Winter 2016 Market Review
Moderator:
Welcome, and thank you for standing by. At this time, all participants will be on a listen-only mode. This call is being recorded. If you have any objections, you may disconnect at this point. I would like to turn over the call to your host, Sally Brandon, Vice President of client services at Rebalance IRA. Sally, you may begin now.
Sally Brandon:
John, thank you. Good afternoon everyone and thank you for joining us for today’s Rebalance IRA Winter Conference Call focusing on the fourth quarter. I want to say a special welcome to all Rebalance IRA employees, clients, prospective clients, and friends who are joining us and listening in this afternoon. We will begin in just a moment with comments from Rebalance IRA Managing Director and Chief Investment Officer, Mitch Tuchman. After comments from Mitch, we will respond to client questions that we have received over the last three months. Clients are always welcome to submit questions via email to [email protected] for future conference calls. A digital playback of the call will be available on our website at rebalance-ira.com/conferencecall.
Please refer to our public filing to the U.S. Securities and Exchange Commission (otherwise known as the SEC) on the legal link at the bottom of the Rebalance IRA website for more information on the various risks and uncertainties.
Mitch, we are ready to get started.
Mitch Tuchman:
Great, Sally. Thank you and first of all, I would just like to say welcome to everybody on the call, especially our clients and employees at Rebalance IRA who are sitting in. During this call, I first plan to review the market and Rebalance IRA asset class performance. Then I am going to talk about this quarter’s topic, which is particularly germane to everyone who is watching the market the first part of 2016, and speak to why the portfolios that we build are very safe via the diversification that we use at Rebalance IRA. Throughout the call, we are going to take a few questions from Sally that we have received from our clients over the last several months. Again, we like questions so if any of you have them for the next conference call, which will be in about three months from now, please send them to [email protected]
Anyway, let’s get started. The markets were very jittery throughout the latter half of 2015 and the beginning of this year; they have gone from slightly nervous to absolutely jumpy. When portfolios rise for six years, everybody is wondering when the music is going to stop. Finally it did, in the beginning of this year. In January alone, in the middle of the month, global markets were down 9%. That makes us all spooked about the dark days of 2008, but this time it is a lot different.
It is really all about energy and falling oil prices, they have become today’s catalyst. They are driving everything; fear in every asset class from technology stocks to banks to, of course, oil and gas stocks. While cheaper oil is very good for the American economy because Americans have more money in their pockets via gas savings and cheaper airline tickets, there are some players that suffer. Those employed in the oil patch, while a small number in the U.S. market, will see some unemployment, but what is also worrying everyone is a higher risk of default on bonds. A lot of bonds were issued, particularly high-yield bonds, to borrowers who are oil producers, so the banks and financial institutions that have issued those loans are getting worried. What happens in this type of panic is traders sell first and then try to figure it out later.
Then there is China. China, the second-largest economy in the world, is slowing. For the last twenty-five years, China has been building its infrastructure. The economy has been sucking up cement, oil, gas, steel, and commodities to build cities, bridges, and highways. Now, the Chinese are moving from an economy-building infrastructure to one that is going to be similar to the American economy in terms of services to consumers, which means considerably less demand for oil and, of course, that is spooking investors.
Add to the mix the fact that Iran has had its sanctions lifted and is beginning to ship oil. You have, perhaps, too much supply and not enough demand, and that is a big shift from ten years ago.
Additionally, the Fed finally decided, after almost a decade, to start raising the interest rate in America. That is akin to taking the drugs away from an addict. It is painful, and there are withdrawal pains, which many market watchers are saying was part of the decline this year.
Against this backdrop, our Rebalance IRA Investment Committee convened a meeting in New York City January 15, 2016, where we spent the better part of a day reviewing the portfolios, the market, and the company in general. You might say, “Well, aren’t you going to do something about all of this?” Really, the unequivocal answer is that the Investment Committee decided that the portfolios are in great shape. They are exactly as we have designed them. The portfolios are operating in exactly the way the Investment Committee intended them to during markets like this. There is really nothing that we have changed, nor anything that concerns us. Again, market upsets, market volatility, black swan events (an event that comes out of the blue), these are the kinds of things that the Investment Committee has anticipated in building the retirement portfolios. There is really no change, and in fact decades of research support the position that we have taken and our experience shows that we are prepared to ride these types of markets out.
The positive news about these market conditions is that our client portfolios are spewing forth dividends every month. As these dividends are coming in at this kind of pricing level we are able to buy back more stock for our clients at even lower prices. Those of you in retirement, or those of you saving for retirement, can rest at ease that these downdrafts are a great opportunity. We are not particularly concerned.
Moving on to asset classes, we work with two broad asset classes to build our client portfolios, which we will discuss later in the call. Generally speaking, in 2015 all of the asset classes were up or down, give or take about a percent, except for two. Whether it was the U.S. stock market, which held steady for most of 2015 despite a little bit of a disruption that self-corrected in September, U.S. stocks were up a little less than a percent. U.S. small cap stocks were down a little more than a percent. The emerging markets asset class was the big loser in all of our portfolios last year, at close to 15% down, while the high-yield convertible bonds (which were affected by oil) were down 5%. This includes the interest paid, which is roughly the same.
Now on to Rebalance IRA client portfolios. First, let me state an SEC compliance disclaimer: these are not actual client portfolios but rather portfolios that were back-tested using sophisticated software that accurately estimates portfolio returns. The bulk of our client portfolios this year, in 2015, were down between 1.5 and 2.5%, which is not bad. The Investment Committee was very happy with that. At any rate, that is what happened this year in our view of the market and really, the fact is that we are very happy with how these portfolios are constructed because they have been designed for exactly these kinds of turbulent markets.
With that, Sally, I would like to hand it over to you. I know we had a couple of questions from clients over the last several months that are relevant to what I have been discussing. What do you have for us?
Sally Brandon:
Sure, the first question I have is from Rita, who asks, “Since the market seems to be getting worse, shouldn’t we sell everything and get back in when it’s all over?”
Mitch Tuchman:
Well, that is a great question and one that is on many peoples’ minds when you have a market behaving as it currently is. Rita, your question, “Shouldn’t we sell everything and get back in when this is all over?” presupposes that someone, me or the Investment Committee or someone outside of Rebalance IRA, knows when this will be over. The assumption of knowing when the market improves is fundamentally the big lie. That is what we call “market timing.” Wall Street and the financial services industry are very much about convincing investors that they have predictive powers about when the markets are going to go up and when they are going to go down. In fact, I turned on CNBC just this morning and there were market forecasters declaring where the S&P 500 would end up this year, when the rout would be over, et cetera. I really feel, based on decades of research and every scientific study that I have ever been exposed to, and I’m speaking both for myself and our Investment Committee, that the people who say they know where the markets are going to go might as well be wearing wizard hats from a fairy tale.
There is nobody that has accurately predicted the ups and downs of the markets for decades on end. If the Investment Committee or myself knew when this was going to be over or where it was going, absolutely, we would act on that information and knowledge, but the fact is no one knows. If you take that as a given, you have to do something very different in the way that you invest your retirement portfolio. You have to build and construct a portfolio that will ride out these stock market moves and grow as the markets grow, which is exactly what we have done. Rita, the answer is, we would love to sell everything and get back in. It may be painful to watch, so my advice would be, and this is not to be flip, simply do not watch the market, because your Rebalance IRA portfolio is built to recover and there has never been a period of time over five years where the portfolios that we have constructed, and the indexes contained in them, have not recovered from market changes.
At any rate, Sally, would you like to share the next question?
Sally Brandon:
The next question I have is from Anna. She asks, “I’ve heard about stop-loss order you can put in a portfolio to protect it. Do you use those to keep my portfolio safe?”
Mitch Tuchman:
For those of you who do not know, what Anna is asking about is another financial services Wall Street sales pitch to convince clients that they can limit their losses. What stop loss orders are, are little devices one can put in a portfolio so that if the price of a fund hits a certain point the device automatically sells the fund. Our answer, again, to that question, predictably, is absolutely not. Again, if you look at the evidence, this is another form of market timing. It’s saying that when a stock hits a certain point or a fund hits a certain point, I am going to make sure it is sold. Then I will be in cash. Unfortunately, those who do that tend not to repurchase the fund or the stock once the stop-loss is executed and then they miss the move back up. If you look at all market data about big moves in the stock market, the moves are very swift and very large. Markets decline very quickly over a matter of days, they also go up very quickly over a matter of days. There are numerous studies that show if you miss the top several days of the market over several years you miss a very big part of the return.
No, the biggest advantage our investors have, Anna, is that we are long-term retirement investors. We are not in this to use the market to make short-term money. We are in this to participate in the growth of global capitalism. Because we are not rushed or hurried or forced to take our profits off the table, we have the benefit of being able to allow these dips to be at our advantage, particularly when we are adding money through dividend reinvestment. This is really another version of Rita’s question and we would honestly be doing all of our clients a disservice with stop-loss orders.
Anyway, Sally, I know you have a couple more questions, but I think they may be relevant to the next section.
I would like to talk about what we mean by diversification. The word is bandied about quite a bit. It’s pounded into investors’ heads. You have to be diversified. I do not think people fully appreciate what diversification is, so let me talk about what it is not.
We had a client the other day that came in and had thirty big U.S. stocks, predominantly Dow Jones Industrial Average stocks. He felt that he was very diversified. Diversification is not owning thirty stocks. It is not owning thirty funds. Funds do different things. You could own a fund that focuses on an industry like the software industry, or you could own a fund that focuses on a sector like the technology sector or the energy sector. Owning a bunch of those funds is not diversification.
Diversification is akin to making a fine salad or putting together a great orchestra or jazz band. It is very consciously constructed with various attributes in mind so that the construction of the portfolio leads to an optimal and efficient diversification, which is what Rebalance IRA is paid to do. It is what your Investment Committee knows how to do. It is our expertise. It is where we are highly, highly sophisticated. We know how to diversify a retirement portfolio. That is what we are in the business, largely, to do. Let me take a few minutes and talk about that.
What diversification really means is that you want to take money of a client, of a retirement investor, and spread it into various buckets. These buckets tend to do different things during different economic circumstances. Right now, while we are experiencing panic in the market, where is the money going? It tends to go into bond funds because during markets like this the bond funds profit, thus why we own them. Other types of funds do not do as well in this particular market, in particular funds that have any kind of energy exposure or financial exposure, like our high-yield bonds in emerging markets. Yet, in other markets, real estate might do well, so we own real estate. In markets where people are excited about the prospects of the world economy, they are buying smaller companies. The trick of our trade is really understanding this concept of asset allocation, how to allocate your assets into the right buckets.
In fact, there is a study done by Yale in which they analyzed the portfolio performance of professional investment managers over a long period of time. They tried to extract what the factors were that really drove portfolio performance. In other words, if one portfolio manager was up, why was he up? We should understand the factors that led to out-performance or under-performance. Number one, one thing that had very little to do with it was stock selection. The manager’s ability to select stocks had very little impact on investment returns. Also, they tried to understand if there were investors who knew how to get in and get out of the market at the right time. We have talked about this during the call, timing the market. In fact, those who tried to time the market had very little impact on investment returns. The one decision that impacts over 90% of portfolios’ performance is, again, this concept of asset allocation. It’s how you move money around in a portfolio.
Sally, I think you had a couple questions related to that as well.
Sally Brandon:
I do, I have two more questions. The first question is from Fred. He sent in a question related to international stocks. He asks, “My exposure to international and emerging markets continue to be disastrous investments for me. How can we keep justifying continued reinvestment in this sector when everything I read is so negative on its recovery?”
Mitch Tuchman:
Well, that is a great question. First of all, we do notice that emerging markets have had a very bad year. I think all of our clients have gotten a document from us. They get this document every year, titled “Which Asset Class Does Best?” Every year, there is inevitably an asset class that does poorly. This year that asset class has been emerging markets. What you will notice from the data, is if you take the long view, which is an absolute necessity for Rebalance IRA clients, the asset class that does poorly usually becomes the winning asset class within several years down the road.
The fact is right now, Fred, emerging markets and international stocks are incredibly inexpensive. For example, I am going to pull up some numbers here. There is a useful metric to assess evaluations, called a cyclically adjusted priced-earnings multiple or a CAPE. Forget all the mumbo jumbo, but basically this measurement shows that the U.S. market at the end of last year was at a twenty-six price-to-earnings multiple, well above the long-run average. Japan was at 20. Europe was at 15, and the emerging markets were at 10, which is well below their long-run averages. In fact, right now, your emerging market fund is paying 3.5% dividends with all the growth that is available to those securities.
A 3.5% dividend is well above anything that you can make with Treasury. While these evaluations have been compressed, we have been buying more of those securities and we have been collecting incredible dividends. Also, remember that the funds that represent each of these asset classes, such as emerging markets, are comprised of almost a thousand companies in over twenty countries. It is not like owning one stock that could go down and never come back. It’s not even like owning one fund, such as an energy fund or a biotech fund, that could get hammered from some event and never come back for many years, like the QQQ or the NASDAQ. In this fund you own a thousand companies in the largest and fastest-growing emerging market economies in the world. We do not worry about it. I think the word “disastrous” is a bit of overkill. In fact, this is about smart portfolio management.
The last point I would like to add is that if there was not a loser in your portfolio, then we would not be diversified properly. I’m going to say that again. If, in your portfolio, there was not a loser asset class, then we would not have been diversified. It would have implied that we were actually too much exposed to things that look alike. The notion of diversification does imply what may be perceived to be a cost. You buy auto insurance and it costs you money every year, but if you pay your premiums and the year is over and you did not get into an accident, you would not bemoan the fact that you paid the premium. You would say, “That was the price for being safe.” That is why we own international stocks and will always plan to own international stocks in our portfolios for that very reason.
Sally, what is the next question?
Sally Brandon:
Our last question is from Howard, who asks, “For someone like me who is drawing money out of my retirement account for required distributions, should I be worried when these corrections hit that we might have to sell my funds at a lower price?”
Mitch Tuchman:
That is a very pertinent question, and for our retirement investors who are living off of their income from their retirement investing this is something that, at times, can get under your skin. One of the things that we pay a lot of attention to with our clients at Rebalance IRA is what percentage in retirement you need in order to take out of your portfolio, in most cases, the percentage of withdrawal from an account. For example, Howard, you are in your mid-seventies if I properly recall. You are required to withdraw 3.8-ish% out of your portfolio. The portfolios that we offer and build for our retired investors generally have enough dividends being paid to provide the required minimum distributions. While stock markets do go down, sometimes dramatically in a particular year, and we do have to trim a little bit, over time we really do not feel that the distribution rate is going to make a material difference in the growth of the portfolio, even when we need to distribute during down years. I can understand the concern. However, if you do the math, there is really nothing to be concerned about.
Sally Brandon:
Okay, great! Well that is all we have in terms in questions today, but Mitch, do you have any closing remarks?
Mitch Tuchman:
Yes, I do. I want to let everybody know about something that has been going on with Rebalance IRA in Washington D.C. that I think is of great interest and should probably be something that every retirement investor should know about. My partner and Co-Managing Director Scott Puritz has been literally front and center stage in a huge fight going on in Washington between the Department of Labor and the financial services industry. It is important to understand this. This fight has been buried in the pages of the newspapers, but essentially the U.S. Department of Labor, which oversees 401(k) plans and retirement plans for investors in American, has been able to successfully win a very big, almost David-and-Goliath-caliber fight, the financial services industry being Goliath and David being the Department of Labor. There are rulings that are to be put in place late March or early April that are going to be historically pro-consumer.
What has been happening is many brokerages in America have been able to hide fees and operate under business practices that are abhorrent and should not be allowable for people with retirement accounts. Brokers have been able to sell clients mutual funds on a commission basis, with the client being none the wiser. We onboard new clients all the time, and there is a category of them we call, “brokerage refugees.” They have been at a stock brokerage house. They did not know that they were paying 2% to 2.5% in fees. When they become a Rebalance IRA client we bring those fees down 50 % to 65%, saving them perhaps the difference between a healthy, enjoyable retirement and one where they may need to supplement retirement with work. These fees and these practices have been a horrible thing for retirement investors. Finally, the Department of Labor will be able to get these regulations passed.
Beginning in March and April, upon the ruling, the entire industry of brokers and insurance agents who were selling retirement investments to everyday investors in their IRA accounts are going to have to disclose the fees in a much more transparent way. It is similar to when the bad business practices within the auto industry were brought to light and they had to begin disclosing their fees. It changed everything.
We have been, as a company, very much involved in this. I mentioned that Scott Puritz testified on behalf of the U.S. Senate on Capitol Hill. Secretary Perez of the U.S. Department of Labor asked one investment firm to testify. He chose ours and he chose Scott Puritz to testify in front of the Senate. Scott was grilled by Elizabeth Warren and Al Franken, two very prominent senators in America. Literally, Rebalance IRA was held up as a poster child for how investing should be about the retirement investor, not the broker. If you would like more information about this issue and our involvement, let us know, we are happy to provide you with some materials. This DOL ruling is very important for anybody who is a retirement investor in America to understand because things are going to change, and they are going to change for the better.
At any rate, this is all I have for everyone today until the next conference call. I would like to thank everyone for being on our call, our clients, prospective clients, and the staff. It has been a really great year, 2015. I think it is very gratifying to watch our clients surviving these sorts of markets, saving a lot in fees and bringing friends to join us at Rebalance IRA.
Sally, I will turn it over to you.
Sally Brandon:
All right, thanks. Just a reminder everybody that a playback of this call will be available on the Rebalance IRA website at rebalance-ira.com/conferencecall. We will also be sending out an email to all of our clients as a reminder. I thank everyone for joining us.
Moderator:
That concludes today’s conference. Thank you for your participation. You may now disconnect.
Fall 2015 Market Review
MODERATOR: Welcome and thank you for standing by. At this time all participants will be on a listen-only mode. This call is being recorded; if you have any objections, you may disconnect at this point.
I’d like to turn over the call to your host, Sally Brandon, Vice President of Client Services at Rebalance IRA. Sally, you may begin now.
SALLY: John, thanks so much. Good afternoon everyone and thank you for joining us for today’s Rebalance IRA Fall Conference Call regarding the 3rd quarter. I first want to say a special welcome to all Rebalance IRA employees, clients, prospective clients, and friends who are joining us and listening in this afternoon. We will begin in just a moment with comments from Rebalance IRA’s Managing Director and Chief Investment Officer, Mitch Tuchman. After comments from Mitch, we’ll respond to clients’ questions that we have received over the last three months. Clients are always welcome to submit questions via email to [email protected] for future conference calls. A digital playback of the call will be available on our website, www.rebalance-ira.com/conferencecall. Please refer to our public filings for the SEC on the Legal link at the bottom of the Rebalance IRA website for more information on the various investment risks and uncertainties. Mitch, we’re ready to get started.
MITCH: Sally, thank you very much and thanks to everyone for joining us today, especially our clients and employees at Rebalance IRA who are sitting in. During this call, I first plan to talk about the market and the Rebalance IRA asset class performance, then we’ll take a few questions that we’ve received via email from clients, and then I’m going to discuss this quarter’s topic which we’re calling The Life of the Active Manager which was reflected in our quarterly update. Then we’ll take a couple questions that came in related to that. Throughout the call, we will be responding to questions, so if you have questions in the future you can always submit them to [email protected]. Let me first talk about the market and the performance.
As our clients, you have all received a colored mosaic chart. We like to talk about each asset class and how they all work together and grow in different ways and different amounts during the year. As a matter of fact, each asset class has its own characteristics. U.S. stocks operate differently than foreign stocks, which operate differently than bonds, which might operate differently than real estate, and this is the gist of our whole diversification approach. The idea is if you mix enough asset classes together that are all doing different things, and as we say in the business, uncorrelated, you get a better result, more diversification and a way to grow your money in a safer way. So that’s why we own a little bit of everything and if, as we all know, every season, every quarter, ever year, there are certain asset classes that do well and others that don’t do well. If we don’t have asset classes that are performing poorly in a quarter, we’re in fact not really well diversified. Right now, through the end of the 3rd quarter in September, the income portion of our portfolio was down 1.6%, but by the end of October it had recovered and was down 1.1%.
Let me take you through the income asset classes. We have high yield dividend equities – this is unique to Rebalance IRA – that we use a proxy for a bond fund because interest rates are artificially manipulated by the government and kept artificially lower than they normally would have been if the market had set those rates by its own market forces.
Equity stocks were down 6.7% through the end of the 3rd quarter; however in October, they largely recovered.
U.S. corporate bonds, which are what we use instead of treasuries for Rebalance IRA clients, were up 1% for the quarter and they are up even further now at the end of October.
We also use high yield corporate bonds and that’s generally been a very strong performer but it did slip within the 3rd quarter and, for the year to date, high yield corporate bonds are down 3.7%.
With the slowing U.S. economy, some are worried that some of these borrows could be pushed into default. We love high yield corporate bonds; they pay a lot more interest than treasuries and also because these are not the greatest borrowers – I’m not talking little companies; think CitiBank and other very big companies that don’t have a pristine credit rating – they cannot lend money out very long so the maturities of our high yield bond fund is closer in. We believe that this greatly offsets interest rate risk by having a fund of bonds that have a short maturity in general, relative to something like government bonds.
Emerging market bonds were also held back over the quarter, but year to date, emerging market bonds are up 2%.
In the growth asset classes, where we expect to make more of our money, through the end of the 3rd quarter, we were down 6%. However, by the end of October, the growth part of our portfolio were largely flat, so we recovered a lot in the month of October.
We have U.S. stocks in that group and a lot of the down side of U.S. stocks over the quarter was because of China – people were worrying about China – so it pulled back. Our U.S. stock market fund was down 5.5% by the end of the 3rd quarter, however that was largely recovered in October.
Same with small cap stocks. Small cap refers to companies that have a market value of a median of a billion dollars versus the much larger companies which could have market values of hundreds of billions of dollars.
Emerging market stocks, again largely due to China, are down 14% for the year.
Developed countries – countries like Japan, the United Kingdom, and Europe – have been doing better than the U.S. They are down 3.4% as of the end of the quarter.
Real estate, which was up almost 33% last year, has taken a deep breath and is down 5.7% through the end of the 3rd quarter.
At any rate, the growth asset classes are doing fine. They have largely recovered and if you roll them all together, you have phenomenal portfolios that we believe mix risk and return in a great way, depending on the client’s risk tolerance.
I also want to mention that these portfolios have been constructed by our Investment Committee – Dr. Charley Ellis, Professor Burton Malkiel, and Jay Vivian who collectively have over 150 years of managing money for very large retirement pools and endowments. This approach is extremely scientific and it’s one that we have our own money in as principals of Rebalance IRA, one we are very proud of. During corrections like this, don’t sweat it too much given the nature of how these portfolios are constructed
That’s about it on the asset classes. Sally, you mentioned that you had some questions from our clients that came in via email.
SALLY: I do, and I have one relevant, great question. It’s from a client on Long Island who asks, “If China is having so many problems, wouldn’t it be wise not to have it in the portfolio?” Mitch, what are your thoughts on that?
MITCH: Every asset class has problems at some point, and this quarter the big rap is against China. People were calling us wondering why we have China in the portfolio. We all know China’s having problems. Well, you know that and we know that, but also everyone else in the world knows that. As a result, the stocks in China have been hammered and actually stocks in China are at historically cheap levels. We like to rebalance our portfolios, which most of you are aware of, and we are adding to the emerging market fund that holds Chinese stocks. The other issue is how much do we really own of China? If you look at your own portfolio, and it depends on which one you own, Rebalance IRA portfolios that do hold emerging market stocks hold anywhere from a little over 5% to about 17% of an emerging market fund. Within that, China is maybe a quarter. For most of our clients, we only own 4% of China. So my question would be, “Do you really think it’s a bad idea to not have at least a few percentage points in the 2nd largest world economy, particularly at historically low prices?” We’re happy with our Chinese exposure; we find its size particularly well suited and we’re not that worried about it.
SALLY: I have another question here from Fred from Santa Monica. He says that he noticed he had a dividend stock fund, but it’s on the income side of his portfolio and he wasn’t sure why that was, knowing that they’re not bonds.
MITCH: That’s a good question. At Rebalance IRA, given the sophistication of our Investment Committee, we have studied how bond prices move when you have the government repressing interest rates, which is what they’re doing today. Interest rates are now, for a 10-year treasury, around 2%. Basically the government is saying, “Hey, give me your money and I’ll give you 2% back per year, for 10 years.” 2% back per year, for 10 years may just beat inflation and if you’re in a taxable account, you’re actually making a deal with the government where you might lose money. We don’t think that’s a great idea and in fact, that’s why we’ve put high dividend paying stocks in our portfolio that we now label “income” as opposed to “fixed income”. These are very, very successful companies, a subset of the S&P 500 that have been raising dividends consistently for 20 years. In fact, many of the bonds that we own from companies like AT&T pay less in interest than their stocks do in dividends. It’s a great way to diversify a bond, or fixed income portfolio, with some of these dividend paying stocks and we’ve found, over the last three years, having that element in the portfolio for income, has actually outperformed a traditional bond portfolio. We are really happy that it’s in there and I’m glad Fred asked that question. In addition, the last thing I want to mention is that in our income portfolio we also have emerging market bonds which are, in a way, a very safe bet as well because they’re all dollar denominated. When you hear all the horror stories about emerging markets and the strong dollar, we’re not as affected by that because those bonds are dollar denominated.
One of the things we talked about in our Market Review letter came from a very important question that one of our clients asked us, which I’ll paraphrase. This question was so relevant that we felt the need to highlight it and I’ll talk quite a bit about it
Over the summer, this client said to us, “If the Fed is going to raise interest rates in October, shouldn’t we sell all our bonds and buy them back at a later date?” Makes sense, right? Everybody knows the Fed is going to raise interest rates in October and when they do that, interest rates will go up so why would one want to own bonds? “Interest rates will go up and my bond values will go down.” This sounds like an astute, normal question but if you’re a market observer and an investment professional, the answer if because everybody already knows that, it’s already priced into the market. I’ve found that clients have a hard time understanding what this means – priced into the market. I’d like to take a little time to explain what priced into the market means. We as investors at Rebalance IRA own index funds, meaning we’re not investing in funds run by individuals trying to beat the market. We’re just trying to mimic the market through the funds that we own. But most of the market is not investing the way that we do. Most of the market is investing in funds run by active managers. I was an active manager for a number of years so I have an intimate understanding of the life and what that means to be an active manager. Given my understanding of that – what I’d like to explain to you – really helps illustrate why prices are set by the market and information that we get as consumers are already in the prices of the stocks or bonds. The net net being that bonds did not actually jump at all in October because the Fed didn’t change the interest rates. Of course, everybody thought they would. Now, everybody thinks they’re going to change interest rates in December, but they may not. Whatever the collective expectation is out there of managers is, it’s already in the stocks or bonds. This is what I mean by that.
If I’m an active manager, the only way that I can beat the market – beat the stocks that I’m trying to work on – is if I find some information that nobody else has about a stock or a bond that will allow me to buy a lot of it and get an edge so that when that information comes out, I’m right and the stock goes up. In order to do that, as a manager, I have to go talk to management teams. For example if I’m analyzing retail stocks, I have to understand what their strategy is, I have to talk to suppliers, to consumers…I’ve got to see if the other investors are missing something and I have to find something that others don’t know about. If I find that out, and I know something they don’t, then I have to go buy that stock and hope that when they figure it out, that I’ll make more than the market. That I’ll beat the market because I will make an oversized return from knowing something that no one else know. So I, as a fund manager might have a boss who says, “You’ve been buying this stock and buying this stock and it keeps going down. What do you think you know that other people don’t know?” I could be getting pressure to sell the stock. If I made a bunch of bad bets, maybe I’m even going to lose my job. So I can only do this with a handful of companies because it’s a lot of work and a lot of research and it’s never-ending. I’m competing with thousands of other people in the market who are doing the same thing. This goes on day in and day out and if 500 people are doing what I’m doing, and they’ve figured out what they think the price is, what makes me think that the price should be even higher, or lower in the case of people shorting stocks, than it is right now. So if you think about all these people out there in every country in the world, highly paid, highly degreed, rocket science degrees, using computer algorithms, meeting management teams, hiring consultants to go check things out in the market. They’re figuring out what the prices ought to be – one guy’s buying and one guy’s selling. They’re competing and setting the prices in the market.
When they do that, the prices are actually fairly perfect, based on all of the information that’s out there. And as a result, when we hear on CNBC some information, it’s yesterday’s news. And it’s yesterday’s news that we get as the public. So when people say to us, “Well, bond prices are going to rise in October, why should I own bonds?” Because all of the information about their being raised, when they’re going to be raised, even how long it’s going to take for them to get to higher normal levels, how many years…all that is in the price and therefore there’s no money to be made by getting out because when it’s all priced in, when the event finally occurs, there’s not going to be a change. Because everyone already knew it and they figured it out. These guys and gals out there doing this are very smart, very aggressive, very highly paid and anything that we think we know, and that we’re hearing at this point, it’s already there. So that’s one reason why at Rebalance IRA we own index funds. It’s because there’s no advantage to doing anything else. Sally, I’d like to turn it back to you for a few other questions relevant to this topic.
SALLY: I have one question from Jessica who is calling in from Houston. She wanted to know, after the market dropped in 3rd quarter, she started to read a lot of bad things about ETFs and wanted to hear your take on this.
MITCH: It’s a great question. Talking about ETFs is a little like talking about real estate. When someone says, well I hear it’s a bad time to be in real estate, I kind of roll my eyes. Because real estate can be anything form a deserted farmhouse in Birmingham, Alabama to a high rise in the middle of Manhattan. It depends…first of all, when the markets dropped there were some ETFs and, again, there’s about 1,500 ETFs, but most of the ETFs out there have relatively few investors. They are really gambling vehicles for traders. Some of those do not accurately reflect the price of the underlying assets, but that’s because there just isn’t a lot of money invested in that fund and there are a lot of issues when markets move around for some of those ETFs. The ETFs that our clients own, that we personally own, none of that really happens. Secondly, it doesn’t really matter to us because we’re not trading them. We’re buying ETFs, holding them, and rebalancing them several times a year. So the big answer here is “nothing to worry about”; the second answer is that some of those articles were written by active managers so you need to consider the source. We’re about long-term success. We’re good and we’re going to continuing owning our ETFs and we’re very happy that we do. Another question, Sally
SALLY: Lastly, we have Scott from Tucson, Arizona who wanted to help a friend understand the fees that he was paying for his accounts and he tried to explain it to him. His friend didn’t really believe him, nor did he understand the big deal. Scott wants to know how he should explain this to his friend.
MITCH: That’s a tough one, and actually managing director at Rebalance IRA, my partner Scott Puritz, has been on television quite a bit recently testifying on behalf of the Department of Labor about this very topic. It’s very difficult to figure out what fees are because the industry has set out to obfuscate them and hide them. The best thing you could tell your friend who has an advisor who is building and managing his portfolio, that there should be an advisory charge that he can find on his statement and second, that the hidden fees come from the fees themselves so it’s very important to open up the funds – go to Yahoo Finance or other websites – and look up the symbols and find the management fee. You can also have your friend call us, of course. We routinely do this for friends of our clients. Hopefully they’ll become a client, but if not, just the goodwill and the information is something we take great pleasure in providing to the general public. Third is trading commissions – sometimes on mutual funds those can be very expensive. Our Rebalance IRA clients are paying very amounts in trading commissions, maybe $60 for the whole portfolio when we rebalance it, .15% to .2% in fund fees, and of course our .5%. We believe if you can’t get it down way below 1%, generally below .8% or .7% for everything, your nest egg can be damaged by the advice you’re getting. We would be happy to help the friend and uncover any of those fees and help them better understand them.
SALLY: That’s great. Well, that’s all we have in terms of questions. Mitch, do you have any closing remarks?
MITCH: I do. I wanted to tell everyone a story that was great to hear as a business owner. We had a client who referred a friend over to us and the friend required almost no convincing. This friend had been with a big broker who wouldn’t tell him what he was paying, but he knew it was a lot and he and our client were comparing war stories and the client told his friend we were like Uber for investing. And the friend said, “Well, what do you mean?” And our client told him this. And again, this was very, very gratifying and I thought it was just a great story. The client said to this friend, “You know, before Uber when I had to get around town and needed a taxi, I’d get a car – sometimes it was a nice vehicle, sometimes it was beat up, usually driven by some surly guy that I didn’t feel that comfortable with, but look, I had to get around. And I’d be driving around town, getting to where I needed to go, and this person is driving this car. I’m putting my life in his hands and the whole time my money is just clicking away on the meter, 25 cents at a time. And then I get out of the car and I pay the fare and I’m glad it all worked out, but it wasn’t a great experience. Then, I find this new service called Uber. I get in the car, the person driving is nice, professional…the car is clean, usually brand new. I’m given a bottle of water when I get in, driven to where I’m going. I feel like a millionaire! There’s no meter clicking my money away. I get out, I get an email on my iPhone with a receipt. And it’s a shockingly small amount of money – about half of what I’d pay a cab.” And because of that, he called us the Uber of investment management. And I think that’s actually true because at Rebalance IRA, like at Uber, we retooled the whole way investment management is delivered, and we can deliver it for a lot less than anybody else.
I want to thank everybody for being on this call – our clients, prospective clients, and our staff. It’s really a landmark quarter. The correction came and went without a hitch. Our clients have survived brilliantly and what is so gratifying is that everyone involved in Rebalance IRA is getting a great result, saving money in fees, and bringing friends on to join us. And with that, Sally, I’ll turn it over to you.
SALLY: This is just a reminder to all that a playback of this call will be available on our website at www.rebalance-ira.com/conferencecall. We’ll also be sending out an email to all our clients as a reminder. Thanks everybody for joining us today.
MODERATOR: And that concludes today’s conference call. Thank you for your participation and you may now disconnect.
