the net asset value at $1.00, even when they had to add their own funds. Due to this limited drop, many investors became concerned about the money they had invested in MMs and started withdrawing funds. To avoid a run on these account the Feds stepped in less than 24 hours later and issued the guarantee.

The question is: is this guarantee enough?

I am personally concerned that the ‘bail-out’ package now before Congress is being politicized by both sides of the aisle. I think much of the problem is caused by media-generated hysteria magnified by politicians on both sides during this election cycle. There is nonetheless a serious problem which demands action by our leaders. Government regulation is tricky: if too little, it doesn’t address the problems adequately; if too much they trigger the ‘Law of Unintended Consequences. ‘There are two dangers: 1) that delaying the bill beyond the end of the week will precipitate a liquidity freeze and market impact; and 2) by adding too many provisions to the bill will lessen the ability for the Fed to address the liquidity issue. Personally, I have more confidence in Paulsen, Bernanke, & Co. than in Congress.

Based on research Jason and I have done, I believe that Schwab is very sound, since they have avoided investing in sub-prime mortgages and related products. We have reviewed the holdings of the regular MMs offered by Schwab. They are well diversified and not exposed to the default risks other brokerages have taken on to increase yield. They will be participating in this new guarantee of MM funds offered by the Feds, as it will be funded by the brokerages who participate.

There are some unanswered questions, however.

How much of an investor’s deposits will be covered? We assume the minimum coverage will be $100,000, similar to FDIC coverage, but it may be more like $500,000 similar to current SIPC coverage (not gov’t. guaranteed).

Will this cover deposit by foreigners? Generally the Fed’s don’t guarantee funds of foreigners. If that is true, it may be expected that foreigners will withdraw funds from the MM funds which could trigger a run.

How much will be covered? Right now, there is $50 billion set aside to cover these guarantees. The problems is that the total amounts in MM funds is $3.5 trillion, so less than 2% is covered. It is likely that the bailout bill would give the Fed more flexibility, which is one reason for the urgency expressed by Bush and his economic advisors.

What are the alternatives for clients? Schwab offers a Treasury Money Market, which invests only in Treasuries. The current yield on this MM is 0.56% as compared to 2.04% on the regular money market.

The answers to these questions will be more clear once the bailout bill is worked out. For now our recommendation generally is that Schwab’s regular MM fund is suitable for our clients. However we are aware that a number of clients are very concerned about absolute safety, so the Treasury MM fund is recommended if you are losing sleep over the safety of your savings. Also, if you have over $100,000 in MM funds, we recommend you consider moving the amount you have in excess of $100,000 to the Treasury MM.

If you would like us to make a change in the money market in your account, please send an email to your Cambridge Team, and we will handle it for you. Also, let us know if you have any further questions regarding this.

Bert Whitehead, MBA, JD

Saturday, September 20, 2008

Holding Down the Fort When It's Raining Shoes

I started to write this update every day this week, and then another shoe or two would drop, so I keep starting over. Since this is a very fast-moving financial transition, I’ll strip this to the important details. Pam is also composing another email to all clients with a more general review of the situation.

Dangers: The biggest danger to clients individually is to panic. Mistakes of the past are unraveling, but this downturn is actually normal for a functioning economy with global growth. On average we have a recession every 5.5 years. We went through this in the 70’s with the S&L crisis, the market fell 25% in one day in the 1987, there was a real estate and international meltdown in 1992, then the dot-com bust in 2000-2002. Now, 5-6 years later, it’s time for another one. We have successfully survived financial upheaval before and we will survive this one.

For Wealth Management Clients, we are monitoring specific risks to your portfolio and acting when necessary. For example, when financial stocks are on the brink of collapse, we take discretionary action to sell them before they stop trading to assure that you will have a tax loss (if the bank goes into bankruptcy, you can’t take the loss until the stock is totally worthless which may be a couple of years). We have sold Fannie Mae stock, Lehman and Merrill Lynch in the past week in clients’ portfolios accordingly.

Other stocks, such as AIG and various money market funds, are being analyzed to determine what action is called for. At the current time, we are keeping Fannie and Freddie bonds in portfolios, as will as annuities, insurance, etc. held by AIG, and money market funds as it appears the feds are taking action to support these securities.

We are ‘watching your back’ continually, so you don’t have to worry about this, and we will continue to update you as needed.

Opportunities: We are generally recommending that clients with extra cash start Dollar-Cost-Averaging into the market. While we don’t know how low the market will drop, most assuredly we will look back in five years and recognize that today’s market was a terrific buying opportunity. It is not appropriate for all clients to be buying stocks now as individual situations may call for more liquidity (see below). Dollar-Cost-Averaging is overwhelmingly more profitable than trying to do market timing.

While US markets are down ~17% this year, international markets are down 25-30%, with virtually every country down over 25%. The Cambridge Global Growth Portfolio by comparison (down 18% YTD) demonstrates the advantages offered by FIM money management. The Cambridge Index Portfolio is tracking the US large-cap markets (such as the S&P 500) as they were designed to do. Unless there is a substantial market turnaround, we will likely have losses to reap which will carryover to future years

We are also cautioning clients in general to maintain liquidity by avoiding illiquid investments (e.g. real estate, partnerships, paying off mortgages, etc.). Because of the credit crisis, some banks are cancelling lines of credit and credit cards, not because the customer has been at fault, but because financial institutions themselves are having difficulty raising capital. We expect this will continue for the next 6-18 months and will advise clients on this individually.

Strengths: U.S. financial and economic foundations are strong, despite what the press says. Foreign markets in general have dropped twice as fast as ours as their economies adjust to new global realities. As Americans, we have unparalleled strengths in terms of education, innovation, and perhaps most importantly = experience. We have been through these crises before and have the leadership in economic matters (e.g. Paulsen, Bernanke, etc.) to respond appropriately. The solutions they have been implementing will not bankrupt the US – keep in mind we have had government intervention in the financial markets before, e.g. during the Great Depression, the RTC to buy assets of S&L’s in the 80’s, the loan to Chrysler in the past decade.

Of course it is a political football, which heightens public paranoia to attract votes. I don’t think that the politicians have a clue about these economic matters = interesting that no one on either side of the aisle saw this trainwreck coming a year ago! While our financial and economic leaders aren’t elected, they aren’t totally immune from political pressure. One of our society’s strengths is that we have very capable people in these key positions who are generally supported by both parties.

As your fee-only financial advisors, we are experience and knowledgeable, and know your personal situations. We have been planning for this possibility all along, which is why virtually all of our clients have US Treasuries in their portfolios to assure them of ample cash flow for 15 years. Interestingly, Treasuries have increased in value by a staggering 15.7% year to date during this market chaos as investors worldwide flock to them as the ultimate in safety. Yes, they have very low yields, but for this part of your portfolio, “Safety Trumps Yeild!”

Using Functional Asset Allocation concepts, you will also be in good shape to profit from the rebound. We do not sell off equity positions during market downturns, so when the market turns around, you will be poised to participate in the following prospertity. It is important to realize that market turn-arounds typically are leading indicators and begin 9-18 months before the economy starts to recover. Thus it is folly to try to guess when the market will shift: by the time you see the change in economic measures the market will have already bolted ahead.

We hope this update is helpful and comforting for you. If you have any questions please call us…we sell sleep, and if you’re losing sleep over this, we’re not doing our job!

Bert Whitehead, MBA, JD

Friday, September 12, 2008

Another Shoe Drops

The failure of Fannie Mae and Freddie Mac has resulted in an interesting bailout. Basically , the feds are now explicitly backing the bonds which Fannie and Freddie have issued, and throwing the shareholders under the bus.

Not to worry: none of our clients held any of their stock, at least in Schwab portfolios. If you have these stocks at another brokerage company you should call them. The shares dropped over 80% this week.

The feds actually had to back up the bonds because so many of them are held by foreigners, especially the Chinese, who were concerned about the safety of the bonds. Previously , the feds only provided an ‘implicit’ guarantee of the bonds. So to keep all the foreigners from dumping their bonds on the market, which would create major chaos, the feds have agreed to ‘explicitly’ guarantee the bonds.

We became wary of these agency bonds over five years ago, and have not purchased any for clients’ accounts. However, some clients have Fannie and Freddie bonds which were purchased earlier. With the ‘explicit’ guarantee, we are recommending that clients keep those bonds for now. There is a wide spread currently, which would mean a 10-20% loss if sold now, whereas the feds are on the hook for the full face amount if the bonds are held to maturity.

We will review this on an ongoing basis, and review your individual situation at your next appointment. At some point we expect that the spread will narrow enough to enable us to swap these bonds for treasuries, once the markets settle down.

If you have any questions about the current market situation, feel free to call your Cambridge Advisor. If you are in the Detroit area, you might be interested in a live seminar I am giving for PBS on Saturday, October 11 th , at their new Wixom facility. The seminar will address: “Yikes! What Do We Do Now?” Call Carrie if you want to attend = there is a $40 donation to PBS.

This is at least the third shoe to drop during this economic upheaval…how many feet do Financial Grinches have?

Bert Whitehead, MBA, JD

Friday, July 18, 2008

Looking for the High Ground July 2008

Looking for the High Ground

The faltering financial sector has raised awareness of the importance of keeping our money safe. This email will review the safety of brokerages as well as banks, with Treasuries as the benchmark. We are primarily looking at short-term options, comparing relative safety with yield.

Attached is a recent analysis to compare yields of various short-term options for cash which Chad Silver prepared in our office.

In comparing CD rates offered by various banks, keep in mind that the shakiest banks offer the highest rates. We use to evaluate the soundness of banks, if you are interested in using it. The CD’s we list are examples offered by banks rated 4 and 5 stars (5 is the highest rating). They are all available through Schwab and are still FDIC insured if held in your Schwab account.

Since some clients use brokerages other than Schwab, you might be interested in this analysis which Jason Moore prepared, comparing stock prices of various wirehouses. A steep drop in stock value doesn’t necessarily mean the company is headed for bankruptcy, but companies which go bankrupt all have dropping prices.

July 13, 2007 July 14, 2008
Charles Schwab $22.22 $19.04 -14%
Merrill Lynch $86.54 $25.93 -70%
Citigroup (Smith Barney) $52.52 $15.47 -71%
E-Trade $1.41 $.25 -82%
Morgan Stanley $73.26 $32.25 -56%
UBS $61.49 $18.72 -70%

All major brokerages, including those above, are covered by SIPC insurance. In the past 50 years, no customer of a brokerage company has lost money due to failure of the company which wasn’t covered by SIPC. Brokerages which failed and required SIPC to pay off their customers are usually small companies with bad recordkeeping, or tainted by fraud.

The only way you could lose money or securities in your Schwab account is if securities were stolen, and Schwab went bankrupt, and SIPC was unable to cover the losses. This is extremely unlikely. (Note that than limited partnerships, futures, foreign exchange transactions, commodity contracts, precious metals contracts, etc. are not considered securities).

Our general recommendation for clients is to use a FIDC insured checking account for general cash needs, and an SIPC insured money market for other cash reserves. For short-term cash, generally we only use Treasury Bills for very large amounts of money which would be beyond FIDC or SIPC limits.

We hope this information is helpful to you. Please let us know if you have further questions.

Bert Whitehead, MBA, JD

Monday, July 7, 2008

The Bear has arrived (supplement)

Now, however, we are in a global economy so it is instructive to note how the US compares to other countries’ markets (on a YTD basis through 7/3/08 except as noted). I have also noted how the holdings in most of our Wealth Management portfolios have performed.

US Markets:
Dow = -14.4% (large cap)
S&P 500 = -14.0% (large cap)
Nasdaq 100 = -12.9% (large cap)
Russell 2000 = -13.1% (small cap)
S&P 400 - -8.3%
S&P 600 = -10.9% (small cap)

International Markets:
MSCI EAFE = -15.6%
Dow Jones World Index = 13.7%
DJ Euro Stoxx = -25.0%
DJ Asia-Pacific = -11.0%

Popular BRIC ‘Emerging Markets’
Brazil = -7.3%
Russia = -11.2%
India = -33.7%
China = -46.8%

Typical WM Holdings:
Cambridge Index = -14.1% (large cap)
Cambridge Active = -7.9%* (mid cap)
CGGP (Cambridge Global Growth Portfolio) = -8.7%* (small cap + intl)
*(as of 6/30/08)

10 yr. US Treasury = +14.03% (52 wk. average).
Gold = + 9.0%
CGM Focus = +11.2%
CGM Realty = +3.1%

Utopia Growth = -10.1% (small cap and intl)
Royce Value Plus = -6.0% (small cap)
First Eagle Overseas = -4.2% (intl – unhedged).

Virtually all equity classes (i.e. stock market indexes) are down in the double digits YTD. The stock holdings in most of our WM portfolios are down considerably less than their corresponding indexes except for the Cambridge Index. In large cap, the Cambridge Index is mirroring the three large cap indexes as it was designed to do.

We are concerned about Utopia fund, which has fallen over 10% YTD. However, since all of this drop occurred in the last month, we are not recommending any changes at this point.

In summary, your overall portfolio is performing as it should. Overall the losses in values of stocks have largely been offset by increases in the value of Treasury bonds. We do not believe that any changes need to be made due to market conditions.

As your investment managers, the hardest recommendation to make in times like these is to “do nothing.” But, as the data shows, we are weathering the storm. I have found that reacting to short-term moves in the market is seldom worthwhile, and only increases investment expenses and taxes.

However, if you are feeling particularly uncomfortable with your investments right now, we should discuss your situation. I have found that often when clients are upset with their investments, they are experiencing endogenous changes in their life. These need to be addressed and if may well be appropriate to review your overall investment allocation to take into account other changes in your life.

Please let us know if we can talk about this, either at our next phone call or regular appointment. If you want to talk sooner, just let us know.

Warm regards,

Bert Whitehead, M.B.A., J.D.

The Bear has arrived

It’s official now: we are in a bear market, i.e. the Dow closed down more than 20% from it’s peak in October 2007. Interestingly, it was at this level in Oct. 2006.

As your financial advisors, we’re keeping a close eye on what’s going on. After a comparison of the market in general to the funds we recommend, we would not suggest changes at this time.

Stocks are down across the globe, with most indexes down in the double digits. The worst hit, as usual, are those that were the ‘hot’ markets in the past couple of years, e.g. emerging markets. This is why we don’t try to chase performance, or ‘shoot where the rabbit was,’ in structuring your portfolios. Our investment selection are performing as well as or better than their corresponding indexes.

Often clients who once thought they had a ‘high risk tolerance’ suddenly want to dump all their stocks in a bear market (which is officially where we are now). This is a principle reason we don’t base your asset allocation on ‘risk tolerance.’ Rather we try to structure your portfolio so that it is congruent with other risks in your life, and advise you on how much risk is appropriate in your portfolio.

For clients in retirement, who have followed our recommendations, you will see that there has not been much change in the total value of your portfolio over the past year, even if you are taking distributions from your investments. This is because 40%-50% of your portfolio is in Treasury bonds, and the increase in their value is largely offsetting losses in the stock portions of your portfolio.

For clients who are in the “accumulation” stages, this is the time when you are in the best position to significantly strengthen your portfolio. Not only should you stay in the market, the best move you can make in these times is to continue to add money to your stock portfolio. “Dollar-cost-averaging” (i.e. investing some money each month automatically on a monthly basis) is the best way to take advantage of a bear market.

Five years from now, you will look back and see that the investments you made during this period are among the best investments you will ever make in your lifetime.

However, if your personal circumstances have changed it may be appropriate to re-evaluate your asset allocation. If you feel ‘stock market anxiety’ right now, give your Cambridge advisor a call to review your personal situation.

Warm regards,
Bert Whitehead, M.B.A., J.D.

Monday, April 14, 2008

Economic Predicament (April 2008)

If It's Not One Thing, It’s . . .

. . . three or four things to make a real economic mess. What has caused the economic predicament we face today? Politicians are all pointing fingers, blaming the "Sub Prime Mortgage Fiasco," or the bursting of the housing bubble, or the falling dollar. It may be instructive to understand how these economic scenarios blow up from time to time.

The 'Great Depression' was variously blamed on Hoover/Rockefeller for not maintaining liquidity in the financial markets when runs started at banks. Others pin the fault on the Congress for the Smoot Hawley Tariff act, which raised our tariffs to protect American jobs, but set off a wave of retaliatory tariffs by other countries that decimated our exports. Often the stock market bubble of the 20's, where stocks were bought with only 10% margin, is fingered as the problem. The truth is, I think, that none of these events by themselves caused the Great Depression, but rather a 'perfect storm' where all these events happened in the same time period. Of course the record 'Grapes of Wrath' drought in the Midwest and plains states in the early 30's exacerbated and prolonged the depression.

This is true of other recessions too. In the 70's, the stock market also ended a record run-up at the end of the 60's, plus the Vietnam War was a huge financial drain. Inflation started rising rapidly, and was likely accelerated by Nixon's Wage and Price controls in the early 70's. Those factors were then aggravated by the increase in oil prices by the oil cartels, as well as the strategy of the Federal Reserve to cut interest rates to head off a recession. The result was 'stagflation' and the death of Savings and Loan companies, salvaged by the RTC.

There were mild recessions too. The late 80's had a brush with the junk bond collapse, compounded somewhat by the stock run-up in the Reagan years. But there were not enough negative whirlwinds to create a major recession. Housing hit some bumps in the early 90's, but again the national economics wasn't impacted by other forces, and in fact the increase in globalization and computerization propped up prosperity.

We were hit very hard in 2000-2002, when Greenspan finally broke the back of stock market’s 'irrational exuberance' which was then soon followed by 9/11. The era came to an end, impoverishing many nouveau-riche millionaires and decimating portfolios. It was the effect of these events happening together that produced the severe economic downturn, which in turn created huge unemployment.

Today we can see the bond market, which had become enamored of 'collateralized debt obligations' which were foisted on the investing public. This created another liquidity crises, and the stock market dropped as companies and individuals found they had committed to more debt than they could handle. The housing market, buoyed by speculators collapsed and now almost every region has a surfeit of excess housing inventory.

Will it get better? Yes, but maybe not right away . . . if there are other set-backs, we could face worse times. For example, if there is a string of
Municipal bond defaults, due to the overwhelming unfunded pension liabilities. Or even a severe earthquake along the California coast, or the overthrow of the Saudi Kingdom or other Middle Eastern political shift which interrupts the world’s oil supply. The economy can withstand one or two of these setbacks and recover quickly as it did in the 80's and 90's. However, if there are three or four of these storms which occur in the same period of time, we could see our economic situation seriously worsen.

The problem is that it is impossible to figure out the timing. It is a mathematical certainty that municipalities are not going to be able to pay the pensions they have promised to the baby boomers and beyond. Scientists agree that a major earthquake in California is inevitable. But no one knows when.

For each of us personally, we can protect ourselves from these outcomes by keeping a diversified portfolio. Treasury bonds are the stalwart buffer against deflation. If we encounter rising inflation and associated high interest rates, a long-term mortgage is our best protection. We will eventually see the dawn of prosperity again, and maintaining a diversified stock portfolio is what allows prudent investors to participate in long term growth.

So, even if it's not one thing, but three or four bad things that make a perfect storm, it's not a good idea to jump ship.

Bert Whitehead, MBA, JD

Wednesday, April 2, 2008

Is US Banking System a House of Cards? (March 2008)

Is US Banking System a House of Cards?

Bear Stearns, one of the largest wirehouses (i.e. stock brokers) in the country tanked this past weekend. That means their stock ended up being worth a little more than a penny on a dollar, dropping from ~ $170 to $2 per share. Shareholders, 1/3 of whom were employees, basically lost everything as JP Morgan bought up the pieces for peanuts.

This raises some questions inquiring minds want to know:

1) Is the US Financial structure about to fold like a house of cards? No. None of Bear Stearns clients lost any money in their brokerage or money market accounts (unless, of course, they owned Bear Stearns stock). Customers’ accounts were transferred intact to JP Morgan. Federal regulations require that clients’ accounts be segregated from firm assets, and are protected by creditors. Details of additional insurance coverage were reviewed in my last email. I personally spoke to Schwab’s compliance attorneys and am satisfied that our clients accounts are well protected. It is large financial institutions that incur the losses with these failures; retail customers such as our clients have never lost any money through the failure of large brokerages.

2) Where should I be investing now? Interest rates have been falling, real estate went bust in most locales, the stock market trends down (although it was up 400 points on Tuesday), gold appears to be in a speculative bubble. Cash looks pretty good right now, even as money market rates are just over 3%. I think dollar-cost-averaging into the stock market will pay off long term. Avoid making any illiquid investments (e.g. real estate, business ventures, etc.).

3) Are the days of a comfortable retirement gone for good? No = the key is balance. A portfolio properly balanced with bonds & cash, real estate, and a diversified stock portfolio will endure. You are protected against deflation, inflation, and still poised to participate in times of prosperity.

4) How long will this last? I’m not a market timer. I am concerned about clients surviving the downside. Things could get worse economically if the municipal bonds market collapses, and there are indications it may. So balance is more important than ever, and trying to guess which way to jump not only produces insomnia, but has been shown to be an almost certain road to lower investment returns. Over the past 20 years, as the market has risen 12%+ per year on average, the average investor has only earned 8% on their stock portfolios. The lower returns are contributed to by higher costs and higher taxes, but most of all are due to clients jumping in an out of the markets. The real costs are in the angst and anxiety of focusing on ‘the market’ rather than ‘the future’ = that’s why you have Stripped Treasury Bond Ladders!

Remember, if you decide to get out of a dropping market, you have to make two decisions right: when to get out, and then when to get back in. Clients who just stay put don’t have to agonize about either, and ten years from now will be farther ahead. Please call us if you have any questions or want to discuss your situation.

Bert Whitehead, MBA,JD

Could Chicken Little Be Right? (March 2008)

To: Cambridge Connection Clients
Could Chicken Little Be Right?
Being a long-term investor is like being on a roller-coaster: The ride up is exhilarating, but the ride down is scary! Here are the answers to some of the questions you may be thinking:
1. Is my portfolio safe? Yes, because you have a substantial amount of your portfolio in US Treasuries. They are very strong, and increasing in value, because there is a world-wide flight to safety. Treasuries are the ‘high ground’ in the investment world…actually more like the top of Mt. Everest.
2. What should I do about the falling dollar? Your portfolio includes a significant allocation of foreign stocks, which are not hedged. All other things being equal, the value of these increases when the dollar falls. This protects you some degree against the falling dollar, but not against a world-wide recession.
3. Almost all my money is at Schwab: is it safe? Your accounts at Schwab are protected by SIPC insurance of $500,000, plus additional insurance on $150,000,000 ($600,000,000 in aggregate) provided by Lloyds of London. They are not government guaranteed, but the only way you could lose anything is if a) Schwab become insolvent, and b) your securities were missing, and c) your accounts exceed the insured amounts. This is highly unlikely = you have a better chance of winning the Big Lottery.
4. What is the most important thing I should do right now? Don’t panic. This is a normal market cycle. The worst thing to do is to jump out. The stock market is volatile, and we will be advising some clients to start ‘Dollar Cost Averaging’ into the market since prices are so low. But of course we don’t know how low they could go.
5. Should I buy gold now? Many of our clients do own gold, but it’s not the right investment for all clients. Give your Cambridge Advisor a call if you would like to consider it.
Rest assured that we are watching this situation continually. We are concerned about the safety of municipal bonds, but we moved those out of client’s account a couple of years ago. Call us if you have any questions.
PS Schwab has lowered the minimum grant for Donor Advised Funds to $100 from $250. The minimum to set up an account has also been lowered to $5,000 from $10,000.

Bert Whitehead, MBA,JD

Got Treasuries? (January 2008)

To: Wealth Management Clients

Subject: Got Treasuries?

Just a note on the current volatility of the world markets (which means stocks across the globe are getting hammered). We generally don’t comment on market moves, as we are not market timers. We do know, however, that many clients may be concerned about their portfolios, and looking for guidance. Here are a few points to consider:

• Your portfolio is protected by your Treasury Bond Ladder. Virtually all of our WM clients have a significant portion of their portfolio in Stripped Treasuries. Many clients doubted the wisdom of buying Treasuries last year, or 3 years ago, or 10 years ago because ‘rates are too low!’ I have a saying: ‘Safety Trumps Yield.’ Your Stripped Treasuries are now keeping your portfolio buoyant. Your yield is locked in while current yields are falling further as there is a world-wide flight to safety in the financial markets.
• No, it is not a good time to bail out of stocks. Your bond ladder assures you 15 years of cash flow guaranteed by the US Treasury. History, documented in many studies, has repeatedly shown that jumping out of stocks in a bear market results in long-term portfolio loss. Stocks are a long-term investment; ask yourself: where will the market be 5 or 10 years from now? Plus, if you get out now, you have the problem of deciding when to get back in. As dramatic as this downturn is, the upturn will be just as sudden and dramatic. You are better staying put with your treasuries than losing sleep over when to get out, and then when to get back in.
• How long will this bear market last? Historically, down markets recover in a couple of years after hitting the nadir. This one could be longer, however, as the specter of municipal bond defaults due to unfunded pension liabilities haunts the market. Many muni bonds which were AAA insured were considered safe. But now the insurance companies that ‘guaranteed’ the bonds are being downgraded as they have lost so much in the subprime debacle. Many municipalities, no longer rated AAA, are not able to raise taxes enough to cover the looming avalanche of baby-boomers pension payouts. Since these pensions are not federally insured, defaults in the muni markets could provide a double whammy to the financial markets. This could delay recovery for as long as 5 years. Which is why your bond ladders are built out for 15 years…

Rest well: we’ve got your back covered!
Bert Whitehead, MBA, JD

Thursday, March 27, 2008

Market Watch (January 2008)

Market Watch

For those of you who are watching the financial markets, this is a must read. For those who have learned to be comfortable tuning out the markets, you can disregard this…

Recently the world markets have been very volatile, trending downward in stocks with unusually wide swings almost every day. Politicians and the news media have turned their attention from the war situation to the economic arena. Clients may be bombarded with advice from all quarters urging them to take action now: Buy! No, Sell! Get into Asia! Get out of all stocks! Don’t buy bonds now, the yield is too low!

We have used the principles of Functional Asset Allocation through the ups and downs of market cycles (see ch. 8 in “Why Smart People Do Stupid Things With Money”). Understanding how to apply the principles during times of market turmoil strips decisions of emotional content and relieves the tendency to believe whoever we talked to last. Here are some pointers:

Your portfolio has been structured by your Cambridge Advisor to achieve balance. Your bond portfolio, especially a treasury ladder where you have sufficient assets, protects you from deflationary times like these.
Your real estate, especially if you have a fixed rate mortgage, protects you against inflation (which is still increasing!).
Your stocks and equity mutual funds propel your portfolio during times of prosperity.
The balance of these three asset categories is based on an assessment of your personal risk profile, not exogenous changes in interest rates, stock market moves, the value of the dollar, etc.

Don’t even think of jumping out of the stock market. Generally the right thing to do is to continue ‘dollar cost averaging’ (adding a set amount each month) into the stock market, keeping large cap US, small cap domestic, and international stocks in proportion. If the stock market continues to drop, know it will eventually turn around and the stocks you buy now will be among the best investments you make in your lifetime.

Even though interest rates seem low, continue building your bond ladder. This is especially important if you are past the accumulation stages of the financial life cycle.

If you have a vacant house, stop ‘trying to sell it.’ Cut the price and get it sold. Your carrying costs will bury any additional money you think you might get by holding onto it.

That having been said, if you are losing sleep over your financial situation, now is the time to call your Cambridge Advisor for a consultation. We have found that often when clients get upset about the ‘market,’ they are actually concerned about changes in their personal situation (e.g. getting laid off, unforeseen medical expenses, etc.) which warrant an update of their risk assessment. In these cases, a shift in your portfolio may be advisable.

We hope this Market Update will calm your concerns: we are watching your investments on an ongoing basis. Nonetheless, please call your Cambridge Advisor if you have concerns because of changes in your personal situation which may need to be reflected in your portfolio.

Bert Whitehead, MBA, JD