Navigating the market turmoil after the Coronavirus outbreak

Navigating the market turmoil after the Coronavirus outbreak

Here is how to navigate the market turmoil after the Coronavirus outbreak, the stock market crash, and bottom low bond yields.

The longest bull market in history is officially over. Today the Dow Jones recorded its biggest daily loss since the October crash in 1987.  Today will remain in the history books. After the Dow Jones index dropped more than 20% from its February 2020 high, we are formally in a bear market.

Navigating the market turmoil after the Coronavirus outbreak
S&P 500 12 year performance

Investors’ flight to safety has pushed 10-year Treasury rate to 0.8% and 30-year treasury to 1.4%, all-time lows.

Navigating the market turmoil after the Coronavirus outbreak

Where are we standing

The coronavirus outbreak is spreading globally. The virus fears are halting public events and forcing companies to change the way they conduct business. The US has imposed travel restrictions on China and the European Union. Many countries in the US are imposing border control restrictions on their neighbors. While the virus outbreak in Wuhan is officially contained according to the Chinese government, large parts of the country remain in lockdown.
The inability of governments around the world to contain COVID-19 spooked investors. We are now observing the worst stock market selloff since the financial crisis of 2008. In certain ways, the daily market conditions are more brutal and unpredictable than a decade ago. Currently, close to 80% of the stock trading is generated by computer algorithms who can send thousands of trades in milliseconds.

DateDow Jones IndexChange% Change
12-Mar-2021,200.95-2,352.27-9.99%
11-Mar-2023,553.22-1,464.94-5.86%
10-Mar-2025,018.161,167.144.89%
9-Mar-2023,851.02-2,013.76-7.79%
6-Mar-2025,864.78-256.50-0.98%
5-Mar-2026,121.28-969.58-3.58%
4-Mar-2027,090.861,173.454.53%
3-Mar-2025,917.41-785.91-2.94%
2-Mar-2026,703.321,293.965.09%
28-Feb-2025,409.36-357.28-1.39%
27-Feb-2025,766.64-1,190.95-4.42%
26-Feb-2026,957.59-123.77-0.46%
25-Feb-2027,081.36-879.44-3.15%
24-Feb-2027,960.80-1,031.61-3.56%

The virus fears initially caused by a meltdown in travel-related stocks. Many airline and cruise ship stocks are now trading at a multi-year low. The heightened concerns for the global recession and the lowered commodity demand from China pushed the price of the oil down significantly. After failed negotiations between OPEC and Russia, Saudi Arabia decided to lower the sale prices of oil by 20% and increase its daily output. In turn, the prices of US oil companies collapsed due to fears that US oil producers can not maintain profitable operations at these low levels. During the previous in 2016, many small oil producers shut down or filed for bankruptcy. The expectation is that many more will follow the same faith soon.
Since the oil and gas and travel-related industry make up for more than 10% of the US GDP, it’s easy to understand that lower revenues and potential job cuts can trickle down to the rest of the US economy.

Are we in a recession?
We wouldn’t know the exact figures until April. The likelihood that the US economy will be in recession in Q1 and Q2 of 2020 is very high. The best-case scenario is for a sluggish economy. We started the year on a strong footing with low employment and strong job growth and housing sales, low price of oil and low-interest rates. However, the crisis in US travel, entertainment, and the energy sector can push the economy down.

What can you do now?

Focus on what you can control.

Have a plan
Having a robust financial plan will help you ensure that you are following of your long-term financial goals and staying on track. The investment performance of your portfolio is a key component of your future financial success but it’s not the most important factor. Be disciplined, patient and consistent in following your long-term goals while putting emotions aside
If you don’t have a financial plan, this a perfect time to initiate it. A holistic financial will help you create a comprehensive view of your personal and financial life and have a clear understanding of core risks and abilities to achieve financial independence and confidence.

Do not read the headlines

Wall Street resides in its own bubble and often overreacts to news whether that is good or bad. Right now, all news is bad news. The only thing that will provide confidence in the market is finding a treatment against the COVID-19, which is probably months or weeks away or drop in virus cases in both the US and Europe. A coordinated effort between the Fed, the Congress and the current administration can provide some stability. Let’s hope that all interested parties can come together and create a working plan.

Assess your risk tolerance
Risk tolerance is how we measure our emotional ability to accept market volatility. It’s not always easy to quantify emotions with numbers. As humans, we are always more likely to be risk-averse during market turbulence and more risk-tolerant when the stock market is going higher. If you want to know how you would feel when the stock market drops 20%, open your investment account today. When you are willing to accept short losses, then your risk tolerance is high. If losses are unacceptable then your risk tolerance is very low.

Review your investment portfolio

Perhaps not today, but soon, you should review your investment portfolio in connection with your long-term financial plan and risk tolerance. Make sure that your investments are aligned with your financial goals and needs.

Do not drop your 401k

One of the biggest mistakes you could possibly make now is to drop and stop contributing to your 401k plan. Many people gave up on their retirement savings during the financial crisis and never restarted them. As a result, we have a generation of people with no retirement savings. As a 401k participant, you make regular monthly or semi-monthly payments to your plan. Despite current losses, you benefit from dollar-cost averaging and buying stocks at lower prices.

Invest now

It may sound crazy but if you are a new investor there is no better time to start investing than now. Stocks rarely go on sale. This is one of those opportunities that come only once in a decade. Remember Warren Buffet’s famous quote:

Be fearful when others are greedy and to be greedy only when others are fearful”

Check my blog for guidance and ideas

  • In late January I posted “How to Survive the Next Market Downturn”. I didn’t think that we will need my guide so soon but here we are. I offer nine steps on how to navigate any stock market crash.

 

  • If you are a conservative investor, who mostly invests in bonds, you were probably somewhat sheltered from the March Market Madness. However, the future for income-seeking investors is cloudy. Current bond yields cannot support future bond investors and will likely deteriorate the economy. For more information on how to traverse from here, read my article on “Why negative interest rates are bad for your portfolio

 

  • Amid market volatility and uncertainty, dividend growth ETFs can provide some shelter. In my latest article “Top 5 Dividend Growth ETFs” I discuss five ETF strategies that offer lower volatility and extra income.

Final words
If you have any questions about your investments and how to update your financial plan, feel free to reach out. if you are worried about finances I am here to listen and help.

Top 5 Dividend Growth ETFs

Dividend Growth ETFs

Dividend growth ETFs offer a convenient and diversified way to invest in companies that consistently grow their dividends. Certainly, dividend-paying stocks provide a predictable stream of cash flows to investors looking for extra income. Companies that steadily grow their dividends year over year are known as dividend aristocrats. Investors often view high dividend blue-chip companies as financially stable and less volatile than growth companies. Above all, the extra cash from dividends provides a buffer from market volatility. Many retirees use dividends to supplement their income during retirement. In the current low-interest environment, dividend growth ETFs are a compelling low-cost option for investors looking for extra yield. With a 10-year US treasury paying below 1%, income investors will need to look elsewhere for income. Furthermore, compared to mutual funds, exchange-traded funds offer an inexpensive and tax-efficient way to invest without worrying about annual capital gains distributions.

Our top Dividend Growth ETF picks

I have prepared a list of my favorite five dividend growth ETFs. Besides their shared focus, these dividend ETFs have a different approach in constructing their underlying portfolio. Depending on your goals, each ETFs will give you a different exposure and dividend payout.

Dividend Growth ETF Performance 2010-2019

TickerCAGRSt DevBest YearWorst YearMax. DrawdownSharpe RatioUS Mkt Correlation
VYM12.86%11.16%30.08%-5.91%-11.84%1.090.95
SDY13.07%11.15%30.07%-2.74%-11.00%1.110.92
VIG12.63%11.30%29.62%-2.08%-14.18%1.060.96
DVY12.96%10.60%28.85%-6.32%-10.08%1.150.88
FVD13.18%10.21%26.77%-3.48%-11.11%1.210.91
SPY13.44%12.44%32.31%-4.56%-16.23%1.041.00

Source: portfoliovisualizer.com

Vanguard High Dividend Yield ETF – VYM

Vanguard High Dividend Yield ETF, VYM, tracks the FTSE High Dividend Yield Index. The index selects high-dividend-paying US companies and weights them by market cap. The underlying index excludes real estate investment trusts (REITs).

VYM ETF offers a low-cost, diversified, conservative exposure to high dividend yield large-cap stocks. Vanguard High Dividend Yield ETF charges 0.06% fee and currently pays a 3.2% dividend yield.

The ETF selects its holdings by ranking companies by their forecast dividends over the next 12 months. Only the stocks in the top half are selected. The remaining stocks are weighted by market capitalization. Due to its methodology, VYM tends to hold a large basket of large-cap value stocks.

SPDR® S&P Dividend ETF – SDY

SPDR® S&P Dividend ETF, SDY, tracks a yield-weighted index of dividend-paying companies from the S&P 1500 Composite Index. SDY uses dividend sustainability screens and only holds companies that have increased dividends for the past 20 years. The highest yielding firms are then weighted by dividend yield.

Many tech companies do not meet the strict requirements of paying dividends in the past 20 years. Therefore, SPDR® S&P Dividend ETF has minimal exposure to technology stocks.  Nevertheless, SDY is one of the few dividend growth ETFs that provides exposure to REITs.

SPDR® S&P Dividend ETF charges 0.35% fee and pays a 2.6% dividend yield. Unlike VYM, which ranks its holdings by market capitalization. SDY has a slight tilt towards mid-cap stocks. Investors looking for a broader exposure to the US dividend-paying stocks may find this ETF compelling despite its higher fee.

Vanguard Dividend Appreciation ETF – VIG

Vanguard Dividend Appreciation ETF, VIG, is the most growth-oriented ETF on our list of Dividend growth ETFs. VYM is the largest fund by assets under management (AUM). It tracks a market-cap-weighted index of US companies that have increased their annual dividends for ten or more consecutive years. VIG charges a 0.06% fee and pays a 1.8% dividend. Notably, this ETFs dividend yield is a tad smaller than the yield on the S&P 500.

VIG focuses on dividend growth rather than dividend yield. The fund selects firms that have increased their dividend payments for the past ten years and market-cap-weights its holdings. VIG has the biggest exposure to large-cap and mid-cap growth stocks. In conclusion, investors looking for exposure to high-quality dividend-paying large-cap stock may wish to consider VIG for their portfolios.

iShares Select Dividend ETF – DVY

iShares Select Dividend ETF offers the highest dividend yield on our list of Dividend growth ETF.  DVY pays 3.7% in dividends and charges 0.39% in fees. DVY tracks a dividend-weighted index of 100 US companies. The index selects dividend stocks from the Dow Jones broad market-cap index, excluding REITs.

DVY offers exposure to the US high-dividend stocks that skews towards large, mid, and small-cap value firms paying consistent dividends. DVY’s methodology has a strict sustainability screen, designed to select companies that pay steady and rising dividends. The screening process includes companies with at least $3 billion of market capitalization. Further on, the ETF selects stocks with five-year dividend growth, a coverage ratio of 167 or higher, positive trailing 12-months earnings per share, and high trading volume. The DVY portfolio has significant sector bets towards utilities and financial services.

First Trust Value Line® Dividend ETF – FVD

First Trust Value Line® Dividend ETF, FVD, aims to track an equal-weighted index of dividend-paying companies. The ETF uses a proprietary screening process that only includes companies with more than $1 billion in market cap. FVD has the highest fee on our list. It charges 0.7%, and it pays a 2.1% dividend.  FVD has the best 10-year performance and has reported a slightly lower risk of all five ETFs. Despite its higher than average performance, it produces one of the lowest yields in the group.

FVD creates its portfolio in two steps. First, it uses Value Line’s proprietary ‘safety rating’ system to select low-beta stocks from companies with strong balance sheets. Then it chooses the stocks with above-average yields and weights them equally. The methodology includes REITs and foreign ADRs. As a result, FVD has the highest exposure to international stocks in our list of Dividend growth ETFs. FVD makes big sector bets towards utilities and financial services.

Additionally, it has a slight tilt towards mid-cap stocks. Despite its higher than average performance, FVD produces one of the lowest yields in the group.  In conclusion, investors willing to accept the high cost of FVD may like to use it as an alternative to the more popular dividend growth ETFs.

Dividend Growth ETF Summary

As a group, dividend growth ETFs offer a steady income for yield-hungry investors. Even though none of them have outperformed the S&P 500 in absolute terms, most of these ETFs reported better risk-adjusted returns. In times market turmoil and uncertainty, dividend growth ETFs offer extra income and lower volatilty.

Disclaimer
Past performance does not guarantee future returns. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is the sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. Before investing, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

The Coronavirus and your money

Coronavirus and your money

The Coronavirus and your money. After an unprecedented 10% rally, which started in October of 2019, the stock market is finally hitting a rough patch. The quick spread of the coronavirus in China and around the world made investors nervous about the future of the global economy. The 2% pullback on January 31 wiped out most of January gains. Despite the quick recovery in early February, the outbreak of the virus in South Korea, Japan, Iran, and Italy triggered a massive sell-off on Monday, February 24. The major US indices dropped 3.5% in one day, with DOW falling over 1,000 points.
Investors seeking safety pushed the price of Gold to $1,650. The 10-year treasury rate fell to 1.34, and the 30-year treasury bonds now pay 1.85%. The price of crude oil fell to $51 per share.

About the virus

The coronavirus, called COVID-19, started in the city of Wuhan in the Chinese province of Hubei. Until now, there were over 80,000 reported cases in China and around the world and nearly 2,700 fatalities. The virus spread came on the heels of Chinese Lunar Year celebrations, which is a primary holiday and travel period. It is estimated that Chinese travelers make 3 billion trips in the 40 days surrounding this major Chinese holiday. Currently, more than 60 million people have been locked down in China alone.
The governments around the world have limited or directly banned travelers coming from China. Many foreign businesses like Apple, IKEA, Disney, and Starbucks have shut down stores and theme parks.

The impact on Wuhan

Wuhan is a major transportation and industrial hub in China. More than 300 of the world’s top companies have a presence in Wuhan, including Microsoft, German-based software company SAP, and carmakers General Motors, Honda, and Groupe PSA.
The total value of trade imports and exports in Wuhan reached $35.3 billion in 2019, a record high that was 13.7% above the previous year.

The Bear case

A continued outbreak of the coronavirus can shave off between 0.5% to 1% of the already slowing Chinese GDP. As the second-biggest economy, China is one of the largest importers of commodities and materials.
An extended lockdown will hurt sales of all foreign companies doing business in China. It can trickle down to the already fragile economies of the EU,  Japan, and other export-oriented countries.
The lockdown in China will hurt the global supply chain and the limit the manufacturing abilities of companies making their products in China.
The virus outbreak in Italy, South Korea, and Iran creates a lot of uncertainty and puts pressure on local authorities to control the further spread out.
The previous virus threats (Ebola, SARS, Zika) hurt travel-related businesses and took several months before the markets fully recovered.

The Bull case

The US economy remains strong. The unemployment rate is at record low levels of 3.5%. Low-interest rates and low gasoline prices will support further growth in consumer spending and housing sales.
While not completely sheltered, the US economy is less dependent on exports to China.
The Fed has more room to cut rates if the US economy experiences a slowdown as a result of the virus.
The Chinese government is introducing a new monetary and fiscal stimulus package to support the economy.
Slowing GDP will make the Chinese government more willing to sign the Phase 2 trade deal with the US.
Pharma companies (reportedly Gilead and Moderna) are pursuing a virus vaccine.
Spring is coming. The warm weather could limit the impact of the virus around the world.

Your investments

  • Keep the course. Have a long-term view and focus on achieving your financial goals.
  • Market volatility is a normal part of the investment cycle.
  • S&P 500 index pays a 1.8% dividend versus a 1.3% yield for the 10-year treasury. A long-term income investors may find it compelling to invest in dividend-paying stocks over bonds.
  • A significant stock pullback will be an opportunity to buy high-quality US companies.
  • If you are looking for a specific action, check out my recent article on how to cope with market downturns: https://www.babylonwealth.com/survive-market-downturn/

How to Survive the next Market Downturn

How to survive a market downturn

Everything you need to know about surviving the next market downturn: we are in the longest bull market in US history. After more than a decade of record-high stock returns, many investors are wondering if there is another market downturn on the horizon. With so many people saving for retirement in 401k plans and various retirement accounts, it’s normal if you are nervous. But if you are a long-term investor, you know these market downturns are inevitable. Market downturns are stressful but a regular feature of the economic cycle.

What is the market downturn?

A market downturn is also known as a bear market or a market correction. During a market downturn, the stock market will experience a sharp decline in value. Often, market downturns are caused by fears of recession, political uncertainty, or bad macroeconomic data.

How low can the market go down?

The largest-ever percentage drop by the S&P 500 index occurred on October 19, 1987 (known as The Black Monday), when the S&P 500 dropped by -20.47%. The next biggest selloff happened on October 15, 2008, when the S&P 500 lost –9.03%. In both cases, the stock market continued to be volatile for several months before reaching a bottom. Every time, the end of the market downturn was the start of a new bull market. Both times, the stock market recovered and reached historic highs in a few years.

What can you do when the next market downturn happens?

The first instinct you may have when the market drops is to sell your investments. In reality, this may not always be the right move. Selling your stocks during market selloff may limit your losses, may lock in your gains but also may lead to missed long-term opportunities. Emotional decisions do not bring a rational outcome.

Dealing with declining stock values and market volatility can be tough. The truth is nobody likes to lose money. The volatile markets can be treacherous for seasoned and inexperienced investors alike. To be a successful investor, you must remain focused on the strength of their portfolio, your goals, and the potential for future growth. I want to share nine strategies that can help you through the next market downturn and boost the long-term growth of your portfolio.

1. Keep calm during the market downturn

Stock investors are cheerful when the stock prices are rising but get anxious during market corrections. Significant drops in stock value can trigger panic. However, fear-based selling to limit losses is the wrong move. Here’s why. Frequently the market selloffs are followed by broad market rallies. A V-shape recovery often follows a market correction.

The hypothetical table below looks at the performance of $10,000 invested in the S&P 500 between January 4, 1988, and December 31, 2018. It’s important to note this hypothetical investment occurred during two of the biggest bear markets in history, the 2000 tech bubble crash and the 2008 global financial crisis. If you had missed the ten best market days, you would lose 2.4% of your average annual return and nearly half of your dollar return.

As long as you are making sound investment choices, your patience, and the ability to tolerate paper losses will earn you more in the long run.

2. Be realistic: Don’t try to time the market

Many investors believe that they can time the market to buy low and sell high. In reality, very few investors succeed in these efforts.

According to a study by the CFA Institute Financial Analyst Journal, a buy-and-hold large-cap strategy would have outperformed, on average, about 80.7% of annual active timing strategies when the choice was between large-cap stocks, short-term T-bills and Treasury bonds.

3. Stay diversified

Diversification is essential for your portfolio preservation and growth. Diversification, or spreading your investments among different asset classes (domestic versus foreign stocks, large-cap versus small-cap equity, treasury and corporate bonds, real estate, commodities, precious metals, etc.), will lower the risk of your portfolio in the long-run. Many experts believe that diversification is the only free lunch you can get in investing.

Uncorrelated asset classes react uniquely during market downturns and changing economic cycles.

For example, fixed income securities and gold tend to rise during bear markets when stocks fall. Conversely, equities rise during economic expansion.

4. Rebalance your portfolio regularly

Rebalancing your portfolio is a technique that allows your investment portfolio to stay aligned with your long terms goals while maintaining a desired level of risk. Typically, portfolio managers will sell out an asset class that has overperformed over the years and is now overweight. With the proceeds of the sale, they will buy an underweighted asset class.

Hypothetically, if you started investing in 2010 with a portfolio consisting of 60% Equities and 40% Fixed Income securities, without rebalancing by the end of 2019, you will hold 79% equities and 21% fixed income. Due to the last decade’s substantial rise in the stock market, many conservative and moderate investors are now holding significant equity positions in their portfolio. Rebalancing before a market downturn will help you bring your investments to your original target risk levels. If you reduce the size of your equity holdings, you will lower your exposure to stock market volatility.

5. Focus on your long-term goals

A market downturn can be tense for all investors. Regardless of how volatile the next stock market correction is, remember that “this too shall pass.”

Market crises come and go, but your goals will most likely remain the same. In fact, most goals have nothing to do with the market. Your investment portfolio is just one of the ways to achieve your goals.

Your personal financial goals can stretch over several years and decades. For investors in their 20s and 30s financial goals can go beyond 30 – 40 years. Even retirees in their 60s must ensure that their money and investments last through several decades.

Remain focused on your long-term goals. Pay of your debt. Stick to a budget. Maintain a high credit score. Live within your means and don’t risk more than you can afford to lose.

6. Use tax-loss harvesting during the market downturn

If you invest in taxable accounts, you can take advantage of tax-loss harvesting opportunities. You can sell securities at depressed prices to offset other capital gains made in the same year. Also, you can carry up to $3,000 of capital losses to offset other income from salary and dividends. The remaining unused amount of capital loss can also be carried over for future years for up to the allowed annual limit.

To take advantage of this option, you have to follow the wash sale rule. You cannot purchase the same security in the next 30 days. To stay invested in the market, you can substitute the depressed stock with another stock that has a similar profile or buy an ETF.

7. Roth Conversion

A falling stock market creates an excellent opportunity to do Roth Conversion. Roth conversion is the process of transferring Tax-Deferred Retirement Funds from a Traditional IRA or 401k plan to a tax-exempt Roth IRA. The Roth conversion requires paying upfront taxes with a goal to lower your future tax burden. The depressed stock prices during a market downturn will allow you to transfer your investments while paying lower taxes. For more about the benefits of Roth IRA, you can read here.

8. Keep a cash buffer

I always recommend to my clients and blog readers to keep at least six months of essential living expenses in a checking or a savings account. We call it an emergency fund. It’s a rainy day, which you need to keep aside for emergencies and unexpected life events. Sometimes market downturns are accompanied by recessions and layoffs. If you lose your job, you will have enough reserves to cover your essential expenses. You will avoid dipping in your retirement savings.

9. Be opportunistic and invest

Market downturns create opportunities for buying stocks at discounted prices. One of the most famous quotes by Warren Buffet’s famous words is “When it’s raining gold, reach for a bucket, not a thimble.” Market selloffs rarely reflect the real long-term value of a company as they are triggered by panic, negative news, or geopolitical events. For long-term investors, market downturns present an excellent opportunity to buy their favorite stocks at a low price. If you want to get in the market after a selloff, look for established companies with strong secular revenue growth, experienced management, solid balance sheet and proven track record of paying dividends or returning money to shareholders.

Final words

Market downturns can put a huge toll on your investments and retirement savings. The lack of reliable information and the instant spread of negative news can influence your judgment and force you to make rash decisions. Market selloffs can challenge even the most experienced investors. That said, don’t allow yourself to panic even if it seems like the world is falling apart. Prepare for the next market downturn by following my list of nine recommendations. This checklist will help you “survive” the next bear market while you still follow your long-term financial goals.

Market Outlook October 2019

market Outlook October 2019

Highlights:

  • S&P 500 recorded a modest gain of 0.9% in the third quarter of 2019
  • Ten-year treasury rate dropped to 1.5% before bouncing back to 1.75%
  • S&P 500 dividend yield is now higher than the 20-year treasury rate
  • Manufacturing index hits contraction territory

Economic Overview

  • The US economy continues to show resiliency despite increased political uncertainty and lower business confidence
  • The consumer sentiment – The US consumer is going strong. Consumer sentiment reached 93 in September 2019. While below record levels, sentiment remains above historical levels. Consumer spending, which makes up 68% of the US GDP, continues to be the primary driver of the economy.
Market Outlook October 2019 Consumer Sentiment
Consumer Sentiment
  • Unemployment hits 3.5%, the lowest level since 1969
  • Wage growth of 2.9% remains above-target inflation levels
  • Household debt to GDP continues to trend down and is now at 76%.
Market Outlook October 2019
Household debt to GDP
  • Fed rate cuts – Fed announced two rate cuts and is expected to cut twice until the end of the year.
  • The 10-year treasury rate is near 1.75%
  • The 30-year mortgage rate is near 3.75%
  • While low-interest rates and low unemployment continue to lift consumer confidence, the question now is, “Can the US consumer save the economy from recession’?
  • The probability of recession is getting higher. Some economists assign a 25% chance of recession by the end of 2020 or 2021.
  • The ISM Manufacturing index dropped to 47 in September, falling under for a second consecutive month. Typically readings under 50 show a sign of contraction and reading over 50 points to expansion. The ISM index is a gauge for business confidence and shows the willingness of corporate managers to higher more employees, buy new equipment and reinvest in their business.
  • Trade war – What started as tariff threats in 2018 have turned into a full-blown trade war with China and the European Union. The Trump administration announced a series of new import tariffs for goods coming from China and the EU. China responded with yuan devaluation and more tariffs. France introduced a new digital tax that is expected to impact primary US tech giants operating in the EU.
  • A study by IHS Markit’s Macroeconomic Advisers calculated that gross domestic product could be boosted by roughly 0.5% if uncertainty over trade policy ultimately dissipates.
  • Chinese FX and Gold reserves – China’s reserve assets dropped by $17.0b in September, comprising of $14.7bn drop in FX reserves and a $2.4bn decline in the gold reserves. China has been adding to its gold reserves for ten straight months since December 2018.
  • Political uncertainty – Impeachment inquiry and upcoming elections have dominated the news lately. Fears of political gridlock and uncertainty are elevating the risk for US businesses.
  • Slowing global growth – The last few recessions were all domestically driven due to asset bubbles and high-interest rates. This time could be different, and I do not say that very often. Just two years ago, we saw a consolidated global growth with countries around the world reporting high GDP numbers. This year we witness a sharp turn and a consolidated global slowdown. EU economies are on the verge of recession. The only thing that supports the Eurozone is the negative interest rates instituted by the ECB. China reported the slowest GDP growth in decades and announced a package of fiscal spending combined with tax cuts, regulatory rollbacks, and targeted monetary easing geared to offset the effect of the trade war and lower consumer spending. So even though the US economy is stable, a prolonged slowdown of global economies could drag the US down as well.

Equities

US Equities had a volatile summer. Most indices are trading close to or below early July levels and only helped by dividends to reach a positive quarterly return. On July 27, 2019, S&P 500 closed at an all-time high of 3,025, followed by an August selloff. A mid-September rally helped S&P 500 pass 3,000 level again, followed by another selloff. S&P 500 keeps hovering near all-time highs despite increased volatility, with 3,000 remaining a distinct level of resistance.

In a small boost for equities, the dividend yield on the S&P 500 is now higher than the 10- and 20- year US Treasury rate and barely below the 30-year rate of 2%.

For many income investors equities become an alternative to generate extra income over safer instruments such as bonds

Market Outlook October 2019
S&P 500 dividend versus 20-year treasury rate

Growth versus Value

Investing in stocks with lower valuations such as price to earnings and price to book ratios has been a losing strategy in the past decade. Investors have favored tech companies with strong revenue growth often at the expense of achieving profits. They gave many of those companies a pass in exchange for a promise to become profitable in the future.

However, while economic uncertainty is going up, the investors’ appetite for risk is going down. The value trade made a big comeback over the summer as investors flee to safe stocks with higher dividends. As a result, the utilities and consumer staple companies have outperformed the tech sector.

The IPO market

The IPO market is an indicator of the strength of the economy and the risk appetite of investors. In 2019, we had multiple flagship companies going public. Unfortunately, many of them became victims of this transition to safety. Amongst the companies with lower post IPO prices are Uber, Lyft, Smiles Direct Club, and Chewy.com. Their shares were down between -25% and -36% since their inception date. Investors walked away from many of these names looking for a clear path to profitability while moving to safety stocks.

Market Outlook October 2019, Uber and Lyft since IPO

Small-Cap

Small caps have trailed large caps due to increased fears of recession and higher market volatility. Small caps tend to outperform in a risk-on environment, where investors have a positive outlook on the economy.

Market Outlook October 2019, Small Cap versus Large Cap

International Stocks

International stocks continue to underperform. On a relative basis, these stocks are better valued and provide a higher dividend than US stocks. Unfortunately, with a few exceptions, most foreign stocks have been hurt by sluggish domestic and international demand and a slowdown in manufacturing due to higher tariffs. Many international economies are much more dependent on exports than the US economy.

Fixed Income

The Fed continued its accommodative policy and lowered its fund rate twice over the summer. Simultaneously, other Central Banks around the world have been cutting their rates very aggressively.

The European Central Bank went as far as lowering its short-term funding rate to -0.50%. As a result, the 30-year German bund is now yielding -0.03%. The value of debt with negative yield reached $13 trillion worldwide including distressed issuers such as Greece, Italy, and Spain.

Investors who buy negative-yielding bonds are effectively lending the government free money.

In one of my posts earlier in 2019, I laid out the dangers of low and negative interest rates. You can read the full article here. In summary, ultra-low and negative interest rates change dramatically the landscape for investors looking to supplement their income by buying government bonds. Those investors need to take more risk in their search for income. Low rates could also encourage frivolous spending by politicians and often lead to asset bubbles.

The Yield Curve

The yield curve shows what interest rate an investor will earn at various maturities. Traditionally, longer maturities require a higher interest rate as there is more risk to the creditor for getting the principal back. The case when long-term rates are lower than short-term rates is called yield inversion. Some economists believe that a yield inversion precedes a recession. However, there is an active debate about whether the difference between 10y and 2y or 10y and 3m is a more accurate indicator.

Market Outlook October 2019, Yield Curve

As you can see from the chart, the yield curve gradually inverted throughout the year. Short-term bonds with 3-month to maturity are now paying higher interest than the 10-year treasury

Credit spreads

The spread between AAA investment-grade and lower-rated high yield bonds is another indicator of an imminent credit crunch and possible economic slowdown.

Market Outlook October 2019, Credit Spreads

Fortunately, corporate rates have been declining alongside treasury rates. Spreads between AAA and BBB-rated investment grade and B-rated high yield bonds have remained steady.

Repo market crisis

The repo market is where banks and money-market funds typically lend each other cash for periods as short as one night in exchange for safe collateral such as Treasuries. The repo rates surged as high as 10% in mid-September from about 2.25% amid an unexpected shortage of available cash in the financial system. For the first time in more than a decade, the Federal Reserve injected cash into the money market to pull down interest rates.

The Fed claimed that the cash shortage was due to technical factors. However, many economists link the shortages of funds as a result of the central bank’s decision to shrink the size of its securities holdings in recent years. The Fed reduced these holdings by not buying new ones when they matured, effectively taking money out of the financial system.

Gold

Gold has been a bright spot in our portfolio in 2019. After several years of dormant performance, investors are switching to Gold as protection from market volatility and low-interest rates. In early September, the precious metal was up nearly 21% YTD, but since then, retracted a bit.

Market Outlook October 2019, Gold

Gold traditionally has a very low correlation to both Equities and Bonds. Even though it doesn’t generate income, it serves as an effective addition to a well-diversified portfolio.

The Gold will move higher if we continue to experience high market volatility and uncertainty on the trade war.

Final words

The US economy remains resilient with low unemployment, steadily growing wages, and strong consumer confidence. However, few cracks are starting to appear on the surface. Many manufacturers are taking a more cautious position as the effects of the global slowdown and tariffs are starting to trickle back to the US. An inverted yield curve and crunch in the repo market have raised additional concerns about the strength of the economy.

Despite the media’s prolonged crisis call, we can avoid a recession. The recent trade agreement between the US and Japan could open the gate for other bilateral trade agreements. Given that the US elections are around the corner, I believe that this administration has a high incentive to seal trade agreements with China and the EU.

The market is expecting two more Fed cuts for a total of 0.5% by the end of the year. If this happens, the Fed fund rate will drop to 1.25% – 1.5%, possibly flattening or even steepening the yield curve, which will be a positive sign for the markets.

Those with mortgage loans paying over 4% in interest may wish to consider refinancing at a lower rate.

Market volatility is inevitable. Keep a long-term view and maintain a well-diversified portfolio.

The end of the year is an excellent time to review your retirement and investment portfolio, rebalance and take advantage of any tax-loss harvesting opportunities.

About the author:

Stoyan Panayotov, CFA, founder of Babylon Wealth Management

Stoyan Panayotov, CFA, MBA is the founder of Babylon Wealth Management and a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning and investment management for growing families, physicians, and successful business owners.

 

If you have any questions about the markets and your investments, reach out to me at stoyan@babylonwealth.com or +1-925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

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10 Behavioral biases that can ruin your investments

10 Behavioral biases that can ruin your investments

As a financial advisor, I often speak with my clients about behavioral biases. Our emotions can put a heavy load on our investment decisions. In this article, I would like to discuss ten behavioral biases that I encounter every day. It’s not a complete list, but it’s a good starting point to understand your behavioral biases and how to deal with them.

We have to make choices every day. Often our decisions are based on limited information or constrained by time. We want to make the right call every single time. But sometimes we are wrong. Sometimes we can be our worst enemy. Stress, distraction, media, and market craziness could get the worst of us.

Behavioral finance

In 2018 Richard Thaler won the Nobel prize for his work in behavioral economics. In his 2009 book “Nudge” and later on in his 2015 book “Misbehaving: The Making of Behavioral Economics,” Thaler reveals the architecture of the human decision-making process. He talks about behavioral biases, anomalies, and impulses that drive our daily choices.

In another study about the value of the financial advisor or the advisor alpha, Vanguard concluded that clients using a financial advisor have the potential to add 1.5% of additional annual returns as a result of behavioral coaching. Further on, Vanguard concludes that because investing evokes emotion, advisors need to help their clients maintain a long-term perspective and a disciplined approach.

 

Afraid to start investing 

Social Security is going into deficit by 2035. And most employers moving toward Defined Contribution Plans (401k, 403b, SEP-IRA). It will be up to you and me to secure our retirement by increasing our savings and investments. However, not everybody is in tune. For many people, investing is hard. It’s too complicated. Not all employers provide adequate training about retirement and investment options. And I don’t blame anyone. As much as I try to educate my blog readers, as well as many colleagues, we are outnumbered by the media and all kinds of financial gurus without proper training and credentials. If you are on the boat and want to start investing, talk to a fiduciary financial advisor, or ask your employer for educational and training literature. Don’t be afraid to ask hard questions and educate yourself.

“This time is different.”

How many times have you heard “This time is different” from a family member or the next financial guru, who is trying to sell you something? Very likely, it’s not going to be any different. As a matter, it could be worse. As humans, we tend to repeat our mistake over and over. It’s not that we don’t learn from our mistakes. But sometimes it’s just more comforting staying on your turf, not trying something new, and hoping that things will change. So, when you hear “This time is different,” you should be on high alert. Try to read between the lines and assess all your options.

Falling for “guaranteed income” or “can’t lose money” sales pitch

As many people are falling behind their retirement savings, they get tempted to a wide range of “guaranteed income” and “can’t lose money” financial products. The long list includes but not limited to annuities, life insurance products, private real estate, cryptocurrency, and reverse mortgage. Many of these products come with sky-high commissions and less than transparent fees, costly riders, and complex restrictions and high breakup fees. The sales pitch is often at an expensive steakhouse or a golf club following a meeting in the salesperson’s office where the deals are closed. If someone is offering you a free steak dinner to buy a financial product that you do not fully understand, please trust me on it – you will be the one picking the tab in the end.

Selling after a market crash

One of the most prominent behavioral biases people make in investing is selling their investments after a market crash. As painful as it could be, it’s one of the worst decisions you could make. Yes, markets are volatile. Yes, markets crash sometimes. But nobody has made any money panicking. You need to control your impulses to sell at the bottom. I know it’s not easy because I have been there myself. What really helps is thinking long-term. You can ask yourself, do you need this money right away. If you are going to retire in another 10 or 20 years, you don’t need to touch your portfolio, period. Market swings are an essential part of the economic cycle. Recessions help clean up the bad companies with a poor business model and ineffective management and let the winners take over.

You may remember that the rise of Apple coincided with the biggest recession in our lifetime, 2008 – 2009. Does anyone still remember Blackberry, Nokia, or Motorola, who were the pioneers of mobile phones?

Keeping your investments in cash

Another common behavioral bias is keeping your investments in cash…..indefinitely. People who keep their 401k or IRA in cash almost always miss the market recovery. At that point, they either have to chase the rally or must wait for a market correction and try to get in again. As a financial advisor, I would like to tell you that it is impossible to time exactly any market rally. By the time you realize it. It’s already too late.

To understand why timing the markets and avoiding risk by keeping cash can be harmful, see what happens if an investor misses the biggest up days in the market. The hypothetical table below looks at the performance of $10,000 invested in the S&P 500 between January 4, 1988, and December 31, 2018. It’s important to note this hypothetical investment occurred during two of the biggest bear markets in history, the 2000 tech bubble crash and the 2008 global financial crisis.

10 Behavioral biases that can ruin your investments - Keeping Cash

As you can see, missing the ten best days over between 1998 and 2018 meant earning nearly 2.5% less on an annual basis and leaving half of the potential absolute gains on the table. Here’s the kicker: Six of the 10 “best days” in the market were within weeks of the worst days in the market. In other words, some of the best days often happen as “v-shaped” bounces off the worst days. Going to cash on a big negative day means increasing the risk of missing a big positive day which, as can be seen from the table above, can have a substantial impact on your returns over time.

Chasing hot investments

One of the most common behavioral biases is chasing hot investments. People generally like to be with the winners. It feels good. It pumps your ego. There is a whole theory of momentum investing based on findings that investors buy recent winners and continue to buy their stock for another 6 to 12 months. We have seen it time and time again – from the tech bubble in 2000, through the mortgage-backed securities in 2008, to cryptocurrency and cannabis stocks in 2018. People like highflyers. Some prior hot stocks like Apple, Google, and Amazon dominate the stock markets today. Others like Motorola, Nokia, and GE dwindle in obscureness. If an investment had a considerable run, sometimes it’s better to let it go. Don’t chase it.

Holding your losers too long

“The most important thing to do if you find yourself in a hole is to stop digging.” – Warren Buffett.

In a research conducted in the 1990s by professor Terrance Odean, he concluded that investors tend to hold to their losers a lot longer than their winners. A result of this approach, those investors continue to incur losses in the near future. Professor Odean offers a few explanations for his findings. One reason is that investors rationally or irrationally believe that their current losers will outperform. A second explanation comes from the Prospect Theory by Kahneman and Tversky (1979). According to them, investors become risk-averse about their winners and risk-seeking to their losers.

When it comes to losing bets, they are willing to take a higher gamble and seek to recover their original purchase price. A third theory that I support and observed is based on emotions. The pain from selling your losers is twice as high as the joy from selling your winners. We don’t like to be wrong. We want to hold on to the hope that we made the right decision. After all, it is a gamble, and the odds will be against you. At some point, we just need to make peace with your losses and move on. It’s not easy, but it’s the right thing to do.

Holding your winners too long

There is a quote by the famous financier Bernard Baruch – “I made my money by selling too soon.” Many people, however, often hold on to their winners for very long. Psychologically, it’s comforting to see your winners and feel great about your investment choices. There is nothing wrong with being a winner. But at some point, you must ask yourself, is it worth it. How long this run can go for and should you cash in some of your profits. What if your winners are making up a large part of your investment portfolio? Wouldn’t this put your entire retirement savings at risk if something were to happen to that investment?

There is no one-size-fits-all answer when it comes to selling your winners. Furthermore, there could be tax implications if you realize the gains in your brokerage account. However, it’s prudent to have an exit strategy. As much as it hurts (stops the joy) to sell the winners, it could lower the risk of your portfolio and allow you to diversify amongst other investments and asset classes.

Checking your portfolio every day

The stock market is volatile. Your investments will change every day. There will be large swings in both directions. So, checking your portfolio every single day can only drive crazy and will not move the needle. It could lead to irrational and emotional decisions that could have serious long-term repercussions. Be patient, disciplined, and follow your long-term plan.

Not seeking advice

Seeking advice from a complete stranger can be scary. You must reveal some of your biggest secrets to a person you never met before. It’s s big step. I wish the media spends more time talking about the thousands of fiduciary advisors out there who honestly and trustworthy look for your best interest.

My financial advisory service is based on trust between you as a client and me as the advisor . So, do not be afraid to seek advice, but you also need to do your homework. Find an advisor who will represent you and your family and will care about your personal goal and financial priorities. Don’t be afraid to interview several advisors before you find the best match for you.

Final words

“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.” – Warren Buffet.

Investing is an emotional act. We put our chips on the table and wish for a great outcome. We win, or we lose. Understanding your emotions and behavioral biases will help you become a better investor. It doesn’t mean that we will always make the right decisions. It doesn’t mean that we will never make a mistake again. We are humans, not robots. Behavioral biases are part of our system. Knowing how we feel and why feel a certain way, can help us when the markets are volatile, when things get ugly or the “next big thing” is offered to us. Look at the big picture. Know your goals and financial priorities. Try to block the noise and keep a long-term view.

Reach out

If you have questions about your investments and retirement savings, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, founder of Babylon Wealth Management

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families, physicians, and successful business owners.

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The biggest risks for your retirement savings

Biggest risks to your retirement savings

Whether you are just starting your career or about to retire, you need to understand the risks you are facing when you plan for your future retirement.

Most experts recommend that you should aim to replace about 80% of work income during your retirement. Part of your retirement income will come from Social Security. Other sources could be a public pension, IRAs, 401k, rental income, sale of real estate or business, royalties, or a part-time job. However, the 80% is not a definite number. The amount you need in retirement could vary substantially depending on your lifestyle, family size, number of dependents, health issues, and so on.

Social Security benefits

The maximum Social Security benefit in 2019:

  • $3,770 for someone who files at age 70.
  • $2,861 for someone at a full retirement age of 66
  • $2,209 for someone aged 62

For reference, very few people reach these upper limits. The average Social Security retirement benefit in 2019 is $1,461 a month. The average disability benefit is $1,234.

Unfortunately, the Social Security trust is already running a deficit. Currently, the Social Security is paying more benefits than all the proceed its receiving from the payroll taxes. Its reserve will be depleted by 2035. After that point, social security recipients will have to receive only a portion of their actual benefit. The current estimate is around 75%.

Pension Shortfall

Similarly to Social Security, most of the public and private pension plans nationwide have an enormous shortfall between assets and their future liabilities. According to a recent study by Pew Charitable Trust and Pension Tracker, US public pension shortfall is over $1 trillion. States like Alaska, California, Illinois, Ohio, Hawaii, and New Jersey have one of the highest pension burdens in the nation. Even after ten years of economic recovery and bull market, most state pension plans are not prepared to face another downturn. Policymakers must take urgent measures to close the pension funding gap, which remains at historically high levels as a share of GDP.

Low savings rate

With social security benefits expected to shrink, I advise my clients that they need to increase their savings in order to supplement their income in the future. Retirement savings in IRA, 401k and even a brokerage account will provide you with the necessary income during your retirement years.

Unfortunately, not everyone is forward-looking. The average 401k balance, according to Fidelity, is $106,000 in 2019, while the average IRA is $110,000. The sad reality is that most Americans do not save enough for retirement and we are facing a retirement crisis.

Not saving enough for retirement is the highest risk of enjoying your retirement years.

Relying on a single source

Many people make the mistake of relying on a single source of income for their retirement.  

Imagine that you were planning to retire in 2009 upon selling a piece of real estate. Or you had all your retirement savings in a 401k plan and the market just crashed 50%.  Many of these folks had to delay their retirement for several years to make up for the lost income. Similarly, selling your business can be risky too. With technology advancements, many businesses are becoming obsolete. You may not always be able to find buyers or get the highest price for your business.

We always recommend to our clients to have a diversified stream of retirement income. Diversifying your source will create a natural safety net and potentially could increase the predictability of your income in retirement.

Market risk

We all would like to retire when the market is up and our retirement account balance is high. However, the income from these retirement accounts like IRA, Roth IRA and 401k are not guaranteed. As more people relying on them for retirement, their savings become subject to market turbulence and the wellbeing of the economy.  Today, prospective retirees must confront with high equity valuations, volatile markets, and ultra-low and even negative yields.

In my practice, I use my clients’ risk tolerance as an indicator of their comfort level during market volatility. With market risk in mind, I craft well-diversified individual retirement strategies based on my clients’ risk tolerance and long-term and short-term financial goals.

Sequence of returns

The sequence of returns is the order of how your portfolio returns happen over time. If you are in your accumulation phase, the sequence of return doesn’t impact your final outcome. You will end up with the same amount regardless of the order of your annual returns.  

However, if you are in your withdrawal phase, the sequence of returns can have a dramatic impact on your retirement income. Most retires with a 401k or IRAs have to periodically sell a portion of their portfolios to supplement their income. Most financial planning software uses an average annual return rate to project future account balance. However, these average estimates become meaningless if you experience a large loss at the start of your retirement.

Our retirement strategies take the sequence of returns very seriously. Some of the tools we use involve maintaining cash buffers, building bond ladders and keeping a flexible budget.

Taxes

Your IRA balance might be comforting but not all of it is yours. You will owe income taxes on every dollar you take out of any tax-deferred account (IRA, 401k, 403b). You will pay capital gain taxes on all realized gains in your brokerage accounts. Even Social Security is taxable.

With skyrocketing deficits in the treasury budget, social security and public pensions will guarantee one thing – higher taxes. There is no doubt that someone will have to pick up the check. And that someone is the US taxpayer – me and you.

Managing your taxes is a core function of our wealth management practice. Obviously, we all must pay taxes. And we can not predict what politicians will decide in the future. However, managing your investments in a tax-efficient manner will ensure that you keep more money in your pocket.

Inflation risk

Most retirees have a significant portion of their portfolios in fixed income. Modern portfolio managers use fixed income instruments to reduce investment risk for their clients. At the time of this article, we are seeing negative and near-zero interest rates around the world. However, with inflation going at around 2% a year, the income from fixed-income investments will not cover the cost of living adjustments. Retirees will effectively lose purchasing power on their dollars.

Interest risk

Bonds lose value when interest rates go up and make gains when interest rates go down. For over a decade, we have seen rock bottom interest rates. We had a small blip in 2018 when the Fed raised rates 4 times and 1 year’s CDs reached 2.5%. At that point in time, many investors were worried that higher interest rates will hurt bond investors, consumers and even companies who use a lot of debt to finance their business. Even though these fears are subdued for now, interest rates remain a viable threat. Negative interest rates are as bad for fixed income investors as the high rates are. Unfortunately, traditional bond portfolios may not be sufficient to provide income and protect investors for market swings. Investors will need to seek alternatives or take higher risks to generate income.

Unexpected expenses

Most financial planning software will lay out a financial plan including your projected costs during retirement. While most financial planning software these days is quite sophisticated, the plan remains a plan. We can not predict the unexpected. In my practice, I regularly see clients withdrawing large sums from their retirement savings to finance a new home, renovation, a new car, college fees, legal fees, unexpectedly high taxes and so on. Reducing your retirement savings can be a bad idea on many levels. I typically recommend building an emergency fund worth at least 6 months of living expenses to cover any unexpected expenses that may occur. That way, you don’t have to touch your retirement savings.

Healthcare cost

The average health care cost of a retired couple is $260,000. This estimate could vary significantly depending on your health. Unless you have full health insurance from your previous employer, you will need to budget a portion of your retirement savings to cover health-related expenses. Keep in mind that Medicare part A covers only part of your health cost. The remaining, parts B, C, and D, will be paid out of pocket or through private insurance.

Furthermore, as CNBC reported, the cost of long-term care insurance has gone up by more than 60% between 2013 and 2018 and continues to go higher. The annual national median cost of a private room in a nursing home was $100,375 in 2018.

For future retirees, even those in good shape, healthcare costs will be one of the largest expenses during retirement. In my practice, I take this risk very seriously and work with my clients to cover all bases of their health care coverage during retirement.

Longevity

Longevity risk is the risk of running out of money during retirement. Running out of money depends on an array of factors including your health, lifestyle, family support and the size and sources of retirement income.  My goal as a financial advisor is to ensure that your money lasts you through the rest of your life.

Legacy risk

For many of my clients leaving a legacy is an important part of their personal goal. Whether funding college expenses, taking care of loved ones or donating to a charitable cause, legacy planning is a cornerstone of our financial plan. Having a robust estate plan will reduce the risks to your assets when you are gone or incapacitated to make decisions.

Liquidity Risk

Liquidity risk is the risk that you will not be able to find buyers for your investments and other assets that you are ready to sell. Often times, during an economic downturn, the liquidity shrinks. There will be more sellers than buyers. The banks are not willing to extend loans to finance riskier deals. In many cases, the sellers will have to sell their assets at a significant discount to facilitate the transaction.

Behavioral risk

Typically, investors are willing to take more risk when the economy is good and the equity markets are high. Investors become more conservative and risk-averse when markets drop significantly. As humans, we have behavioral biases, Sometimes, we let our emotions get the worst of us. We spend frivolously. We chase hot stocks. Or keep all investments in cash. Or sell after a market crash. Working with a fiduciary advisor will help you understand these biases. Together, we can find a way to make unbiased decisions looking after your top financial priorities.

Final Words

Preparing for retirement is a long process. It involves a wide range of obstacles. With proper long-term planning, you can avoid or minimize some of these risks. You can focus on reaching your financial goals and enjoying what matters most to you.

Reach out

If you need help growing your retirement savings, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit my Insights page, where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families, physicians, and successful business owners.

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Market Outlook July 2019

Market Outlook July 2019

Breaking records

So far 2019 has been the year of breaking records. We are officially in the longest economic expansion, which started in June of 2009. After the steep market selloff in December, the major US indices have recovered their losses and reached new highs. The hopes for a resolution on trade, the Fed lowering interest rates and strong US consumer spending, have lifted the markets.  At the same time, many investors remain nervous fearing an upcoming recession and slowing global growth.

S&P 500 in record territory

S&P 500 hit an all-time high in June, which turned out to be best June since 1938. Furthermore, the US Large Cap Index had its best first quarter (January thru March) and the best first half of the year since the 1980s.

S&P 500 Performance since January 2018
Market Outlook July 2019

US treasuries rates declined

Despite the enthusiasm in the equity world, fixed income investors are ringing the alarm bell. 10-year treasury rate dropped under 2%, while 2-year treasuries fell as low as 1.7%.

10-year Treasury versus 2-year treasury and 3-month treasury.

We continue to observe a persistent yield inversion with the 3-month treasury rates higher than 2-year and 10-year rates. Simultaneously, the spread between the 2 and 10-year remains positive. Historically, a yield inversion has been a sign for an upcoming recession. However, most economists believe that the 2-10-year spread is a better indicator than the 3m-10-year spread.

Gold is on the move

Gold passed 1,400. With increased market volatility and investors fears for a recession, Gold has made a small comeback and reached $1,400, the highest level since 2014.

Bonds beating S&P 500

Despite the record highs, S&P 500 has underperformed the Bond market and Gold from October 2018 to June 2019 S&P 500 is up only 1.8% since October 1, 2018, while the 10-year bond rose 8.7% and Gold gained 16.8%. For those loyal believers of diversification like myself, these figures show that diversification still works.

S&P 500 versus 10-year treasury and Gold

Defensive Stocks lead the rally in Q2

Consumer Staples and Utilities outperformed the broader market in Q2 of 2019. The combination of lower interest rates, higher market volatility and fears for recessions, have led many investors into a defensive mode. Consumer staples like Procter & Gamble and Clorox together with utility giants like Southern and Con Edison have led the rally in the past three months.

Utilities and Consumer Staples performance versus S&P 500.

Small-Cap lagging

Small cap stocks are still under all-time high levels in August of 2018. While both S&P 600 and Russell 2000 recovered from the market selloff in December o 2018, they are still below their record high levels by -13.6% and 10% respectively

S&P 600 and Russell 2000 9-month performance.

International Stocks disappoint

International Developed and Emerging Stocks have also not recovered from their record highs in January of 2018.  The FTSE International Developed market index is 13.4% below its highest levels. While MSCI EM index dropped nearly 18.3% from these levels.

International stocks performance

The Fed

After hiking their target rates four times in 2018, the Fed has taken a more dovish position and opened the door for a possible rate cut in 2020 if not sooner. Currently, the market is expecting a 50-bps to a 75-bps rate cut by the end of the year.

As I wrote this article, The Fed chairman Jerome Powell testified in front of congress that crosscurrents from weaker global economy and trade tensions are dampening the U.S. economic outlook. He also said inflation continues to run below the Fed’s 2% target, adding: “There is a risk that weak inflation will be even more persistent than we currently anticipate.”

Unemployment

The unemployment rate remains at a record low level at 3.7%. In June, the US economy added 224,000 new jobs and 335,000 people entered the workforce. The wage growth was 3.1%.

Consumer spending

The US consumer confidence remains high at 98 albeit below the record levels in 2018. Consumer spending has reached $13 trillion. Combined with low unemployment, the consumer spending will be a strong force in supporting the current economic expansion.

Manufacturing is weakening

The Institute for Supply Management (ISM) reported that its manufacturing index dropped to 51.7 in June from 52.1 in May. Readings above 50 indicate activity indicate expanding, while those below 50 show contraction. While we still in the expansion territory, June 2019 had the lowest value since 2016. Trade tensions with China, Mexico, and Europe, and slowing global growth have triggered the alarm as many businesses are preparing for a slowdown by delaying capital investment and large inventory purchases.  

Trade war truce for now

The trade war is on pause. After a break in May, the US and China will continue their trade negotiations. European auto tariffs are on hold. And raising tariffs on Mexican goods is no longer on the table (for now). Cheering investors have lifted the markets in June hoping for a long-term resolution.

Dividend is the king

With interest rates remaining low, I expect dividend stocks to attract more investors’ interest. Except for consumer staples and utilities, dividend stocks have trailed the S&P 500 so far this year. Many of the dividend payers like AT&T, AbbVie, Chevron, and IBM had a lagging performance. However, the investor’s appetite for income could reverse this trend.

The 3,000

As I was writing this article the S&P 500 crossed the magical 3,000. If the index is able to maintain this level, we could have a possible catalyst for another leg up of this bull market.

The elections are coming

The US Presidential elections are coming.  Health Care cost, rising student debt, income inequality, looming retirement crisis, illegal immigration, and the skyrocketing budget deficit will be among the main topics of discussion. Historically there were only four times during an election year when the stock market crashed. All of them coincided with major economic crises – The Great Depression, World War II, the bubble, and the Financial crisis.  Only one time, 1940 was a reelection year.

S&P 500 Returns During Election Years

YearReturnCandidates
192843.60%Hoover vs. Smith
1932-8.20%Roosevelt vs. Hoover
193633.90%Roosevelt vs. Landon
1940-9.80%Roosevelt vs. Willkie
194419.70%Roosevelt vs. Dewey
19485.50%Truman vs. Dewey
195218.40%Eisenhower vs. Stevenson
19566.60%Eisenhower vs. Stevenson
19600.50%Kennedy vs. Nixon
196416.50%Johnson vs. Goldwater
196811.10%Nixon vs. Humphrey
197219.00%Nixon vs. McGovern
197623.80%Carter vs. Ford
198032.40%Reagan vs. Carter
19846.30%Reagan vs. Mondale
198816.80%Bush vs. Dukakis
19927.60%Clinton vs. Bush
199623.00%Clinton vs. Dole
2000-9.10%Bush vs. Gore
200410.90%Bush vs. Kerry
2008-37.00%Obama vs. McCain
201216.00%Obama vs. Romney
201611.90%Trump vs. Clinton

Final words

The US Economy remains strong despite headwinds from trade tensions and slowing global growth. GDP growth above 3% combined with a possible rate cut lat and resolution of the trade negotiations with China, could lift the equity markets another 5% to 10%.

Another market pullback is possible but I would see it as a buying opportunity if the economy remains strong.

If your portfolio has extra cash, this could be a good opportunity to buy short-term CDs at above 2% rate.

Reach out

If you have any questions about the markets and your investment portfolio, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit my Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families and successful business owners.

8 reasons to open a solo 401k plan

8 reasons why entrepreneurs should open a solo 401k plan

What is a solo 401k plan

The solo 401k plan is a powerful tool for entrepreneurs to save money for retirement and reduce their current tax bill. These plans are often ignored and overshadowed by the more popular corporate 401k and SEP IRA plans.  In fact, there is a lack of widely available public information about them. Simply put, not many people know about it. In this article, I will discuss 8 reasons why entrepreneurs should open a solo 401k plan.

Solo or one participant 401k plans are available to solo entrepreneurs who do not have any personnel on staff. If a business owner employs seasonal workers who register less than 1,000 hours a year, then he or she may be eligible for the solo 401k plans as well. The solo plans have most of the characteristics of the traditional 401k plan without any of the restrictions.

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What are some of the most significant benefits of the self-employed 401k?

Maximize your retirement savings with a solo 401k

Self-employed 401k allows a business owner to save up to $56,000 a year for retirement, plus an additional $6,000 if age 50 and over. How does the math work exactly?

Solo entrepreneurs play a dual role in their business – an employee and an employer. As an employee, they can contribute up to $19,000 a year plus catch-up of $6,000 if over the age of 50. Further, the business owner can add up to $37,000 of contribution as an employer match. The employee’s side of the contribution is subject to 25% of the total compensation, which the business owner must pay herself.

Example: Jessica, age 52, has a solo practice. She earns a W2 salary of $100,000 from her S-corporation. Jessica set-up a solo 401k plan. In 2017 she can contribute $18,000 plus $6,000 catch-up, for a total of $24,000 as an employee of her company. Additionally, Jessica can add up to $25,000 (25% x $100,000) as an employer. All-n-all, she can save up to $49,000 in her solo 401k plan.

One important side note, if a business owner works for another company and participates in their 401(k), the above limits are applicable per person, not per plan. Therefore, the entrepreneur has to deduct any contributions from the second plan to stay within the allowed limits.

Add your spouse

A business owner can add his or her spouse to the 401k plan subject to the same limits discussed above. To be eligible for these contributions, the spouse has to earn income from the business. The spouse must report a wage from the company on a W2 form for tax purposes.

Reduce your current tax bill

The solo 401k plans contributions will reduce your tax bill at year-end. The wage contributions will lower your ordinary income tax. The company contributions will decrease your corporate tax.

This is a very significant benefit for all business owners and in particular for those who fall into higher income tax brackets. If an entrepreneur believes that her tax rate will go down in the future, maximizing her current solo 401k contributions now, can deliver substantial tax benefits in the long run.

Opt for Roth contributions

Most solo 401k plans allow for Roth contributions. These contributions are after taxes. Therefore, they do not lower current taxes. However, the long-term benefit is that all investments from Roth contributions grow tax-free. No taxes will be due at withdrawal during retirement.

Only the employee contributions are eligible for the Roth status. So solo entrepreneur can add up to $19,000 plus $6,000 in post-tax Roth contributions and $37,000 as tax-deductible employer contributions.

The Roth contributions are especially beneficial for young entrepreneurs or those in a lower tax bracket who expect that their income and taxes will be higher when they retire. By paying taxes now at a lower rate, plan owners avoid paying much larger tax bill later when they retire, assuming their tax rate will be higher.

No annual test

Solo 401k plans are not subject to the same strict regulations as their corporate rivals. Self-employed plans do not require a discrimination test as long as the only participants are the business owner and the spouse.

If the company employs workers who meet the eligibility requirements, they must be included in the plan.  To be eligible for the 401k plan, the worker must be a salaried full-time employee working more than 1,000 hours a year. In those cases, the plan administrator must conduct annual discrimination test which assesses the employee participation in the 401k plan. As long as solo entrepreneurs do not hire any full-time workers, they can avoid the discrimination test in their 401k plan.

No annual filing

Another benefit of the 401k plans is the exemption from annual filing a form 5500-EZ, as long as the year-end plan assets do not exceed $250,000. If plan assets exceed that amount, the plan administrator or the owner himself must do the annual filing. To learn more about the annual filing process, visit this page.

Asset protection

401k plans offer one of the highest bankruptcy protection than any other retirement accounts including IRA. The assets in 401k are safe from creditors as long as they remain there.

In general, all ERISA eligible retirement plans like 401k plan are sheltered from creditors. Non-ERISA plans like IRAs are also protected up to $1,283,025 (in aggregate) under federal law plus any additional state law protection.

Flexibility

You can open a self-employed 401k plan at nearly any broker like Fidelity, Schwab or Vanguard. The process is relatively straightforward. It requires filling out a form, company name, Tax ID, etc. Most brokers will act as your plan administrator. As long as, the business owner remain self-employed, doesn’t hire any full-time workers and plan assets do not exceed $250,000, plan administration will be relatively straightforward.

As a sponsor of your 401k plan, you can choose to manage it yourself or hire an investment advisor. Either way, most solo 401k plans offer a broader range of investments than comparable corporate 401k plans. Depending on your provider you may have access to a more extensive selection of investment choices including ETFs, low-cost mutual funds, stocks, and REITs. Always verify your investment selection and trading costs before opening an account with any financial provider.

About the author:

Stoyan Panayotov, CFA, MBA is a fee-only financial advisor in Walnut Creek, CA, serving clients in the San Francisco Bay Area and nationally. Babylon Wealth Management specializes in financial planning, retirement planning, and investment management for growing families, physicians, and successful business owners.

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Saving for college with a 529 plan

College savings with a 529 plan

What is a 529 plan?

The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children college expenses.

In the past 20 years, college expenses have skyrocketed exponentially putting many families in a difficult situation.  Between 1998 and 2018, college tuition and fee have doubled in most private non-profit schools and more than tripled in most 4-year public colleges and universities.

College tuition and fees growth between 1998 and 2018.
Source: College Board

With this article, I would like to share how the 529 plan can help you send your kids or grandkids to college.

Student Debt is Growing

The student debt has reached $1.56 trillion with a growing number of parents taking on student loans to pay for their children’ college expenses. The total number of US borrowers with student loan debt is now 44.7 million.

Amid this grim statistic, less than 30% of families are aware of the 529 plan. The 529 plan could be a powerful vehicle to save for college expenses. Fortunately, 529 plans have grown in popularity in the past 10 years. There are more than 13 million 529 accounts with an average size of $24,057.

Let’s break down some of the benefits of the 529 plan.

College Savings Made Easy

Nowadays, you can easily open an account with any 529 state plan in just a few minutes and manage it online. You can set up automatic contributions from your bank account. Also, many employers allow direct payroll deductions and some even offer a match. Your contributions and dividends are reinvested automatically., so you don’t have to worry about it yourself. As a parent, you can open a 529 plan with as little as $25 and contribute as low as $15 per pay period. Most direct plans have no application, sales, or maintenance fees. 529 plan is affordable even for those on a modest budget.

529 plan offers flexible Investment Options

Most 529 plans provide a wide variety of professionally managed investment portfolios including age-based, indexed, and actively-managed options. The age-based option is an all-in-one portfolio series intended for those saving for college. The allocation automatically shifts from aggressive to conservative investments as your child approaches college age.

Alternatively, you can design your portfolio choosing between a mix of actively managed and index funds, matching your risk tolerance, timeline, and investment preferences. Some 529 plans offer guaranteed options, which limit your investment risk but also cap your upside.

Earnings Grow Tax-Free

529 plan works similarly to the Roth IRA. You make post-tax contributions. And your investment earnings will grow free from federal and state income tax when used for qualified expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Tax-exempt growth
529 plan versus taxable investment account
The chart hypothetically assumes a $6,300 annual contribution, a 5% average annual return and a 20% average tax rate on taxable income in a comparable brokerage account. The final year post-tax difference would be $14,539, without taking into consideration state tax deductions.on contributions and impact on financial aid application.

Your State May Offer a Tax Break

Over 30 states offer a full or partial tax deduction or credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower significantly your state tax bill. However, these states usually require you to use the state-run 529 plan.

If you live in any of the remaining states that don’t offer any state tax deductions, such as California, you can open a 529 account in any state of your choice.

Use at Schools Anywhere

529 funds can be used at any accredited university, college or vocational school nationwide and more than 400 schools abroad. Basically, any institution eligible to participate in a federal student aid program qualifies. A 529 plan can be used to pay for tuition, certain room and board costs, computers and related technology expenses as well as fees, books, supplies, and other equipment.

The TCJA law of 2017 expanded the use of 529 funds and allowed parents to use up to $10,000 annually per student for tuition expenses at a public, private or religious elementary, middle, or high school. However, please check with your 529 plan as not all states passed that provision

Smaller Impact on Scholarship and Financial Aid

Many parents worry that 529 savings can adversely affect eligibility for scholarships and financial aid. Fortunately, 529 plan savings have no impact on merit scholarships. You can even withdraw funds from the 529 plan penalty-free up to the amount of the student scholarship.

For FAFSA, funds are typically treated as ownership of the parent, not the child, reducing the impact on financial aid application. A key component of the financial aid application is the Expected Family Contribution (EFC). Since 529 plans are considered parents’ assets, they are assessed at 5.64% of their value. For comparison, any accounts owned directly by the student such as custodial accounts (UTMAs, UGMAs), trusts and investment accounts are assessed at 20% of their value.

Lower Cost versus Borrowing Money

Starting the 529 plan early can save you money in the long run. The tax advantages of the 529 plan combined with the compounding growth over 18 years it will provide you with substantial long-term savings compared to taking a student loan.

529 plan provide Estate Tax Planning Benefits

Your 529 plan contributions may qualify for an annual gift tax exclusion of $15,000 per year for single filers and $30,000 a year for couples. The 529 plan is the only investment vehicle that allows you to contribute up to 5 years’ worth of gifts at once — for a maximum of $75,000 for a single filer and $150,000 for couples.

Other Family Members Can Contribute Too

Grandparents, as well as other family and friends, can make gifts to your 529 account. They can also set up their own 529 accounts and designate your child as a beneficiary. The grandparent-owned 529 account is not reportable on the student’s FAFSA, which is good for financial aid eligibility. However, any distributions to the student or the student’s school from a grandparent-owned 529 will be added to the student income on the following year’s FAFSA. Student income is assessed at 50%, which means if a grandparent pays $10,000 of college costs it would reduce the student’s eligibility for aid by $5,000.

Transfer funds to ABLE Account

Achieving a Better Life Experience (ABLE) account was first introduced in 2014. The ABLE account works similarly to a 529 plan with certain conditions. It allows parents of children with disabilities to save for qualified education, job training, healthcare, and living expenses.

Under the TCJA law, 529 funds can be rolled over into an ABLE account, without paying taxes or penalties.

Assign Extra Funds to Other Family Members

Finally, if your child or grandchild doesn’t need all the money or his or her education plans change, you can designate a new beneficiary penalty-free so long as they’re an eligible member of your family. Moreover, you can even use the extra funds for your personal education and learning new skills.