By: Paul Sutherland, CFP®
On one of our near-daily walks this fall, my son Henry (age 4) asks me as we walk by a giant rainwater drain on the street near our home, “We should never hide in there, right Daddy?” I tell him he’s right as he explains how it would be hard to get him out, and that his older brother told him he would end up in the ocean if he falls in – so he is respectful to not play near the drain. We hike a lot, and my boys know there are places where they must hold onto a “big person’s” hand and places where they are free to explore. There are risks in hiking, but they are manageable with a bit of common sense.
Investing, too, is about common sense. And part of that common sense is “kissing the ugly” and acknowledging the risks while being conscious of the blessings and benefits of a well-managed and resilient portfolio. At a recent FIM Group Investment Committee meeting, Zach Liggett shared some notes with the team of a recent client meeting he and Matt Desmond had with a family who has been with us for at least 10 years. The client told Zach that a “consultant” gave him a “free review” of his portfolio after taking over the client’s employer retirement plan. Zach’s notes from this meeting are reprinted below. What is interesting is that the young “consultant” is an insurance agent and commissioned stock broker with a “host” of “solutions” to sell.
Zach’s Notes From a Recent Client Meeting (January 2014)
Client came with his notes on the FIM portfolio review done by a young consultant with a local financial consulting firm, which we spent nearly two hours discussing/rebutting. Given that it’s been a while since I’ve faced this kind of comprehensive critique in a client meeting, I thought I’d go over the highlights. The general gist was that our Balanced Conservative portfolio was way too risky for a soon-to-be-retiree – too expensive, not customized (tax inefficient) and performed poorly versus alternatives, especially during the crisis. We took the approach of explaining FIM facts rather than bashing a competitor model that lacks accountability (they seem to get around the fact that they have no performance track record to share by selling themselves as consultants who outsource investment management to “external specialists”). Here are the general points we discussed (italicized points are the critiques brought up by the consultant).
1) Your FIM Group-managed portfolio has speculative penny stocks galore. This was an easy one to address. We discussed how foreign currency conversion can make the US$ prices of these positions appear as “penny stocks.” In addition, we discussed how the US$ price of a position has zero relationship to the “speculativeness” of the position or its expected return. Noted an example: Hutchison Port Holdings Trust (Singapore-listed, trades in 1,000 share lots, S$.86 share price, US$.68 price; US$5B market cap that does $1.6 billion in revs and makes hundreds of millions each year operating world-class ports).
2) Your FIM Group-managed portfolio is loaded with tiny international stocks that no one has ever heard of (like some Belgian thing I can’t even find on the Internet ...). I assumed that the consultant meant Belgium-listed Quest for Growth, which was the client’s single-largest equity position. We acknowledged that as a firm we have never shied away from geography or market capitalization as constraints on our investment universe, because some of the best inefficiencies/values/returns can be found away from “large-cap U.S. stocks.” We walked through the thesis of patiently acquiring this hybrid (listed/private equity) investment company more than two years ago when Europe was in the crapper and its discount to NAV was >40%, and how his position has appreciated nearly $50K v. his average cost. Then we walked through Saizen REIT, which is also quite small and unnoticed by many investors, but offered us a portfolio of very stable Japanese apartment buildings for 50 cents on the dollar and how we still like it today as a >6.5% yielder with more than 20% upside to its liquidation value.
3) Your FIM Group-managed portfolio has way too much real estate. I said we were surprised at the criticism here as REITs make up only about 13% of their accounts, with related positions (real estate services, other real assets) probably making up another 5%-10% (Brookfield, CapitaLand, Hutch Port, Hutch, etc.). We discussed how this area was probably our #1 area of conviction in the current environment given strong balance sheets, steady income and 6%-8% yields, rock solid leases that adjust with inflation, etc. I noted how we are currently seeing better value abroad where yields/growth prospects are superior in many cases to the U.S. as QE has compressed yields here. But then I mentioned that we do have certain niches in the U.S., like hospitals, that currently fit our buy parameters (Medical Properties Trust as an example here, where we get 6.5% yield that should grow over time in a nearly recession-proof area of the market with properties very hard to replicate). I encouraged our client to stay tuned as we will address this area in more detail on our upcoming webinar (editor note: replays of FIM Group webinars can be found on the “Resources” tab at www.fimg.net).
4) Combining points #1, #2 and #3 above, your FIM Group-managed portfolio is too risky for a retiree account. Of course the consultant has nothing to show us that we can compare against, but we talked about the risk we care most about: getting you to retirement and keeping you retired. We discussed how FIM Group’s investment team focuses on the three core things that matter most to delivering investment success: investment quality, investment price (valuation) and client parameters (especially cash flow needs and volatility tolerance). I described how we shock test portfolios with a primary focus on cash flow resilience, as this is what matters most (sentiment always recovers). Then I added that in today’s world of record-low interest rates and high stock market valuations, a rowing v. sailing approach is much more risk-averse than conventional, style-box-modeled approaches.
5) Your FIM Group-managed portfolio stunk during 2008. Yes, our client portfolio values temporarily suffered during this period (we can’t compare v. this consultant because they have no track record to show), but the fundamental quality of our portfolios held up well, and as sentiment recovered, so did values. Clients who didn’t panic have recovered nicely, and we were able to meet income needs without nuking large parts of the portfolios at distressed prices during this period. Income generation also stayed solid through this challenging period. We expect there will be other corrections over the next 30+ years of this client’s retirement, but that the same principles apply. Manage the three core pillars of quality/price/parameters, focus risk management on the risk of permanent loss and stay sane during periods of irrational sentiment. This will keep you retired.
6) Your FIM Group-managed portfolio uses high expense ratio funds with marginal historic performance. I’m assuming here that the consultant meant the closed-end funds we have become aggressive buyers of over the last six months. We walked through the workings of CEFs (flexible structure for managers and bonus return potential as discounts to NAV shrink) and why they remain our focus area within fixed income. That they do carry expense ratios (some of which look inflated given the utilization of leverage by the managers) and that we only buy when we feel the return advantage is there.
7) Your FIM Group-managed portfolio is not customized or tax-efficient. I noted that we absolutely recognize the impact taxes can have on net worth over time, and that we manage this risk factor closely. That said, we don’t let the tax tail wag the portfolio dog, and there are times when the expected returns (of say a non-qualified dividend-paying stock) still justify holding it in a taxable account if cash is not available in a tax-deferred one.
With more than 30 years in the business, I’ve seen just about every critique of our style from a wide range of brokers, agents and consultants like the one summarized in Zach’s notes here. More often than not, our portfolios do indeed look very different from the typical “closet-index” portfolios hawked by the majority of our competitors. That is especially the case today as we believe many large-cap U.S. stocks or plain-Jane bonds prevalent in today’s mania are trading at valuations that we believe will perform poorly based on their valuations and our belief that the world economic growth will be slow going forward. FIM Group has stuck to a traditional style of investing based on the study of successful investors like Benjamin Graham and David Dodd authors of the classic investors’ bibles Security Analysis and The Intelligent Investor. Warren Buffett called The Intelligent Investor “By far the best book on investing ever written.” Of course, traditional investing as described by Graham, Buffett and other more traditionalist investors is about common sense, patience, hard work, discipline, making money and managing risk. It’s not about pretty theories and “what's hot.”
I’m thankful that these clients trusted us enough and were willing to give us two hours of their time to run through the critique. One of the compelling things about our firm is that we strive to always give clients direct access to the decision-makers on their portfolios, and that we hold ourselves 100% accountable for the results we deliver. If you have questions or wish to go deeper in understanding the logic and “common sense” of your portfolio, ALWAYS feel free to call me or other members of the investment team.
And for the consultants, advisers and brokers offering free portfolio reviews of our client portfolios, I’ll offer the same invitation to you as well. Come on in and take a look at FIM Group and our philosophy, processes, discipline and results. It’s much better to compete for business from a position of knowledge and truth (about FIM Group and our skills) than from a position of naiveté and ignorance.
By: Zach Liggett, CFA®
When it comes to financial decision-making, it sure seems like triple-bottom-line (3BL) thinking is capturing more of our collective mindshare. The 3BL perspective, for those not up on their sustainability lingo, takes the traditional accounting framework focused singularly on financial profit and adds both social and environmental considerations. While the 3BL mindset has often been characterized by others as simply a “feel-good” strategy, I would counter that such thinking can play a critical role in improving the overall financial resilience of both the companies we invest in and the families we advise. I like to call this “the 3BL Advantage.”
On the corporate side, management teams are increasingly embracing 3BL thinking to gain and retain a competitive advantage over peers. This competitive advantage, in turn, becomes a core driver of the sustainable cash flow growth that makes a company attractive to investors (and ultimately more valuable!). Intuitively, this should make sense. Recognizing and mitigating dependencies on finite natural resources, reducing exposures to environmental risks, keeping your workforce safe, healthy and happy, and generating goodwill in the communities where you operate are all pretty clear means of building and retaining a competitive edge. Deutsche Bank put out a lengthy report in 2012 that adds some numbers to this overall thesis. After reviewing dozens of academic studies, it found that companies earning high marks for environmental, social and governance factors (ESG) had overwhelmingly positive correlation with lower cost of capital (in effect, a judgment from the market that these companies are less risky), and higher corporate financial performance.
New Flyer’s Embrace of the 3BL
To shed some additional light on how 3BL thinking can help support a sustainable competitive advantage, let’s take a look at the case of New Flyer Industries. New Flyer is a Canada-listed transit bus manufacturer that we have recently added to appropriate client accounts (it is profiled in this month’s Investment Team Spotlight). Management at New Flyer recognizes the value of 3BL thinking and has been working to integrate this philosophy throughout the firm. In addition to incorporating an array of clean technologies into the buses that it sells to mass transit operators (such as hybrid-electric configurations and LED headlights), New Flyer also invests significantly in workplace safety and wellness initiatives, engages closely with and contributes solidly to the communities in which it conducts operations, and continually works to make its operations less harmful to the environment. These efforts have helped the company reduce environmental and energy costs, improve workforce productivity, achieve a leading market share in the North American mass transit bus market, and gain what we believe will be sustainable competitive advantages over peers.
Family Financial Resilience-Building
Switching over to family finances, the premise of a 3BL Advantage is equally strong. Let’s create a possible example with a hypothetical client in Northern Michigan that decides several years ago to really roll up their sleeves and incrementally build more 3BL into their financial decision-making DNA.
Back in the late-2000s this family was cruising right along, with one young daughter and a new baby boy on the way, a solidly growing income, and all indications pointing to a bright future ahead. Both husband and wife worked hard and considered themselves to be pretty responsible across the financial, environmental and social spectrums. They volunteered in their community, led a relatively healthy lifestyle and felt they were on a pretty good track toward a happy, prosperous future. Like most of their fellow citizens, though, they led busy lives and made the lion’s share of their financial decisions with a traditional framework emphasizing a single bottom line.
After just completing an addition on their waterfront home (financed at super low rates!), the global financial crisis hit, their employment income took a sharp hit and their new baby was born. This confluence of life events brought them to the conclusion that, holy cow, maybe it was time to consider some changes.
Taking a Fresh Look
So about three years ago, this family took a fresh look at the largest items in their family budget (housing, energy, transportation, healthcare and food) and basically said, “How do we create a more resilient financial life and align the money in our lives more closely with our values?” They started with their largest asset, their beautiful but largely underutilized waterfront home, and did some 3BL math. Environmentally, the home was an energy hog and a beast to clean and maintain with most of the 3,500 sq. ft. underutilized at any given time. From a social perspective it was in a fairly isolated location with few neighbors to interact with. And when they reassessed the cost to power, heat, clean, maintain, insure, service debt and pay taxes on the home, it didn’t take long to reach the conclusion that a change here would be the lowest hanging fruit in their quest for 3BL gains.
This family then worked their way through other items in the budget and generated some pretty significant results. They discovered ways to reduce their larger, ongoing financial outlays, while at the same time generating more environmental and social impact. And even though their kids were still pretty young, they worked to be transparent and instructional with their process, hoping that the benefits of this 3BL Advantage would trickle down and persist into the next generation.
Implementing the Changes
Fast forward a few years to 2014 and what are some of the specific changes this family made?
1) After selling their home, they took two years to experiment in small home living by renting several different places ranging from 600 to 1,200 sq. ft. Eventually, they found a simple 1,000-sq.-ft. home in a neighborhood they liked and purchased it with the equity proceeds of their previous home. With no mortgage and a much smaller footprint to heat, insure, clean, maintain and pay taxes on, they harvested more than $3,000/month in reduced living expenses (yikes!). And while they gave up their waterfront view, their new home is just two blocks from two different access points on one of the finest lakes in Michigan.
2) With their new home just a short walking distance to grocery shopping and schools, they were also able to improve their overall “transportation footprint.” Although the husband must still commute into work, the family found that they could trade in one of their gas-guzzling SUVs for a smaller, gas-sipping commuter car (they’re hopeful that someday public transit will provide an even more environmentally friendly commuting choice). As the husband commutes about 1,000 miles a month, the 15 mpg gain in fuel efficiency works out to more than 30 fewer gallons of gas a month (close to $100/mo. at today’s prices).
3) On the health and food side of things, they decided to grow some of their own food organically, support local farmers also growing in a sustainable way and reduce the level of processed junk they were consuming. So they shop a lot at farmer’s markets, their local natural foods co-op, and directly with farmers with whom they’ve developed personal relationships. They also cook most of their meals from home and try their best to work toward a zero-waste lifestyle. While they anticipated a jump in their monthly food bill, that really hasn’t been the case. They purchase quite a bit in bulk and buy in season as best they can. Already, they feel much more connected to the lands and farmers that produce their food and take pride in doing even a micro part to help our unsustainable food and farming system evolve toward a more resilient footing. Longer-term, they hope the investments made in the family diet will pay dividends down the road in the form of richer health and reduced sickcare bills.
4) An additional benefit the 3BL Advantage brings to this family is that they can invest and grow their newfound savings in a mission-aligned way that further boosts their family’s financial resilience. Some of this savings comes into their FIM Group-managed portfolio each month and is invested in 3BL-focused companies like New Flyer. But they’ve also been experimenting with alternative investments sourced in the community through informal community networking groups like As Local As Possible, which brings 3BL-minded investors together with 3BL business owners who have capital needs. So far, these experiments have been limited in scope (mainly relatively small-sized unsecured loans), but high in social and environmental impact. They expect to continue these experiments and widen their investing universe to things like sustainably farmed agricultural land, sustainably harvested timber, local energy efficiency projects and other 3BL opportunities.
The Double Windfall
To wrap this up, I’ll simply reiterate my belief that the 3BL Advantage is much more than just a “feel-good” thing. At the company level, management teams that embrace 3BL thinking are more likely to sustain their competitive edge than those trapped in the traditional approach that hyper-emphasizes financial profits alone. And for families, even modest shifts in mindset toward 3BL can provide a valuable double windfall: boosted resilience to future shocks and better alignment of your money with the values dear to you.
By: Renee Egelski, CFP®
For some, Social Security benefits are a major source of income, while for others they’re just an added bonus. Either way, decisions made when claiming benefits can significantly impact the optimization of benefits, especially for married couples. Social Security rules are both numerous and complex. Below are some general questions and some strategies to help you make the most of your Social Security benefits.
When can I collect Social Security benefits?
Although you can retire early at age 62, the longer you wait to begin receiving your benefit (up to age 70), the more you’ll receive each month. If you retire before full retirement age, you’ll receive a permanently reduced retirement benefit. For each month that you delay receiving Social Security benefits past your full retirement age, your benefit will permanently increase by a certain percentage, up to the maximum age of 70.
Your full retirement age depends on the year in which you were born.
If you were born in:
Your full retirement age is:
66 and 2 months
66 and 4 months
66 and 6 months
66 and 8 months
66 and 10 months
1960 or later
What if I change my mind about when to begin collecting Social Security benefits?
You have a limited opportunity to change your mind after you’ve applied for benefits. You can complete Form SSA-521, Request for Withdrawal of Application, and reapply at a later date. But if you’re already receiving benefits, you can only withdraw your claim if it has been less than 12 months since you first became entitled to benefits, and you’re limited to one withdrawal per lifetime. In addition, there are financial consequences – you must repay all benefits already paid to you or your family members based on your application, as well as any money withheld from your checks, including Medicare premiums or tax withholding.
How will my earnings affect my benefit?
You can work and still receive Social Security benefits, but the income that you earn before you reach full retirement age may temporarily affect your benefit. If you’re under full retirement age for the entire year, $1 of your benefit will be withheld for every $2 you earn over the annual earnings limit ($15,480 in 2014). A higher earnings limit applies in the year you reach full retirement age, and the calculation is different too, $1 of your benefit will be withheld for every $3 you earn over $41,400 (in 2014).
Are my Social Security benefits subject to income tax?
A portion of your benefits may be subject to income tax if your combined income, modified adjusted gross income (MAGI), plus one-half of your Social Security benefits exceed certain limits. Your MAGI includes your adjusted gross income + tax-exempt interest income, and foreign income exempt from tax. For a married couple filing jointly, up to 50% of benefits may be subject to tax if your combined income exceeds $32,000, and up to 85% of benefits may be taxed if your combined income exceeds $44,000 (unless you and your spouse live apart for the entire year).
When should I begin receiving retirement benefits?
There is no “right” answer. It’s an individual decision that must be based on many factors, including other sources of retirement income, your marital status, whether you plan to continue working, your life expectancy and your tax situation. Your benefit will be higher the longer you wait, and if you choose to start receiving benefits early, you’ll receive less per month, but you might receive benefits over a longer period of time.
For a married couple, it is especially important to consider how the age at which you begin benefits will affect your spouse’s benefit options. Some important things to note:
The maximum spousal benefit is 50% of the other spouse’s benefit at full retirement age.
In order to receive a spousal benefit, the other spouse must have claimed (or applied for) his/her personal benefit.
If a spouse files at full retirement age, he/she can suspend his/her own benefit to let the delayed credits accumulate for a larger benefit later. Just filing allows the other spouse to claim a spousal benefit.
If one spouse is already collecting benefits, and the other spouse waits until age 66 to claim any benefit, he/she can choose which benefit he/she begins with, and also choose to switch to other benefit (spousal or personal) at a later age.
If benefits are claimed at any age below full retirement age, the option to choose which benefit (personal or spousal) to collect on is lost – the higher amount of the two will automatically be paid.
Decisions made can also affect other aspects of your financial plan, such as the timing and amount of your other retirement asset distributions. If you are approaching retirement and would like to learn more about Social Security, please contact one of our offices to request a detailed Social Security Brochure. In addition, our financial planners are available to help analyze your individual situation so that you can make more informed decisions and optimize your benefits.
There is no Spotlight for this issue.