Understanding Your Bonds - III

Understanding Your Bonds - II

Skip's Thoughts on Fiduciary Regulations (1)

http://helmswealthmanagement.blogspot.com/2017/03/what-to-ask-prospective-advisors_9.html

Blog Ideas

Hi Everybody,

I need your help to improve my blog.  

Please call or email topics you’d like to see in 2017 about personal finance, investments and all-things money.  I’ll probably still sneak in some market comments but want to be sure I cover what’s on your mind.

Next year should be fertile ground on taxes, healthcare and interest rates.  I wouldn’t be surprised to see some de/re/un-regulating in investments too.

Don’t be bashful!  Let us know your burning financial questions and I’ll do my best to get you answers.

Thanks and Happy New Year, Skip

Bonus Blog:

The HWM blog morphed out of my original market letter.  I’d write painstaking research comments and ask clients what they thought.¹  Most said they couldn’t care less and to just do what I thought was best.  There has been more interest in recent Wall Street skullduggery but after a while, people either get it or they won’t.

I do this all day long and forget that not everyone knows what I take for granted.  Demand more!  If you can’t get straight answers anywhere else, let’s see what I can do.  Personal questions are answered privately.  sh  

¹ I sent a market comment to my former partner at Merrill Lynch for proofreading.  He wrote back:  “This is brilliant!  It’s too bad nobody will read it.”  I thought about just stepping on a rake a couple times because it would be faster and probably less painful than scrapping the newsletter.  The comment never saw the light of day and the blog was born.  I still have the rake for emergency editing, though.

The Qualifying Charitable Distribution

Using the Qualifying Charitable Distribution (QCD) for IRA’s

There is a tax provision that allows people over 70 ½ to transfer up to $100,000 a year from their IRA to a qualifying charity as a direct pass-through.  It usually doesn’t affect your other taxes and can be used to satisfy your Required Minimum Distributions.  In other words – the state and federal governments never see a dime.  

I’d like to come at the opportunity from two different angles.  The first is for people who are both generous to charity and to their family.  The second is for leaders (or soon-to-be leaders) in those charities.

For families: think of this more as succession planning than current tax planning.  

Your family inherits your assets in three buckets.  Bucket one has things like real estate, securities and personal possessions.  Your heirs may get a step-up in the cost basis so all capital gains are forgiven.  Assets pass at 100 cents on the dollar.

Bucket two has life insurance.  Structured correctly, your family gets those benefits income tax free.

Bucket three has assets that are always taxable like annuities and retirement accounts.  If you don’t pay the tax, your heirs will.  Your children (the employed ones) could lose up to 40% of the value to the government.

Bucket three is the low-hanging fruit for charitable giving.  If you want to do right by your church or cause, give them assets with limited value to your taxable heirs.  Leave your family the assets they can keep.  The QCD is a good start.

At your annual financial planning review, make a list of what’s in your three buckets.  You may also find things in the first two you can do without now and enjoy the deduction.  Some gifts are best given from a warm hand.

For inspiring charitable leaders:  This isn’t about using the QCD – it’s about selling it.

You know people who could contribute a lot more than they have.  Next time you ask for a donation, DO NOT ask for cash!

Try this instead:

Hello Jeff, It’s campaign time again.  Will you be using the new IRA direct transfer this year?

Huh?

It’s a loophole that allows folks to transfer money directly from their IRA to charities like us without paying any taxes.  You can use it to avoid taxes on your required distributions too.  It’s limited to a hundred thousand dollars a year – but we can work around that.  Handy estate gift too …

Er, uh ….

Why don’t you and Helen join us for lunch next Thursday?  I can tell you how we’re taking advantage of the opportunity.

See you then.

Let’s break this down:  In a few sentences, you significantly raised the bar, brought new assets into the conversation, broached death and taxes tactfully, let him know he’s not alone and closed for the “ask” appointment.

Does it matter if he isn’t 70 ½ yet?  No.  Taking money from an IRA and deducting it works about the same as the pass-through for most people in their sixties.

Does it matter if he doesn’t even have an IRA?  No. There may be things in buckets one and two that offer nice write-offs.  

What does matter is you just started a peer-to-peer conversation about his serious money.  Cash is a byproduct of assets.  Go for the source!

BTW, big checks like this make nice challenge grants to help other contributors find their wallets.  Leverage them.  Maybe Jeff can make a couple calls.

Your pancake breakfast isn’t going to restore the chapel.  Be inspirational!  

If I can help explain this to friends who serve, just say when and where and I’ll be there.

As always, the opinions expressed here are mine and don’t necessarily reflect the views of LPL Financial or anyone else.  This is generic information so definitely run this by your tax and legal advisors for your specific situation.  They may have even better ways to have your cake and eat it too.  sh   

You Have To Watch The Commercials Too!

I don’t watch a lot of financial TV but a couple weeks ago, an economist I respect was on one of the two major financial networks.  I tuned-in a few minutes early.

While I was waiting, the channel ran four commercials from:

           

            a)     A reverse-mortgage lender,

            b)    A delinquent-tax negotiator,

            c)     A time-share liquidator and

            d)    Someone selling electronic patches for back pain.

I’m no marketing genius but I’d say the advertisers were targeting people who can’t pay their bills, can’t pay their taxes, make poor real estate choices and/or have sore backs.

That’s no accident.  Networks design content to target the customers their advertisers want to reach.  Time is not on their customers’ side.  You need to turn a quick profit or dump assets when the IRS is breathing down your neck. 

I hope my clients don’t use those products …

… except maybe for the back-patches.  We’re not as young as we used to be.

Our objective is to patiently own investments that mature in the fullness of time.  Time has a habit of smoothing the bumps.

Almost everyone is forgiven.  Viewers are hoping to learn something that improves their lives.  Advertisers and stations have the right to sell their wares.  My economist showcased his firm’s services to a national audience.

But I’m on shaky ground.  If an idea I got here blew-up in my face, there would be nobody but Skip to blame.  My clients would rightly think so.

So when you watch financial TV, if the ads are for products you pray you’ll never need, remember who the content is for.

Ah!  My back feels better already!  Sh

The opinions expressed here are those of Skip Helms and do not necessarily reflect those of LPL Financial or anyone else. Investing involves risks, including the loss of principal. Past performance does not guarantee future results. Please consider potential transactions carefully and read all appropriate materials before investing or sending money. Securities offered through LPL Financial, Member FINRA/SIPC

On Market Timing - Part Three

What do we do now?

In the first blog I focused on the perils of short-term market timing. 

In the second I made my case that making 30-year commitments to any asset class is dangerous.  If you are paying for investment management, get it.

My very best (and hard learned) advice is to find how long your cherished financial goals will take and build your strategy around that.

Let’s say your primary investment goal is to make a balloon payment in 18 months.  You could put your money in T-bills or an insured savings account.  You won’t earn much but the check will be ready when needed.

Another strategy (which I don’t recommend) would be to purchase short-term speculative holdings like coffee futures or lottery tickets.  You create an opportunity for higher returns but greatly increase the chance of severe losses.

Investing in long-term holdings like stocks or real estate might not make sense because the year-to-year results are too unpredictable. 

My last chart is from J. P. Morgan showing market returns for stocks and bonds when held for 1, 5, 10 and 20-year time periods.

The green bars show the S&P 500 going back to 1950.  On the far left, returns for any given year have fluctuated wildly.  A lot of those years are below the 0% line.  If you need next year to be a good year, you are market timing.

My domain is further right.  I believe you need a minimum five-year commitment to stock portfolios.  I’m expecting a great year, a terrible year and three somewhere in the middle.  Maybe a market timer can tell you which order that will happen – if it happens at all – but I won’t try.[1]

On the five year bar, we’ve averaged our great and rotten years.  Very few of the five-year holds are below the zero line.  On the ten year bar, the only losing decade was 2001-2010. 

Now let’s say your primary investment objective is to live a comfortable retirement over the next 30 years with a rising income.

Putting more than a couple years’ reserves in savings won’t work.  You can’t even keep up with inflation – much less earn any spending money.

I hope you aren’t thinking about speculating in coffee futures to make balloon payments. 

You have long-term needs.  Have a leisurely cup of coffee and look for long-term strategies – maybe one of those mature green bars.

Remember the little girl and her yo-yo.  You have thirty steps.  What the yo-yo does on any one of them doesn’t really matter. 

It matters to the man who needs a balloon payment in 18 months.

It matters to financial entertainers hawking their products.

It really matters to people who don’t know it doesn’t matter.

But it shouldn’t matter much to you.

That’s it for now.  Thanks for sticking with me for one of my more technical blogs.

If I can help, give me a call, sh

The opinions expressed here are those of Skip Helms and do not necessarily reflect those of LPL Financial or anyone else. It is not possible to determine the top or the bottom of the market. Investing involves risks, including the loss of principal. Past performance does not guarantee future results. Please consider potential transactions carefully and read all appropriate materials before investing or sending money. No strategy, such as asset allocation or diversification assures a profit or protects against loss. Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA / SIPC

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[1] I keep a picture of a Lehman Bros. employee leaving their London headquarters with his personal possessions in a cardboard box.  Whenever I get full of myself and think I know it all, I pull that picture up and remind myself just how humbling this business can be.  sh 

Thoughts on Robo Advisors II

Last week I ended my blog by asking if a client was receiving the help he needs to retire comfortably. If the answer was “yes”, that’s a good start. If the answer was “no”, I said he has work to do.

But I didn’t say what he should do. That response needs context.

The targets for discount robo-advisors are investors who currently pay full service advisors for automated money management. Most investors I’ve met couldn’t tell if their portfolio was actively managed or indexed. Discounters helpfully point out if it is indexed, why pay a middleman when they can save a percent (or so) a year by doing it themselves?

To my way of thinking; this assumes the client’s primary goal is to own a generic portfolio at a bargain price. I make the case that if he doesn’t even know what he owns, why does he own it in the first place? You invest for goals. Are these the right holdings for those goals? Maybe his advisor can answer that. That’s not a lock either but it’s the first place to ask.

I don’t use the same portfolio process as robo-advisors – either the full-service or self-serve versions. But like I said last week, personal advice matters more than which prudent asset management you use. Leaving stocks and bonds alone this time, here are two structural concerns about robo-advice I think are harmful:

The first is the enrollment process. Every packaged portfolio I’ve ever seen starts with an in-depth questionnaire about the client’s situation, objectives and concerns. Often it’s the front half of the new account form.

It is my unshakeable belief that the average investor doesn’t have the experience or the temperament to answer those questions in his or her own best interests.

That especially applies to risk.

Clients express risk emotionally. For a lot of people, market losses hurt more than gains feel good. Some are sure declines are permanent. They are sure the next drop is the big one. They can’t even open their statements. Some investors salvaged what they could in 2009 and bought gold and canned beans to survive the end of civilization.

In this business, risk is cold, hard numbers. The robo-computer has to translate that tangle of unresolved angst into a binary response. After you’ve answered enough questions with feelings, you get a canned portfolio based on your fears – not your goals.

Reducing market volatility is a tactic, not a goal.

Not being old and broke is a goal.

Putting your churlish daughter through grad school is a goal.

Whoever asks those questions needs to know your goals first so you can prioritize. In all but the wealthiest cases, there are compromises to make between what you have, what you want and what’s possible.

My second concern is that after you get your automated portfolio, you are supposed to suddenly have the self-discipline to hold it through the worst markets without any emotional support.

Ask the canned-bean investor (or his wife) how that’s working out.

One of my favorite after-school movies was Ulysses with Kirk Douglas.[i] Remember him lashed to the mast in writhing torment as the Sirens tempted him with songs of love and loss? He would have gutted his ship on the rocks if he hadn’t told his men to stuff wax in their ears and row for their lives – no matter how he begged them not to when his stress became unbearable.

The Sirens of financial entertainment sing new reasons to wreck your ship 24/7. You need experienced oarsmen to ignore them and row you where you need to be.

If the value of avoiding those just two (of plenty more) possible mistakes isn’t worth many times the cost difference between human advice and robo-advice, either you don’t need it (rare) or you aren’t getting it.

Back to last week’s blog; I hope dad doesn’t fire “that broker”. I’d like to believe that in those 20-something years, they’ve carefully planned for mom and dad to live the rewarding, dignified retirement they deserve.

I’d like to believe that for all of us. sh


The opinions expressed here are those of Skip Helms and do not necessarily reflect those of LPL Financial or anyone else. Investing involves risks, including the loss of principal. Past performance does not guarantee future results. Please consider potential transactions carefully and read all appropriate materials before investing or sending money. Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC



[i] Ulysses: All rights reserved by Lions Gate Films, Inc.

The Muni King of New Mexico

I just finished writing a short blog piece trying to untangle the inverse relationship between bond values and interest rates. While marshaling my thoughts, I remembered a day many years ago when I got my first lessons on municipal finance, yields, and how the game is played.

My financial career started at the Merrill Lynch branch in Santa Fe, New Mexico. On my second day at work (February 19th 1985 -- I looked it up) my boss called me into his office and said he needed me to run over to the state capital building and put in Merrill's syndicate bid for a municipal bond underwriting.

He handed me an envelope containing; instructions, a delivery receipt in case we won the deal and a check for $5 million payable to the State of New Mexico. I'm sure I either stared or blinked for a couple seconds and then he told me process. I touched the envelope in my suit pocket a dozen times during the one mile trip to the state house.

At the time, my wife was a municipal bond analyst so at least I knew what munis were -- but two days into my illustrious career, that was about all I knew about the securities business. Six or seven well dressed men (including me) were shown into the governor's office and given a single sheet of paper listing ten general obligation series bonds with differing amounts, coupons and maturity dates.

We all scattered to various pay phones we'd scouted earlier that morning (no cell phones back then) and called our underwriting desks. I gave my contact the bonds he had to price then waited a few minutes while they did the calculations. He got back on phone and gave me the yield-to-maturity and bid price for each issue and, most important, a weighted total for the whole enchilada. I think it came to $56 million and change -- which was a big deal for a small, solvent state.

What the underwriter had done, I would learn a month later in training, was calculate what we and our partners thought we could sell those bonds for after various markups in the sales food-chain.

This was a competitive bid. The state already had their ducks in a row -- credit rating, maturities, amounts, coupons and a half-inch red-herring prospectus. All they wanted was the highest dollar amount. You never see the other bids but this could have been decided by a hundredth of a percent.

All of the bidders were back inside our half hour deadline and we presented our envelopes to an aide. In addition to my meteoric rise in high-finance, I got to meet Governor Toney Anaya. Until then, the highest political figure I knew was the mayor of my former town -- who was also the catcher on my softball team.

The governor and several financial staffers opened the bids exactly on the hour and sorted through the bids. Then one of them asked me to come over to the desk and thanked the other bidders. We'd won! Governor Anaya shook my hand and said thank you and I handed him the good-faith check. Years of manners training kicked in and I managed to thank him for his trust. He gave the check to an aid who signed the receipt and I was on my way back to the office five minutes later. The underwriting desk would handle the rest.

I walked straight into my bosses office and told him the news. He was all smiles and congratulated me on a job well done. I found out later that Merrill hadn't won a New Mexico bid in years so this was rare. I think it was the only deal we won in the 15 years I worked there.

The office didn't get a piece of the underwriting fees but the brokers knew there would be quality local inventory soon -- and that we'd be the only ones in town who had it. Plus we knew the size of the deal and the maturities so people could line-up their call list for when those bonds hit the street. Not that we knew how many we would get. As the lead, Merrill would get more than anybody else but the other syndicate partners, all big names on Wall Street, would get their share. And everybody's institutional desk would get their fill before the branch offices got a sniff.

I must have been a little full of myself because one of the old hands chuckled and asked how much I made on the deal. Well, I got the same couple hours training pay I would have gotten if I'd studied for my securities exam -- so Skip wasn't buying drinks at the Palace that night.

It didn't matter. For that day, I was the Muni King of New Mexico!

Skip and his wife Nancy in 1985

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.

Municipal bonds are subject to availability and change in price. They are subect to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.

Good, Bad, or Unfathomable

Most of my short-term market indicators have gone green (positive) on US stocks. The medium-term indicators are still underwater since they have to overcome the sharp sell-off in August to regain their momentum. Long-term indicators have been bullish since 2011.

As long as the long-term indicators stay green, such market-timing as I ever attempt is limited to trying to find the strongest industries and right-sized companies within strong markets.

I’ve been calling clients this week to commit cash reserves. Conversations after a correction always bring out their political concerns. That’s when I explain that markets and politics almost never correlate. A country’s economic system (capitalist, socialist, communist, kleptocracy) matters – but guessing what politicians will do is a hard way to make money.

Barry Ritholtz (money manager, Bloomberg columnist and interesting man) has a funny story that says it well. He said when George W. Bush brought his tax-cuts forward in 2001 and 2003, his liberal friends said it would blow-up the deficit and sold their stocks. Stocks went up almost 100%.

When Barack Obama was elected, his conservative friends were sure this Kenyan socialist would destroy the economy and sold their stocks. Stocks went up almost 200%.

Long-story short – a stock only goes up for one reason: more people want to buy it than sell it. Good, bad or unfathomable, those people are entitled to their opinions. We’re more concerned about what they do than why they do it. sh

The opinions expressed here are those of Skip Helms and do not necessarily reflect those of LPL Financial or anyone else. Investing involves risks, including the loss of principal. Past performance does not guarantee future results. Please consider potential transactions carefully and read all appropriate materials before investing or sending money. Securities offered through LPL Financial, Member FINRA/SIPC

International investing involves special risks such as currency fluctuations and political instability and may not be suitable for all investors.

All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.

A Question on Bonds and Rates

Hello Mr. Helms,

On your podcast you said that bonds lose money when interest rates rise. I thought bonds always paid the same interest. How does that change?

You're right about the interest. The vast majority of bonds pay a fixed cash-flow during their life and return a fixed amount at maturity. Since those two things don't change, the only way markets can react to supply and demand for those payments is the price of the bond itself.

I've never done a good job explaining this. Rates and prices work inversely. It's like trying to cut your hair in the mirror.

But I've got a good example that seems to work:

Let's say you loan me $1,000. I agree to pay the owner $50 a year for the next 10 years and return the principal with the last payment -- basically a 10-year 5% bond.

A year later, you need to sell your bond. Unfortunately, the going rate for 9-year bonds has gone from $50 a year (5%) to $100 a year (10%). Nobody is going to pay you $1,000 for your bond when they can get twice the income for the same investment.

If you want to sell, you'll have to discount the price until the combination of the profit the new buyer makes in 9 years -- plus my $50 a year -- equals a 10% return. In the business that's called yield-to-maturity. Some of it is interest. Some is the gain (or loss) at payoff.

With a bond-price calculator I entered $50 a year for 9 years with $1,000 at the end at a yield-to-maturity of 10% and got a price of $712 for your bond. If rates had gone down, you could expect a profit instead.

And it isn't just your bond. Bonds are priced constantly in world markets whether they are for sale or not. That's why the values can change on your statement even with no activity.

As a rule, the longer an owner has to wait for his principal, the wider the price fluctuations because of market uncertainty. Lower-quality bonds usually fluctuate more than high-quality bonds for the same reason.

So the best answer to your question is that yields rise because bond prices fall. The new owner's increased yield comes from the old owner's wallet.

I used an extreme example to show the process. Rates doubling in a single year would be a disaster for the bond market and probably every other financial market in the bargain. Right now rates are historically low but don't appear to be in any hurry to go up either.

And advisors can't legally borrow money from clients. -SH


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.