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Brian Perry
ABOUT Brian

In addition to overseeing Pure’s investment offering and platform, Brian works closely with Pure’s financial advisors, helping provide them with the tools and resources necessary to serve their clients and continue the firm’s mission of providing the highest quality financial education and planning to as many people as possible. He has been actively involved in [...]

Consumer prices and producer prices are soaring and the Federal Reserve has increased interest rates. Brian Perry, CFP®, CFA®, Executive Vice President and Chief Investment Officer at Pure Financial Advisors, explains how inflation and the Fed are impacting your retirement investment portfolio, and how you can react intelligently.

Free Financial Assessment

Outline:

00:14 – Inflation and the Fed

  • Consumer Prices Soar: Consumer Price Index since 1997, data as of May 12, 2022
  • Producer Prices Up Even More: Producer Price Index, data as of May 12, 2022
  • Federal Reserve Balance Sheet
  • The Fed Has Done This Before: Summary of Federal Funds Rate Changes
  • Bonds and Fed Rate Increases: Annualized returns During Rising Rate Periods
  • Historical Impact of Fed Tightening

10:41 – Markets and Inflation

  • Is Crypto an Inflation Hedge? Bitcoin 6 Month Data as of May 12, 2022
  • What About Gold? Gold COMEX (June 2022) 6 Month Data as of May 12, 2022
  • Dollar at 20 Year Highs: US dollar Index Since 1967, Data as of May 12, 2022

20:41 – Commodity Prices Rally: Dow Jones Commodity Index 10 Year Data as of May 12, 2022, But Commodities Have Been a Horrible Investment: iShares S&P GSCI Commodity-Indexed Trust – Growth of Hypothetical $10,000

22:04 – 10 Year Treasury Yield Soars: US 10 Year Treasury Data as of May 12, 2022

  • Bonds Have Historically Bad Year

31:54 – What About Stocks?

  • S&P 500 and Market Shocks Since 1928
  • Stocks Go Up and Down: S&P Intra-Year Declines Vs. Calendar Year Returns, 1980 to Year to Date

34:27 – What Kind of Stocks Should You Buy?

  • P/E ratio of the Top 10 and Remaining Stocks in the S&P 500, 1996-2022
  • Value vs. Growth Relative Valuations
  • S&P 500 Sector Correlations to the US 10 Year Treasury Yield
  • Year to Date Returns by Size and Style
  • Why Should You Invest in Global Stocks? MSCI EAFE and MCSI USA Relative Performance, 1971-2022

41:16 – Stocks and the Mid-Term Election: Hypothetical Growth of $1 Invested in the S&P 500 Index and Party Control of Congress, 1926 – 2019

Questions:

– How do I protect my 401(K) and stop bleeding from my funds? Money in large/mid-cap index funds down
– I-Bonds and the current interest rate?
– Is the downside in bonds already baked in?
– Should I move to cash?
– RMDs push me into a higher tax bracket. Should I move everything to Roth?
– What happens when the Fed reduces quantitive easing?
– I’m sitting on large amounts of cash and still require liquidity. Options?
– For those not invested, is this downturn in the market to our advantage? What are the caveats?
– Is dollar-cost averaging into the S&P 500 the best way to invest now?
– Is there a way to avoid that capital gains bill?
– Stable coins tanked, NFT’s have proven to be vapor, both a big part of crypto. How much do you really trust them?
– Real estate instead of the stock market?
– Whole life insurance?
– 72T plans?

Inflation and the Markets White Paper

Transcript:

Andi: Please welcome your presenter, Brian Perry, CFP®, CFA. Brian, how are you?

Brian: Yeah, it’s certainly an interesting day. Like I said, markets go up, markets go down. I think the best advice in general, when markets are volatile, is just to stick to the plan. When you look at inflation-I don’t know if anybody’s noticed yet, but prices are higher. This chart shows what you’ve probably noticed every time you fill up your car, every time that you go to the food store. Highest inflation that we’ve seen. This chart goes back 25 years. You can see that inflation is almost twice as high as it’s been at any point in the last 2.5 decades.

If we went back to the early 80’s, this was the highest inflation we’ve seen since then. So what’s going on? Well, what’s going on is that COVID essentially full-stopped the economy. And certainly in my lifetime and really, in recent history of any sort, we’ve never had an economy where we just shut it down. And when COVID came around, businesses shuttered, people weren’t allowed to leave their house, the economy basically full-stopped. It actually didn’t go as badly as it could have. If you asked me, I would’ve said the economy would have fallen to pieces, but massive government stimulus kind of underpinned the economy.

And then when it started back up again, everything seemed to be going along normally except that because of supply chain issues, there was some higher inflation. So I don’t know if anybody’s tried to order furniture recently. We got a new dining room table we bought about a week ago. Half of them you couldn’t get until September. We actually were lucky. We have a dining room table that we bought and got delivered two days later. And so that’s kind of the good news. The bad news is that there are no dining room table chairs for the next two months. And so we have to eat standing up. And those kinds of things have led to competition for buying less goods. And that’s the classic definition of inflation. Inflation is more dollars chasing less goods. And so, it may be getting a little bit better now, but if anybody tried to buy a used car in the last 6 months, you go to the lot, there aren’t any. For the first time certainly in my history if you go to buy a new car there’s MSRP. And you’re not subtracting from that price, there’s add ons. I was in one dealership where they were adding anywhere from $10,000 to $100,000 above MSRP on every car. So certainly a lot of inflation is going on.

And if you look at the next slide, this is the consumer front. If you look at the producer front, it’s even worse. And so consumers, that’s what all of us pay when we go out to buy something. But producers, this is as a company. What is the cost of their inputs? As you might imagine, if you’re a company and the cost of the things that you’re producing goes up, you have two choices. You can see your profits collapse, or you can try to pass on as much of those price increases as possible to the consumer.

And we’re seeing a little bit of both. That’s one of the reasons that when you think about inflation, one of the best antidotes, not in the short term, but in the longer term is high quality companies. Ownership in them. Because high quality companies have the ability to pass on price increases. So, if you think about a company like Disney, they keep raising the price of going to the parks. I went to Disneyland a couple of months ago and the place was packed, because people want to go to Disney. If you have an iPhone, you’re probably not going to cancel your Apple Music subscription if it goes up 5% or 10%, because you’re used to listening to the music. So good companies generally have reasonable pricing power as an inflation hedge.

But a lot of this too, in my opinion, is driven by COVID, but also by the fed. And if we turn to the next slide, what you can see is some of what the fed has done as far as being accommodative. And they’ve done two things. One is that they have an overnight lending rate and they cut that to 0. The second is that they’ve been adding to their balance sheet in what is known as quantitative easing. And so this chart looks at what they went out and bought in the way of different bonds, treasuries, mortgage-backed securities, and the like. And you can see the big spike in 2008 and through the mid 2000s finally started to level off, and then the massive increase to the order of about $5 trillion that they’ve added over the last couple of years.

I’m generally supportive. So I worked in the bond market for many years and the bond market is really focused on the federal reserve. And if you look at the federal reserve, I think they usually do a pretty good job at a difficult task. Because they’re trying to direct the economy, they’re trying to control monetary policy. But it’s almost like they’re trying to do surgery when the tools that they have are blunt instruments. And there’s a lag. It’s usually anticipated that when the fed does something, there’s a 6 month lag before it takes effect. And so I don’t think the fed is perfect, but they generally do a pretty good job. Now with that being said, I think the fed is actually criminally poor in their recent performance. I think the fed has done just an abominable job over the last several years of containing inflation. For the last 18 months, what we heard was that inflation was transitory. I think anybody out there that was in the real world out shopping would have said that inflation was real, it was persistent, and it was painful. Yet, the fed not only didn’t do anything to fight inflation, they actually encouraged inflation by continuing to buy all of those bonds that we talked about, by continuing to keep interest rates at zero. The fed was actually stoking inflation at the same time that we had the highest inflation in a generation or more. Finally in the last couple months what’s happened since the calendar turned to 2022 is the fed basically got their blinders off and said, oh my goodness, we’re being stupid about this. We need to change this. We need to do something about inflation. They finally went and started raising interest rates.

And yet even as they were raising interest rates, do you know what they continued to do? They came up with a plan to taper off, to stop buying all those bonds. But as they came up with that plan, they kept buying. It’s the equivalent of saying we need to fill in this hole, next month we’re going to fill in this hole. But in the meantime, we’re going to keep digging. Why would you keep digging a hole if you know you’re planning to fill it up? And that’s what they did. So the result is that we have the highest inflation in a generation, which everybody out there is feeling right now. So again, I think the fed’s performance recently has just been abominable, but hopefully now they finally have their eyes on the prize of containing inflation. We saw them raise interest rates a couple of times already this year, most recently by 50 basis points. The plan or the expectation is that they’ll be raised by another 50 basis points at the next two meetings. And that’s really what’s injected volatility into the financial markets over this year.

Certainly Russia, the invasion of Ukraine has had a big impact. The fact, quite frankly, that markets were overvalued 6 months ago has had a big impact. But the other part of it is just this uncertainty about the federal reserve, inflation, et cetera. And what we see is that usually when the fed starts to take action and it’s anticipated that they’ll do something, markets are volatile. But the fed has done this before. Despite my condemnation of what they’ve done in the last couple of years, they’ve been down this road before and it hasn’t been a disaster every time.

So if you look at this slide, it talks about recent fed increase cycles going back to 1990 and recent fed decrease cycles. What you can see is that there’ve been a variety of both. In fact, there have been 5 prior times that the fed has raised interest rates and the markets didn’t collapse. If we flash forward to the next slide, bonds are the most directly affected by interest rates. And yet what we see is that throughout the last 4 fed interest rate cycles, bonds actually posted prior performance. I know there’s a lot of bars on this slide and what they are is different bond indexes, but the key is in each of the numbers there is positive. It means that in the mid 1990’s, in the 1999-2000 period, in the 2004-2007 period, and again, in the late aughts, the fed was raising interest rates, tightening monetary policy, and bonds did okay. So next time you hear somebody say, “the fed’s going to raise interest rates, the bond market is going to collapse.” It doesn’t necessarily make it so. Now, I freely acknowledge bonds have not done well this year, and we’ll talk more about that. But I just want to be clear that a lot of times what happens historically is that bonds sell off as the fed is approaching or beginning to tighten interest rates, and then as they continue to tighten them, bonds actually tend to do okay.

So let’s flash forward to the next slide here and take a look at what the impact of fed tightening has been on both the S&P and the-and so you can see, this goes back to the early 80’s. You can see the different fed cycles, and I want to focus on a couple things here. First of all, across the second line there you can see the fed funds rate, how much it went up. So 300 basis points, 325, 300 and so on across these different interest rate cycles. And then what you see in the next line is the 2 year treasury increase and the next year is a 10 year treasury increase. And what you’ll notice is that the 2 year treasury in general moves a lot more than the 10 year.

The reason being, the federal reserve has a lot more impact on short term interest rates and shorter term than it does longer term. And so what happens is that when the fed is raising the overnight lending rate, the 2 year treasury tends to go up a lot, the 10 year treasury, which is really the market proxy, doesn’t move as much. In fact, a lot of times it begins to stabilize. And here’s why. If you’re a bond holder, you have a couple of risks. One risk is that you don’t get paid back. If you don’t get your money back, you’re essentially making a loan. That’s the worst case outcome. But let’s assume it’s a US government bond and you think you’re going to get paid back. Well, then your risk is that the dollars you get paid back aren’t worth as much as the dollars you paid out. That’s inflation eating away at it.

Well, why does the fed raise interest rates? They raise interest rates to lower future inflation. So all else being equal in a vacuum, you want the fed to raise interest rates. You’d rather there’s no inflation all, but given that there is inflation, you want the fed to do something to contain it. So as a bond holder, especially a longer term bond holder, the federal reserve, as long as they catch up and aren’t seen as being behind the curve, them raising interest rates should, all else being equal, help longer-term bonds rather than hurt longer-term bonds.

As far as stocks, you can see there too, that the performance is very mixed. So slide back just real quick. The second line from the bottom there, the S&P 500, you can see that across these fed tightenings, sometimes stocks were down in the early 80’s, again in the early 90’s they were down. A number of the other times they were up across the cycle and you can see the impact on the US dollar at the bottom was more mixed as well. I think in this particular instance, the fed was pretty behind the curve and they’re fighting to keep up. But just want to point out that historically the fed making interest rate increases has not spelled armageddon across the board for financial markets.

So let’s talk about some specific markets and inflation. Let’s start with cryptocurrency. We get a lot of questions about crypto, we should probably do a webinar at some point on it. I know that we’ve done a video in the not terribly distant future. If you want to get a little more of our thoughts on it, you can check it out online. We certainly think crypto at this point is a viable asset class. It’s insanely volatile. It’s about 4 to 5 times more volatile than stocks. Let’s just take that into account. Over the last decade, do you know what the average daily price movement in Bitcoin is? This is every day. The average price movement is 4.5% up and down in Bitcoin. Really volatile. When you think about the blockchain, you think about cryptocurrency, but we think it’s becoming established enough that it’s a viable asset class. Of course, it’s still, how do you use it? Do you use it, et cetera?

Here’s how I don’t think you use it. I don’t think you use it as an inflation hedge. Because the whole point of an inflation hedge is that when inflation goes up, it should go up. Well, here’s cryptocurrency, here’s Bitcoin in the last 6 months doing nothing but going down. And so in the last 6 months, we’ve had the highest inflation since most of us were kids or not even born. And yet crypto measured by Bitcoin has gotten cut in half. That’s the opposite of an inflation hedge. That’s like an anti inflation hedge. So again, not banging on cryptocurrency or Bitcoin or saying that they don’t have value, but you need to make sure you’re using the right tool for the right job. And at least based on this sample size, it doesn’t look to me like Bitcoin is a good inflation hedge.

Then we get the question, what about gold? For a millennium, gold has been an inflation hedge. You get gold bugs out there. Let me store my gold coins. If inflation comes, if the world comes to an end, gold is going to do great. Well, if the world comes to an end, you can’t eat gold, so that’s not going to help you. You can’t fight off zombies using gold coins and whatnot. And it’s heavy as can be to carry around. But besides that, we’re finally getting into the inflation gold bugs have been waiting for. They’ve been waiting 20 years to get this happen. And yet look at gold. It’s exactly flat to down a couple percent since inflation picked up in the last 6 months. So how good of an inflation hedge is gold if you finally get what you’ve been waiting for all these decades and it hasn’t gone up in value?

I have to be careful too, Andi. Like when I go off on gold like that, there are people that are really passionate about it. I might get some angry comments or something like that. People get fired up about gold, but the unfortunate reality is that it just hasn’t been a good investment. I mean, it looks nice.

Andi: Well, so far, we don’t have any comments on gold just yet, but we do have a number of questions and I will remind you if you do have questions about anything that Brian is talking about here, you can just type that into the chat and we will get to those as time permits.

Aaron says, “Bonds look crap to me. I’m 51, and how do I protect my 401(k) funds? All money in large mid cap index funds went down 300k.”

Brian: Well, first of all, I think what Aaron really needs to do is be more open about your feelings. Kind of tell us what you really think.

It’s tough. There’s really no place to hide. And this is not historically unusual. So there’ve been periods in time, including the last couple of decades where bonds and stocks move inversely and people have gotten really used to that, but there have also been periods of time where they move in lock step in the same direction. We’re actually seeing the worst year on record in the bond market. Stocks are falling and bonds are falling. What I would say is that bonds still serve as an inflation hedge. You look at today, when I walked in here, the Dow was down 1200 points. NASDAQ was down 4.5%. So a pretty bad day in the stock market. Bonds are actually up today. So that flight to safety, that protection, that insurance still seems to hold a role.

I think it’s about a couple of things. One is what’s your time horizon? Because we can talk about there being no place to hide and in the short term, I think that’s true. If you think you need the funds in the short-term, put it in cash, put it in a CD, or money market.But if you’re stretching your horizon out to multiple years, that’s where I think bonds come in as a complement to stocks. And then it’s about what type of bonds do you hold? And we don’t think you should necessarily pile into longer term bonds because the longer term the bond, the more sensitive it is to interest rate movements. So you’ll want a little bit shorter term bonds that will give you more protection. Short, intermediate term bonds will give you less sensitivity to interest while still giving you some diversification away from stocks.

And then maybe you consider some alternatives. I don’t know whether it’s real estate, there are all kinds of alternative investments out there. Some of them are terrible. Some of them are illiquid or expensive, but some could make sense. I think it’s about making sure that your time horizon matches what you’re trying to do and not trying to say, “Hey, I’m going to buy stocks and bonds and worry about what happens in the next 6 months.” You want to worry about what happens in the next 6 years. 6 months should be in cash.

Andi: Isabel says, “would you please define short term? What does that count as?”

Brian: It’s going to be slightly different. I could ask 100 people and they’d define it differently. I would say short-term is anything under a couple years. If you’re planning to buy a house, pay for a wedding, buy a car in the next 12, 18 months, I would not have that subject to the markets. I would have that money set aside in cash. Call it 6 months to 2 years. Anything past there, I think you’re into the intermediate term. That’s from an investment perspective. If I flip that question on its head and talk about bonds, I would define short-term bonds as anything with a maturity under 3 years, 2.5 or 3 years. Intermediate, anything from call it 3 to 6 or 7. And then long-term anything beyond that.

Andi: Sherri says, “what is your perspective of the I bonds and the current interest rate?”

Brian: I think they could be fine. So I bonds are inflation adjusted bonds. They’re like the savings bonds you can get at the bank. The coupon rate is zero. The inflation adjustment is like 8%, 9%. So right now they could be attractive. If that rate falls, theoretically you could be zero. There have been instances in the past where the rate on those was zero or even trending towards negative. That being said, they can make sense for a little bit of money, but if you’re looking to put large sums to work, you’re limited to $10,000 or maybe $15,000 a year. So it’s not really an asset class you can go into with both feet, but if you have a few bucks and you buy a couple I don’t think it’s the worst thing in the world.

Andi: I just put a note in chat. We are getting a whole bunch of questions. So if we don’t have a chance to answer it today, you can email info@purefinancial.com and Brian will be able to answer your question offline, off-air. We got another question from James. He said, “do you think that most of the downside in bonds is already baked in?”

Brian: We’re not in the prediction game, so I’m going to freely admit I don’t have a crystal ball, but I’ll give you my best guess. I think we’ve seen the steepest sharpest part of the move higher in interest rates. We were at 50 basis points, a half of 1% on the 10 year treasury at the height of COVID and now we’re at about 3%. So I think the sharpest part of that move has happened. That’s not to say that they can’t continue to go up. But if this was a baseball game, I would say we’re in the 6th or 7th inning. Maybe a little bit closer to the end. I now think there’s room for rates to go either up or down. So they’re a little more balanced versus if you flash back 12 months, I think it was pretty clear that the path of least resistance was higher.

Andi: Tina says, “everything is concerning for those at 10 to 15 years from retirement. What is the best course of action? How do you stop the bleeding from your funds?”

Brian: I’ll be honest. I would almost flip it on your head. Just based on that time horizon, if you’re 10 to 15 years from retirement, I would say everything is actually great. And let me tell you why I say that. Now, if you’re recently retired, if you’re retired a year ago, 6 months ago, a little more of an issue because now you’ve got to figure out how to effectively distribute that income back to yourself and potentially be selling securities in a downmarket. If you’re a dozen years out from retirement, historically there are very few instances in which stocks are not higher at the end of a 12 year cycle. Presumably, and hopefully you’re still contributing to your retirement accounts. So you’re forced to dollar cost average if there’s contributions going into your retirement account every week. If you have a cash surplus, you could be buying money outside of your retirement account, maybe in a non-retirement account or a Roth account or whatever.

So you can be buying stocks or bonds, frankly. Valuations on stocks are way more compelling than they were a year ago. So I think what that means is future expected returns are higher than they would have been. Beginning yield is a good proxy for future bond returns. Again, a couple of years ago, the yield on the main bond index was 1.5%. Now it’s north of 4%. So you just double and a half almost tripled the expected return from your bonds going forward. So again, if you’ve got a dozen years and you’re still contributing, I think what’s happening right now, it’s not fun, but it’s your friend. If you’re in your 20’s or 30’s, you should be high-fiving. The best thing that could happen to somebody in their thirties is a 15 year bear market while they accumulate. So the key though, is that you need to have some portion of wealth to distribute that income back to yourself. Because honestly, accumulating wealth is difficult, but relative to distributing it back to yourself where, Hey, now you need to make it to and through retirement without running out of money. You don’t know what inflation is going to be. You don’t know how long you’re going to live. You don’t know how your health is going to be. You don’t know what the markets are going to be like, you don’t know what inflation is going to be, et cetera. And you also don’t want to deprive yourself too much because life is short. You want to spend enough and enjoy yourself without running out. That’s really hard. That’s why you want to do some level of financial planning, whether on your own or with a professional to map that out, figure out what the right investment mix is and then how to distribute that cashflow back to yourself in a tax efficient manner.

Another thing that we get a lot of questions on is commodities. And as most of you are aware, commodity prices have skyrocketed. They’ve gone up quite a bit. So if you look, we saw this long gradual decline in commodity prices from basically the financial crisis on to about right before COVID, and then COVID and boom prices fell quite a bit. Since then we’re up sharply, double and a half or something reflected in wheat prices, prices at the food store, gasoline, et cetera. But despite that rally, let’s look at how actual commodity investments have done if you flash forward to the next slide.

And so here’s commodities. The actual reality is that commodities have been a horrible investment. After peaking right before the financial crisis, the index is off by about two thirds. This is a growth of $10,000. If you put $10,000 to work in 2006 and you’ve stayed with it for the better part of 2 decades you’ve got about half what you invested versus if you’d put it in stocks, bonds, et cetera. The reality is that although commodities get a lot of attention during times of inflation, actual commodities and commodity futures haven’t been great investments. One thing you can do, and one thing that we do as a firm, is we invest in natural resources, stocks. So commodity producers. They’ve performed a little bit better. They’ve actually been the best performing sector of the stock market this year and have done OK.

We talked a little bit about the 10 year treasury yield. I don’t think we need to focus on this slide, but we can flash forward to the next one. And when you look at this, this looks at the Bloomberg aggregate. So this is like the S&P 500 for the bond market. And this goes back to 1980. I highlighted in red the years that you have negative returns and you can see 1994 down 3%, 1999 down about 1%, 2013, down 2% and 2021 down 1.5%. So what’s the takeaway there? The takeaway there is that most years bonds are up and that when they’re down, they’re not down much. So far this year, as of a couple days ago, the Bloomberg aggregate was down 10.5%. So a factor of 3x, 4x worse than the previous worst year. This gets back to the question that somebody said bonds are a crap investment. They definitely have been a terrible investment this year. Again in a day like today, that flight to quality, I do think they’re providing that insurance.

But just know a couple things. One is that the higher interest rates go the better the future returns of bonds. So bonds are a better investment today than they were 6 months ago, a year ago, 2 years ago, 3 years ago. Second of all, on a day like today, when stocks are off sharply bonds provide that insurance, they act as that flight to quality often. The third thing is that we are having historically an aberration. This is not a normal year for bonds. Imagine a year in which stocks were off 4 times more than their worst year in history. So the worst year in history stocks were down 80% or something like that, but a really, really, really bad year for stocks is down 30%. Well, mathematically stocks can’t go down 120%, but the equivalent of bonds this year would be stocks going down 80%, 90%. A really bad year in bonds. But even in this bad year, they’re outperforming stocks. Future expected returns are better. So I don’t think I’d be hitting the panic button and abandoning bonds at this point.

We’re going to turn to some slides about stocks, but why don’t we hit pause and ask a few questions?

Andi: Question, “I’m due to retire in a year and have been watching things drop. Should I move to cash?”

Brian: I’m going to answer that question, but with the understanding, I don’t know your particular details, so just take this as a blanket answer, not specific to you. We do offer free financial assessments. If you want to come in and talk to one of my colleagues, we can dive a little more closely into your particulars and give you maybe a better answer.

The general answer is no. And here’s why. Most people, even as they approach retirement are still going to live 20, 30, 40, 50 years in retirement. Over that course of time, cash is going to lose its purchasing power even if inflation normalizes, and what’s going to happen is that you’re going to run out of money in your seventies. And then you’ll be living on ramen noodles and that’s not a place you want to go.

What I do think you want to do is you want to look over, what is your mix right now? How much risk are you taking in your diversified portfolio? What kind of expected returns do you have in it? Again, financial assessments, that’s what we do for people. You can do it with us if you want, if not do it on your own, but look at what kind of mix you’ve got and if that’s appropriate for A) somebody that’s retiring in a year, B) somebody with your other income sources and your asset level, and then C) with your life expectancy, because what you probably want is not to move to cash, but to make sure that you have the right mix of cash, stocks, bonds, et cetera, to get you not just over the next year, not just provide cash flow the first year of retirement, but provide cash flow across your retirement.

Andi: The next question is from John, “I’ve been retired for 14 years and the RMDs are really pushing me into a higher tax bracket. Do you think I should move everything to Roth?”

Brian: Really good question. Again, this is without looking at your particulars, I can’t say that because it depends. A Roth is a retirement account where instead of getting a tax break when you put the money in, you get a tax break when you put the money out. So with a pre tax retirement account, your income comes down in the year you put it in, it grows tax deferred, but when you come out, it’s all ordinary income, the money you put in as well as the gains. With a Roth account, when you put money in you don’t get a tax break, but the growth is tax-free. And then when you pull the money out, both the money you put in, as well as any gains is free of taxes. So a Roth conversion is when you move money from a pre tax retirement account, like a 401(k) or an IRA or a 403(b) to a Roth. To figure out if you should do it, you look at what’s your tax bracket today. Then you run a tax projection for future years looking at what your income is, including required minimum distributions, what tax bracket _ probably consider a Roth conversion, but whether or not you should do it is going to depend on running your numbers and figuring out your particulars.

Andi: Richard says, “what will happen when the fed starts to reduce its quantitative easing?”

Brian: Quantitative easing is the technical term for that chart I showed where the fed has been buying all these bonds to further accommodate monetary policy. The short answer is it’s going to lead to less demand in the marketplace from the fed. Because now instead of buying the fed is selling, so supply and demand dynamics would say that interest rates should go up a little bit. However, just keep in mind, I think that the fed will be very thoughtful in how they do it. They’re going to telegraph how they’re going to unwind this. They’ve done this before in the mid 2000’s. They’ll say, “Hey, we’re going to sell $50 billion worth of mortgage backed securities a month.” And so the market knows what to expect. It shouldn’t be surprised. Unless the fed throws a curve ball or comes out with more or less. As long as there are other buyers, it should be absorbed by the marketplace. And I think the anticipation of this, one of the reasons you’ve seen interest rates go higher is that other market participants are saying, “well, the fed is going to be selling these bonds, I might be willing to buy it, but I’m willing to buy it at 3%, not 2%.” So some of the repricing you’ve already seen, I think the fed will be thoughtful in how they_. But all else equal, it leads to more supply for the less demand and potentially higher rates. But again, I think the biggest portion of the move has probably already been seen.

Andi: Robert says, “if you’re currently sitting on large amounts of cash and still require some liquidity, what are the best options at this point?”

Brian: If I was sitting on a large amount of cash, I would consider putting not all of it, but some of it to work now in the markets. I’d come up with some sort of a plan for what is home base? How much of my cash do I actually want to get invested over time? And then I’d come up with a plan to put some portion to work now, some portion in a month, 3 months. As far as a place to store it, I wouldn’t want to lock it up for a long period of time because as the fed moves, longer-term interest rates are a little bit more independent, but short-term interest rates are more key to the fed. I would suspect that you could get higher rates of return from a bank account, a savings account, a money market, a CD._

Andi: _ “Is this downturn in the market to our advantage, and what are the caveats?”

Brian: So the question is, if you haven’t invested yet, is the downturn to your advantage and what are the caveats?

Assuming you’ve got a long-term, longer term time horizon, call it 5, 10, 15 years, 20 years, whatever, yeah. The more markets fall, the better off. Think about it like this. Nobody goes to the mall anymore, but when you used to go to the mall, if you went on the Wednesday before Thanksgiving, it was empty. If you went on Black Friday, people are literally beating each other up to get in the door first. It’s because everybody likes a sale. People want to buy the same thing for less. Hey, that TV used to be $1,000, now it’s $800. Financial markets and stocks are the only thing I know of where the more the price gets reduced, the less people want it. It should be the opposite. The more prices fall, the more you should buy, it’s better for you. If you buy a series of cash flows at a price, and then you can buy it at a lower price, those cash flows are going to be better. You’re going to get your money back sooner. So the fall for those that want to invest or haven’t invested previously is a good thing.

The caveat is just, you want to assess how much risk you can tolerate, what your time horizon is. I can honestly say with conviction, markets are more attractive today than they were 6 months ago. I can honestly say that if you buy today, your future expected returns are higher today than they would have been 6 months ago. But what I can’t say with any conviction is whether or not markets will go up or down in the next 6 months. So as you consider investing, whether you haven’t invested in the past, or whether you’re invested and you’re reassessing your portfolio, you need to ask yourself if markets continue to fall, can you stick with it for a period of time? Because again, in the long run, decade, 15 years, 20 years, markets should be higher. 6 months from now, I have no idea.

Andi: I think at this point it might be a good idea to get back into slides.

Brian: Cool. Let’s flip over to some stock slides.

What about stocks? Let’s go to the next slide. So, first of all just to touch briefly, this looks at unfortunately, a whole series of wars. And it’s kind of depressing because it goes back to like 1930. And what you see is that there’ve been all these different wars and conflicts and stuff. But the takeaway is that throughout that period, the S&P 500 has moved higher. And the reason I bring this up is that one of the catalysts for volatility this year was Russia invading Ukraine. And I absolutely don’t want to minimize the human toll of that or the geopolitical consequences, but from strictly speaking, a market impact, my educated guess is that it’s probably a relatively short-term impact that over time will be left in the background. The two caveats are one, if Russia was to use weapons of mass destruction, particularly nukes, I think all bets are off. The other would be that if NATO gets pulled into the conflict in some way, shape or form. If NATO gets involved or there’s weapons of mass destruction, I think the story changes. But as long as the conflict stays isolated to Russia and the UK, I think from a financial market perspective, we’ll gradually move towards it. And in fact, I think we already have. You’ve really seen markets, what they’re focusing in on now is inflation, the fed, the outlook for growth in the economy, potentially this little resurgence that we’re seeing in COVID, lockdowns in China around COVID, that’s really the focus of markets more so than Russia at this point.

So the other thing I think is important to point out is that stocks go up and down. If you look since 1980, the gray bar is where stocks have ended the year. You can see about 75% of the time, stocks go up for the year. About a quarter of the time they go down. The red dot with the number on it is the entry year decline. And what you see is that even in many of these years where you’ve got a gray bar that shows a positive year for stocks, you get a decline at some point during the year. I could point to a year there where socks were up 15%, but at some point they fell 17%. Another year where stocks were up 23%, but at some point they were down 28%, and so on. The thing I’m trying to emphasize here is that right now stocks as measured by the S&P are probably down 17% or 18%, the NASDAQ down more like the mid 20’s. However, that doesn’t guarantee that the rest of the year will be negative. I don’t know if it’ll be positive or negative, but there’s plenty of historical precedent for a sell off the first half of the year, followed by an increase the second half of the year.

Part of what you want to consider though is what kinds of stocks to buy. And what’s been a really popular strategy the last handful of years is to pile into the biggest growth stocks. I’m not pointing out any one of these stocks as a particularly bad or good investment, but if you think about the Googles, the Teslas, the Amazons, the Apples, the Nvidias. When we see people come in, it’s really not unusual to see somebody that has done really well in the last several years that’s concentrated in those several stocks. As a general rule, you don’t want to concentrate on any particular stocks. Concentrated positions can be a great way to build wealth, but they’re a terrible way to keep wealth. The ceiling is high. If you just buy a few stocks, that’s potentially a good way to make a lot of money. Most of the great fortunes in the world have been made with a concentrated position, but diversification helps keep that fortune. The other key thing to consider here is the green line is the top 10 stocks in the S&P 500, the gray line is the other 490 stocks. And then this is their valuations. And what you can see is that there have been two periods where those top 10 stocks have been drastically more expensive than the rest of the S&P 500. One was in the 1990s and one is today. You might remember how the 1990s ended, where a lot of these biggest stocks back then, GE, Microsoft, et cetera, Amazon, collapsed in value. The companies didn’t go away, but the stocks did horrible while the rest of the market didn’t do great, but it didn’t do as badly. Now today, when we look at the average price earnings, that’s a measure of valuation of the top 10 stocks, is almost 31%. The rest of the stocks had 16.5%. So the rest of the market is a lot less expensive than those big growth stocks. So again, I would suggest that you go out and look at your portfolio and see what kind of exposures you’re actually taking within that portfolio.

Value stocks, too, are less expensive than growth stocks. And so let’s flip over to the next slide. If you look year to date across the top here, you have big companies, the bottom, you have small. Down the left-hand column, you have value stocks. So these are less expensive than their peers. The right-hand side, you have growth stocks. What you’ll notice is that the value stocks in the left-hand column have outperformed their growth peers by about 15% this year as of the end of last week. So value stocks have done significantly better than growth. That’s a reversal from the last several years. If you look over the last 3 or 4 years, growth stocks have beaten value stocks. However, historically value stocks have done significantly better than growth stocks. If you look over the course of decades or even the better part of a century, value stocks have tended to outperform growth stocks. And we’re seeing a little bit of that play through this year with some significant outperformance.

Again, part of that is because growth stocks are just very expensive. Even with this outperformance, by the way, even with value outperforming growth by about 15% this year, if you look at long term norms, value stocks, relative to growth stocks, those relative valuations, the value stocks are still historically cheap. So even though you’ve seen our performance in value stocks this year it doesn’t necessarily mean that that trend is set to reverse. In fact, value stocks are still very cheap.

Andi: Karen is actually asking, “is dollar cost averaging into the S&P 500 the best way to invest now?”

Brian: If you look at the numbers, dollar cost averaging is never the best way to invest. So if you just look at the numbers and you run the probabilities, the best way to invest, if you have cash, is to put it to work tomorrow or today. Because markets go up over time. Remember that long-term chart. In most scenarios, if you put money to work today, you’re going to be better off than if you put money to work tomorrow.

Now, a couple caveats. One is that it’s psychologically damaging. If you’ve been sitting on cash for a couple years and you put it to work tomorrow and the market falls 20%, well, A) you’re probably going to sell and pull out and B) you’re probably never going to go back in if you do that. So dollar cost averaging can work for people that have cash that are worried about future declines or psychologically just aren’t comfortable or emotionally where markets are going. Dollar cost averaging is 100% better than sitting on the sidelines and can be a viable strategy for those.

Global stocks. So periods in purple here is when the globe essentially outperforms the US and periods in gray is when the U S outperforms global stocks. And what we’ve seen recently over the last decade or so is really the longest run of outperformance by US stocks relative to global stocks that we’ve seen in history. There’s two main reasons. One is the strength of the dollar. So the dollar has been strong most of the last decade and certainly in the last couple of years. We get the question all the time, is the dollar going to collapse? Keep in mind, currencies are relative. So you could look at the US, point out all the problems the country has, and think the dollar is going to do terrible. But currencies are relative. What currency are you going to buy instead of the dollar?

So relative to most countries, the US has done better over the last decade. So the dollar has been strong. A strong dollar is bad for US investors buying international stocks. A weak dollar is good for US investors buying international stocks. The other component here is that the stocks that have done the best in the last decade are those large tech companies. They’ve done the worst so far this year, but they’ve done the best in the last decade. Most of the tech companies or many of the tech companies are clustered in the United States, which has led to some of that outperformance relative to international.

We still think you should invest globally though. Couple of reasons. One is that sector rotation varies. So this year energy stocks have done the best. Previously it was tech. I don’t know what sector is going to do the best going forward. But there are plenty of sectors that are out weighted in Europe versus the US and some of those sectors could do better going forward. Second is that countries have different economic cycles and inflation cycles. They also have different cycles of COVID now. So you’re getting exposure to some countries that might do relatively better with some of those things if you invest internationally. International stocks are cheaper than US stocks right now. And finally, if you set aside markets and this and that, and just think of companies, there are lots of great companies around the world and if you only invest in the US you don’t get to invest in Toyota, Nestle, Unilever, et cetera. So we think a global approach for almost all investors makes some degree of sense.

The last point I want to comment on, and then we can go back to questions, is that we have an election coming up. I guess the good news is it’s been a crazy year. We’ve had Russia and Ukraine, we had the pandemic surging and then going away, we could go out of our house without a mask, and now I heard New York might require masks again because COVID is going back up, obviously market volatility, inflation, et cetera. The only good news of all this is that it seems like some of the political stuff has shifted to the back burner. But it’s ramping up. We’ve got primaries, we’ve got the midterm elections coming. I’m sure you all have strong views on whether you prefer Republicans, Democrats or none of the above. I think it’s important to realize that here under blue, you’ve got Democrats controlling the Senate and house red, you’ve got the Republicans controlling both, and the stripes are mixed. Under most of those scenarios, markets have done okay. So it’s great to have political views, to know who you want to win, but just know that at least historically neither party has managed to destroy the country despite sometimes their best efforts.

With that, let’s take a pause here. Let’s answer some questions. As we do that again, like I mentioned there’s a lot going on. It’s a crazy world. The markets, inflation. I think this is a really good time to assess your portfolio, to make sure that the amount of risk that you’re taking is appropriate, that you’re not taking on new risks. Also that you’re not being too conservative. There’s probably a required rate of return that you need to get in order to meet your financial goals.  And then from a tax perspective, one of the Biden administration’s main thrust was to raise taxes on some people. It hasn’t happened yet, but we’ll see what happens heading into and then after the midterms. We offer free financial assessments for folks that come to one of these. Usually we charge $250 an hour to meet with people, but for those that come to a webinar we waive the fee and we’ll meet with you for an hour or two. What we do is we take a look at people’s portfolios, assess what kind of risk they’re taking, what kind of required rate of return they might have, and if they’re likely to get there. We take a look at their cash flows. If they have decisions around social security, pensions we guide them on that. If they are trying to retire, how much money do they need? Are they in a good position to retire? And then we’ll go through taxes as well and give thoughts around, Hey, are there steps you can take? I know we had a question earlier about, should I convert my account to a Roth account ahead of RMDs? We’ll take a look at that sort of thing. Are there things you can do to minimize your taxes today or in the future? Again, usually we charge $250 an hour to meet with people. But if you come into a webinar and you want to do an assessment, we’ll have one of our CERTIFIED FINANCIAL PLANNERS™ meet with you for free. We’re fiduciaries. We’re legally obligated to act in your best interest. We don’t sell any products. There’s no cost or obligation, but we’ll give you some thoughts on your finances and what steps you might take in order to meet your financial goals. If you’re interested in that, I think Andi put up the offer. Go ahead, click through that. You can sign up. We’re happy to meet with you. But let’s turn now to some questions and see what else is on everybody’s mind.

Andi: Speaking of politics, Lynn says, “is there a way to avoid that cap gains bill?”

Brian: It depends a little on the situation. So that’s a pretty broad question. If you’ve already sold something, unless you haven’t realized capital gain, unless you have something that you can sell at a loss to offset it, or you want to make some sort of large charitable contribution, the answer might be no. If you haven’t realized it yet, then yeah. There’s a whole host of things you could do. Depending on your unique circumstances you could consider things like a 1031 exchange, if it’s a property or a Delaware statutory trust. If it’s a property, you can consider things like tax exempt trust. You could consider things like tax loss harvesting other parts of your portfolio to offset the tax gain that you’re realizing. So there are a whole host of things you can do. You can gift some of the appreciated security. So there are definitely steps you can take to mitigate in some circumstances, cap gains. Just depends on your particulars.

Andi: Glenn wants to know, “how much do you trust crypto? Stable coins tanked. NFT’s have proven to be vapor. Both a big part of crypto.”

Brian: I think it depends. So here’s our view. NFTs, I don’t know anything about. Maybe this is an age thing. I don’t understand what people are actually buying and I personally probably wouldn’t want to get involved in NFTs.

Stable coin. The problem there is one of structure where you’re essentially trying to peg a value to something. Countries around the world have what’s called a policy trilemma where if you try to peg your currency to another currency, like Hong Kong used to peg their currency to the US, and you’re trying to control monetary supply interest rates and your currency, you can only control two of them. I think that’s what’s running into stable coin is that unless you have an unlimited supply of dollars or whatever you’re using to back it, it’s really hard to peg.

I don’t know about any one particular crypto, so I don’t even want to say Bitcoin is going to be around forever. If you think, is Bitcoin Facebook? Maybe. But it could be MySpace. It could be the early leader that goes away. I don’t know. What I think has legs is the blockchain, the underlying technology that can do smart contracts, that can do decentralized finance, that can allow people to exchange things of value more quickly like if you’re doing a contract for a house and speeding up the escrow process. I think the underlying architecture has legs and will stick around. I’m starting to think that some form of crypto has enough there that it might stick around. But which one is it? I don’t know. So as a firm when we look at the space, we think more of a shotgun approach makes sense than a rifle approach, if you will.

Andi: The next question actually is from Erin again, you said, “should I invest in real estate instead of the stock market?”

Brian: This is a pretty broad question. Real estate is a great investment, or can be. Some of the biggest fortunes in the world have been made with real estate, but it depends entirely on a couple of things. One is what stock would you buy versus what real estate property would you buy? If you buy a great real estate investment, it could do really well. If you buy a great stock, you could do really well. If you buy a house that falls down or a stock that goes to zero it’s a horrible investment. So it’s really specific to what you actually buy. And what are you trying to accomplish? I think people look at real estate sometimes and they feel comfortable with it because they can feel it, touch it, see it versus a piece of paper or an electronic ledger with a stock.

The other thing is real estate’s not marked to market every day. There’s an old joke about how the stock market operates if you think about the equivalent with real estate, if your neighbor every day jumped up and down on the other side of the fence, shouting out what price you would pay for your house all day long and that price was always changing, you’d probably be terrified to own real estate. If I jumped up and down over your fence, Hey, I’ll give you $200,000. I’ll give you $220,000. I’ll give you $190,000. I’ll give you $250,000. And not only am I doing that, but I’m also a manic depressive. So some days I’m really sad and I’m telling you, I’ll pay you $100,000. Other days I’m ebullient and I’m saying I’ll pay $500,000. And you’re actually taking that in and thinking that reflects what your house is worth. You’d probably be pretty unnerved. That’s how the stock market works. In the short-term, it’s a voting machine. In the long term, it’s a weighing machine. To be successful in any asset class, whether it’s real estate, stocks, et cetera, you need to move past the short-term voting emotions and get to the long-term weighing. And what are you trying to accomplish with your investments? Is it the right tool for the right job? Sometimes real estate can be great. Sometimes stocks can be great.

Andi: Following on from that, “is whole life insurance a good way to invest for a long horizon?”

Brian: I don’t think we ever want to exclude an entire asset class or say, Hey, anything is completely good or completely bad, but as a general rule of thumb, Swiss army knives are okay at a number of things, but they’re not really great at any one thing. And when you think of something like whole life insurance, you basically have a term life policy and then a mutual fund, if you will. We think that a lot of times you can get a better mutual fund and a better term life policy individually at a better cost, as opposed to putting them together in a whole life policy. So we’re not always huge proponents, but again, it depends on your specifics.

Andi: For those of you who have asked specific questions about your retirement, I would strongly suggest you actually call the number that you see on your screen or email us, or schedule that free financial assessment. If you have any further questions, this is your last chance. You got about 5 more minutes for now.

Brian: It’s been an interesting time. There’s an old Chinese proverb and there’s debate about whether it’s a blessing or a curse, but it says, may you live in interesting times. Certainly these are interesting times, but I think it’s always interesting. I hear sometimes people say that they don’t want to invest because things are uncertain. When is the future not uncertain? For anybody that was born in the 50’s or sooner you might remember October 1962, hiding underneath desks like the one I’m sitting at hoping that that would protect you from the nuclear fallout if Russia launched nukes from Cuba during the Cuban missile crisis, where the world was at the brink of nuclear armageddon. At that time, the Dow was at about 600. Today, it’s at what? 35,000 or something like that. During that time, that ensuing 60 years, we’ve had a ton of presidential assassinations, wars, recessions, the financial crisis, COVID, et cetera. And yet, despite it all, the upward power of markets has produced strong returns for investors. If you think human progress is going to continue and people’s lives are going to get better, I would strongly suspect it will be because companies are making goods and services that are improving people’s lives. I don’t know exactly which companies, but I think investors will be rewarded over the intermediate and long haul for staying the course or putting money to work during volatile times.

Andi: We did have one more question come in and Jennifer says, “do you have any comments on 72(t) plans?”

Brian: What that is is that’s an IRS code, and what that means is if you’re before age 59.5 and you want to take a distribution from an IRA, there’s a penalty, a 10% penalty with limited exceptions for hardship. 72(t) is a way to take substantially equal payments from an IRA free of penalty before age 59.5. It can make sense. If you retire before you’re 59.5, you need money, your options for taking it are relatively limited. Under certain circumstances, you can pull it from a 401(k) or 403(b) or whatever. And in certain circumstances using 72(t), you can pull it from an IRA. But you need to map it out because it’s a pretty rigid structure that determines how that cash comes back to you. So you definitely want to take a look and map out how much you need each year, how much is going to be forced out to make sure it’s the right choice.

And I think that speaks to what I’ve been talking about the markets today, but one of the biggest opportunities when times are volatile is from a tax planning perspective. So for instance, we got a question before about Roth conversions,. Down markets are great opportunities to convert more shares for fewer dollars and pay less in taxes. So you can have a strategy of doing Roth conversions, but be tactical about when you execute that based on market sell offs. Volatile markets are a great time to do tax loss. They are a great time to potentially look at taking an asset that would have been appreciated, selling it, and then repurchasing it down the road or buying something similar to avoid the wash sale rule. It’s a good time to reassess your cash flow planning and stuff. So I think, financial planning in down markets is even more important, whether that’s from a tax perspective, cash flow planning, et cetera, I think opens up all kinds of opportunities that you definitely want to assess during these volatile times.

Again, if you want to come in and you can meet with us, you can talk about these things customized to your particulars, but if you don’t talk to us, talk to somebody. Hopefully you’ve all found the last hour valuable. Hopefully this has been a good use of your time. You’ve learned a couple things. But learning is great. Taking action based on what you learn is more important. So either talk about this with your financial professionals, dive deeper on some of this on your own, or talk to us, but do something with the information if you want to maximize the efficiency of the time you spent today.

Andi: And I will answer the question that many have asked: is this being recorded so that people can watch it after the fact? Yes, you will receive an email when it’s ready for you to watch at your leisure. And that’s all we have for today.

Brian: Thanks everybody.

Andi: Thank you all. Have a great day.

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