One of our clients asked recently if he had been taken off the mailing list for the Newsletter, which brought to mind how long it had been since we last wrote. One reason for the delay is that it has been difficult to comment on this very unpredictable stock market since major forces influencing the markets change so rapidly: unemployment trends, the economy, the possibility of a double dip recession, and most recently first Europe's and then Greece's response to the Greek debt crisis. So volatility in the markets is the topic of the first article. That lead article is followed by articles on considerations for the best age to begin collecting Social Security benefits, a discussion about end of life choices, and a couple of miscellaneous matters. We conclude, as always, with what is happening with employees in the office. -David W. Otto
KEEP A CLEAR HEAD
What a week/month/quarter/year this has been. This piece is written in early November, but we think it likely that at least two of those four nouns in the first sentence will be fairly apt most anytime during this period. During August the market moved more than 4% in each of four of the five days in a single week. Two days were up by more than 4%; two days were down by more than 4%. Similarly, a blended portfolio was down about 6% in September and up a similar amount in October.
That market volatility is a likely norm for the foreseeable future is a difficult reality to accept. At the moment, however, the impact of uncertain markets is made worse by the fact that many - if not most - portfolios are, at best, about even with where they began in 2011. The occasional improvements we have seen in the markets have failed to signify that recovery is just around the corner.
During times of uncertainty, investors are often tempted to pull back in order to protect themselves. Such reactions have problems of their own. Abandoning the market totally can put retirement goals at risk. Often, buying CDs leads not only to small returns, but also to losses due to the subtle erosion created by inflation. Switching to government bonds may have helped in the past, but these too can decline in value, and their yields are likely to underperform the stock market in the long run.
At times like this, it seems important to again focus on the strategies that Otto & Associates rely on. We have three general principles which we list here and expand on below:
• We pay as little attention as possible to headline news and as much attention as we can to constructing big picture understandings of market analysis, consumers, and the economy, so as to look for positive options and avoid pitfalls.
• We watch for opportunities in sectors of the markets where there is reason to believe investments are mispriced. This will cause us to overweight certain sectors (today one area that is priced too low, in our opinion, is commercial real estate) and underweight other sectors (it is our opinion that today traditional U.S. government bonds are vulnerable to long term price deterioration).
• Most importantly, we keep client goals in mind. Often those goals include a comfortable retirement and may also involve college funding, leaving a legacy, and perhaps some interim goals such as paying for a wedding, funding a trip, or helping a relative who has financial needs.
First, at Otto and Associates we try to discount the headline news. You can depend on the media to have dramatic stories. You can also depend on the drama having a negative tilt more of the time because it is that news which draws an audience. But as we read the market tea leaves, the reality today may not be as negative as the headlines would lead you to believe. Related to that fact, we keep in mind that because the market is an auction, in the short term it is very responsive to the latest news.
Second, we firmly believe there are often places where money can be made, even in a declining market. The difficulty comes in identifying those opportunities. Our goal is to find situations where, because of current circumstances, it is likely that stocks, or bonds, or a certain sector or a group of countries will outperform other investments. Some investment managers have said that they make half their money on the day they buy an investment - because they focus a lot of attention on buying what they understand to be undervalued and will most likely increase in value in the future.
Because we at O&A do not consider ourselves experts in picking individual stocks or bonds, we use mutual funds, some of which focus exclusively on trying to identify sectors and specific companies that are undervalued. Longleaf Partners, a stock mutual fund we have owned for a long time, is one such fund. While the fund goes through periods of underperforming the market, in the long run the managers buy stocks that have worked out for their investors. They have been right enough of the time that in the last ten years, they have outperformed the broad market. While the market has achieved only 2.6% growth per year during this period, Longleaf Partners has done considerably better at 4.6%. In round figures, $10,000 invested in the broad stock market would have made $2,930 during that period. Longleaf Partners made almost twice that at $5,650.
In addition, over the years O&A has developed some special knowledge in three particular areas: oil and gas, closed-end funds, and real estate. We have bought very little oil and gas properties since 2004 because we believe both the price and the risk are too high. The majority of the oil and gas investments we bought was in the late '90s, when oil was selling at $10 - $17 per barrel. It now sells in the range of $80 - $95, and all of our clients who invested in this sector have been well rewarded.
Closed-end funds also continue to be an interest that we follow, though we buy them only when the discount is historically wide (call the office for a copy of the Sept., 2004 Newsletter for a full discussion of closed-end funds), which has occurred in only a limited way in the last couple of years. We expect closed end funds will become attractive again.
In addition, we have expertise in private placement real estate, an area where we can purchase investments only for qualified investors who have larger accounts. In the last two years we have invested significant client money in this area.
Finally, while there will be variations on several main themes in business news, and opportunities in the investment world will come and go, client goals remain fairly consistent as they evolve over the years. Younger people tend to focus on accumulating assets in order to buy a house, or save money to support themselves and perhaps a family. As people accomplish these goals and age, they normally focus more on having sufficient assets for retirement.
It is these goals that we always keep in mind - and urge clients to keep in mind. Investing is not aimed at accumulating as much money as possible. Rather, investing is part of a larger financial plan directed toward meeting a person's or a family's financial goals.
Many years ago, when the market seemed only to go up, two of our clients whose children were out of the house, said that their goal was to accumulate $1,000,000 by the time they retired. We made a note of that because it was a very concrete target and one which seemed reasonable to us. Some years later after the market had experienced significant growth, they expressed their happiness with what they had accumulated and added: we are well on our way to our goal of accumulating $2,000,000. We reminded them that they had just moved the goalposts by doubling their target, something they were completely unaware of. Currently, we keep clear records of client aspirations, review them regularly and revise them advisedly. "Enough" should not be a moving target.
Older adults can be especially at risk for feeling the need to always have a bit more money or for worrying about running out of money. One way this shows itself is when retirees say, "We do not want to spend our principal," not realizing that they have mentally redefined "principal" to include both initial contributions and accumulated growth. It may be a reasonable goal not to spend "principal" when people are in their 60s - maybe also for those in their early 70s. But at some point spending money that has been accumulated over the years may be required.
Writing down aspirations and keeping them figuratively in view often helps to keep financial matters in perspective. This is one technique that helps mitigate the effect of the daily headlines which can distract us from the larger goals we want to accomplish in life.
SOCIAL SECURITY BENEFITS
Everyone hypothesizes about when to start taking Social Security retirement benefits. Should I begin taking payments at age 62, assuming I am retired? Should I wait until "full retirement" at age 66? Or should I hang on until age 70?
The choice you make has clear ramifications, some of which you may not have thought of. Let's begin with an illustration from a client's Social Security statement:
Mr. Jones is not yet 62, but his Social Security (Benefits) Statement projects that, assuming he continues to work until at least age 62, he will receive: $1,554/month if he begins taking benefits at age 62 $2,144/month if he begins at age 66 $2,752/month if he begins at age 70 He would receive no additional benefits if he delayed beyond age 70.
The above statement demonstrates what is true for everyone who can claim Social Security retirement benefits: you receive 33.3% more at age 66 than you would receive at age 62. And if you delay taking benefits until age 70, you receive an additional 32%. The actual benefit goes up monthly by a proportional amount, increasing .67% per month. This means that someone who decided to begin taking payments when she is sixty-eight and a half would receive 20% more money than she would get had she begun at age 66. However, for this article we will limit the discussion to the three ages of 62, 66, and 70.
What are the issues that go into making the decision as to when to begin taking benefits? Some people think the first question to ask is how long you have to live to make a delay in taking of benefits worthwhile. We think there are other matters to consider ahead of that question.
Marital status is a very important factor because of some complementary choices a husband and wife have. For a couple where the husband and wife are the same age, but he has more Social Security credits and has had a consistently higher income, there are some natural choices, although each situation needs to be evaluated on its own merits. In this scenario, if the wife outlives her husband (which is likely), she will qualify for the higher survivor benefit, assuming her husband predeceases her. Consequently, if the husband delays receiving his payment, under average circumstances he will receive a much higher benefit for a number of years, and then she will receive that higher benefit after he dies.
In this illustration, we would normally advise the wife, assuming she is retired, to begin taking her own benefits at age 62, while her husband delays until age 70. If she does not retire at age 62, she should normally begin taking benefits when she does retire, or at age 66, whichever comes first. People can begin taking Social Security payments without penalty at age 66 even when they continue to earn a salary. Taking benefits before age 66 means there will be a penalty if the person earns more than $14,160 in salary income. (It is actually more complicated in that a person can earn more than twice that amount the year prior to turning 66, with less of a penalty.)
Another less tangible consideration in the decision of when to begin taking benefits is that many people tend to spend more when they have added income. It can be tempting to take Social Security as soon as possible because things are tight financially. By deferring Social Security benefits, people might learn to live just as happily on a bit less, allowing for more of a cushion against inflation or unexpected expenses in older age.
Delaying Social Security benefits can also act as a kind of insurance policy in case a person or a survivor lives far beyond normal life expectancy, when he might run short of money. At 96 years of age, Mr. Jones (see the benefits listed at the beginning of this article), might well appreciate receiving $2,752, (the scheduled amount he would receive beginning at age 70) plus many years of a COLA rather than $2,144 he would receive if he began drawing at age 62, plus the COLA.
Even so, there are some good reasons to start Social Security benefits sooner. If someone needs money and can't work, there may be little choice but to take benefits. If a person is in bad health and expected to live only a limited time, there is good reason to sign up for benefits earlier. And sometimes clients' emotions dictate that they start early, even knowing that there will be a price to pay down the road for satisfying the emotional desire at an earlier age.
There may be no "right" answer for when to begin taking Social Security payments, but some personal situations are clearer than others. While we are available to consult with any of our readers on this matter, the Social Security website is also quite helpful. The address is www.ssa.gov .
END OF LIFE CHOICES
People are talking more these days about end-of-life choices. We at O&A very much encourage these discussions. While it is important to pay attention to how to minimize taxes in passing money onto heirs, and to where assets should go, there are additional considerations that people need to discuss and make decisions about. In fact, when end-of-life choices are addressed, some of the answers to the financial questions may fall into place more easily.
In October Susan and I (David) presented a seminar at the Montshire Museum of Science in Norwich, VT, on these very issues. While the basic theme was estate planning, we did not begin with the traditional discussion of vehicles available to efficiently pass money on at death. In fact, beyond a few questions and passing references, those matters never came up.
Rather, we focused on the idea of "legacy," what a person's life has stood for, what values the person has tried to convey and live, and how those values can be passed on. How do you want to be remembered? What contributions have you made throughout your life? And how might money be used to further accomplish those values?
One area that we did not have sufficient time for was that of health care issues at the end of life. In 2009 Jane Brody wrote Jane Brody's Guide to the Great Beyond: A Practical Primer to Help You and Your Loved Ones Prepare Medically, Legally, and Emotionally for the End of Life. What she didn't know was that within months of publishing the book, she would come face-to-face with the subject of the book when her husband was diagnosed with lung cancer.
We have included below an edited version of an article, written by Ms. Brody and printed in the New York Times, on Jan. 17, 2011, ten months after her husband's death. While the article has a bit of a political bent, we include it here because it raises important questions and offers an example of one family's experience. We hope it will stimulate your thinking.
"The specter of 'death panels' was raised yet again..., prompting the Obama administration to give in to political pressure a second time [and curtail] its effort to encourage end-of-life planning.
"Of course, the goal of this effort was not to make it easier to 'pull the plug on grandma' in order to save the government's money, as some opponents would have it. The regulation in question…, simply listed 'advance care planning' as one of the services that could be offered in the 'annual wellness visit' for Medicare beneficiaries.
"The widespread misconceptions about the regulation were exemplified in a letter to the editor published in the New York Times. 'Death panels,' the writer said, would have denied her 93-year-old mother colon cancer surgery that has given her the chance to live several more years.
"But that is not at all what the regulation would have done. Instead, 'by providing Medicare coverage for end-of-life planning with a physician, it would have encouraged doctors to talk to their patients about their wishes and make it far easier and more likely for these important conversations to take place,' said Barbara Coombs Lee, president of Compassion & Choices, an organization that helps people negotiate end-of-life problems….
"Encouraging such conversations might indeed save money in the long run. Doctors and hospitals are paid only for treating living patients, so there is always a possibility that financial incentives, conscious or unconscious, would prompt many expensive, if futile life-extending measures - efforts that many patients would veto if they could….
"At least as important, the quality of life in their final days was much worse than among those who did have such discussions. Countless studies have shown that extensive medical interventions can make the last weeks of life an excruciating experience for patients and those who care about them.
"Although talk about end-of-life options has often emphasized avoiding unwanted, intrusive and futile care, that does not mean everyone would or should make that choice. Many patients, especially younger ones, might be inclined to ask that every conceivable measure be taken….
"For [some] patients, hospice care is the right decision. Studies have found that terminally ill patients are likely to live longer, with a better quality of life, when they choose hospice over aggressive treatment to the bitter end.
"The point is that end-of-life care is an individual decision that should be thoroughly discussed with one's family and physicians. Studies have shown that when doctors don't know a patient's wishes, they are inclined to use every possible procedure and medication to try to postpone the inevitable.
"In an interview on the syndicated news program "Democracy Now!" on Jan. 5, the writer and surgeon Dr. Aatul Gawande said that patients with terminal cancer who discuss end-of-life choices with their doctors "are less likely to die in the intensive care unit, more likely to have a better quality of life [with] less suffering at the end…, and six months later their family members are markedly less likely to be depressed."
"….A year ago, my husband was given a diagnosis of Stage 4 cancer. As his designated health care proxy, I had agreed long before he became ill to abide by the instructions in his living will. If he was terminally ill and could not speak for himself, he wanted no extraordinary measures taken to try to keep him alive longer than nature intended.
"Knowing this helped me and my family avoid agonizing decisions and discord. We were able to say meaningful goodbyes and spare him unnecessary physical and emotional distress in his final weeks of life.
"Preparing these advance directives should not wait until someone develops a potentially fatal disease. Patients in the throes of terminal illness may resist discussions suggesting that death may be imminent, and close family members may be reluctant to imply as much.
"Compassion & Choices has an excellent free guide and "tool kit" to help people prepare advanced directives. They can be downloaded from the organization's Web site, www.compassionandchoices.org (select the "care" tab, then "planning for the future") or call (800) 247-7421 for a free hard copy of the documents."
Compassion and Choices is a very useful organization in helping to think through such matters. O&A also has available for clients "Five Wishes", a multi-page pamphlet that provides a variety of issues for people to think about. However, Compassion and Choices has something similar, along with a lot of additional resources. As always, we at O&A are available to be part of the discussion.
Otto & Associates, Inc. is required to make our ADV (a form that we complete annually for the Securities and Exchange Commission) and brochure available. Many of you have seen the three-panel brochure which explains our work, backgrounds, etc. For the most recent version of the brochure or for an updated version of the ADV, please call the office. The information in the brochure is also available on our website www.ottoandassociates.com. ADVs can also be found through the SEC's website www.sec.gov.
The end of the year is within sight, so please think about whether some financial planning year-end deadlines apply to you. Contact us soon if you'd like our help with:
• Contributions to or rebalancing of College Savings 529 accounts for children or grandchildren
• Contributions of appreciated stock or mutual funds to charities
• Conversions of IRAs to Roth IRAs
We keep track of IRA Required Minimum Distributions and will make certain that those who must take a distribution will do so. Also, we will consider tax loss selling, when appropriate. There is no need to call about these matters unless you have questions or concerns.
One of the biggest recent events in the office occurred in January when Susan Otto Goodell learned that she had passed her comprehensive CFP (Certified Financial Planner) exam. It was a grueling process, including six courses plus six exams over a couple of years, ending with the comprehensive exam. Congratulations, Susan!
However, a very close second to that event happened on Nov. 6 when Kathy Patton completed her first NYC Marathon. We're proud of you, Kathy!
David's 100 mile bike ride in July to raise money for cancer research pales in comparison. (Riding at the same time as David were his wife, Mary, all of Susan's family, and some other family and friends. Jeff (Susan's husband) and Carter (her 14 year old son) also rode 100 miles, and the rest of the team, including Mary, Susan, and 11-year old Eliza rode 50 miles.
Judy, who had some trouble recovering from a knee replacement, is again able to do most things. We're very happy to have her back.
And Deborah has launched her third and final child. She visited her son Harry during Parents' Weekend at Grinnell College in Iowa (also Mary's alma mater) in October. (While there she traveled to Rock Island, IL, to see Harry run a cross country race where he performed very well - which is impressive given that he is a freshman.)
Deborah, Susan, and David attended a three day NAPFA conference in Brooklyn in October. There were a number of outstanding speakers and seminars available to the attendees, as well as two opportunities to walk across the Brooklyn Bridge early in the morning. And during recent months Deborah has been keeping up to date by attending a number of conferences sponsored by mutual funds where many clients have money invested: Artio Julius Baer, Third Avenue, and Baron (two separate conferences for each of the last two.) Judy also attended a Baron conference.