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2014 April Newsletter

Paul Sutherland, CFP®
By: Paul Sutherland, CFP®

Wisdom 4:14

When I was in my teens, I remember answering a question with one word, and being startled by its clarity. I was asked about what I wanted to be when I got older. My answer was simply “Wiser.” I wanted wisdom. As a kid, my reading list was rich in philosophy, religion and practical “success” stuff like The Law of Success by Napoleon Hill. I was interested in things like how to be successful, how to have successful relationships, how to build virtue and character, how to change the world for the better, and how to think accurately and create the future through my actions today. I had not thought of this for awhile, but recently I stumbled across a great article in The New York Times about wisdom while on a trip to a peace conference at a South Carolina university where I presented the keynote address. Speaking to the young people and chatting with older professors and administrators got me thinking about wisdom once more and harkened me back to my youth.

I think wisdom is relevant because it seems, especially today, that you rarely see young investment managers in this business with sophisticated investors as clients. High-functioning people want to hire seasoned professionals, seasoned teams, and believe in working directly with the people who actually manage the portfolio. Only those who are unsophisticated are turned on by fancy charts, brochures and “if” talk (“If you had done this, you would have done that …”). Their prospective clients don’t even have the sense to say, “What have your clients experienced in performance over the last 10 years?” Not some made-up if story. 

Art and Wisdom

I find that I have more conviction, and am more keen to buy, sell or avoid an investment without hesitation when something seems right. Some managers will say, “What will my clients think if I sell this stock that I just bought recently at a loss?” As all my clients are aware, I sell when it is time (in my opinion) regardless of whether the investment ended in a huge profit or loss. I sell because the price-to-value no longer justifies owning the investment, the investment’s fundamentals erode, management goes “goofy” or I simply find something I like better. 

Having sold and closed out at least 3,000 investments over my career, I have become unabashedly dispassionate about selling when I need to. Investing is about achieving goals and using risk management to assess the margin of safety embedded in the opportunity. In other words, it’s about being adequately compensated for the risk. And that assessment is part technical (review of the balance sheet, capital structure, income statements) and part art (review of the management, products, product strategy, competition, culture and the intangibles). When I earned my MBA, one of my instructors said, “If you can’t measure it, it does not exist.” This is what the number-crunchers in our business like to stare at. Numbers are empirical. Numbers are elegant. Numbers are not ambiguous. If a company sells $5 million of product, it’s a known fact. If a company has grown its sales by 10% per year for five years, it’s a known fact. There’s plenty of certainty in that. But investing in the future is filled with incomplete information and a lot of uncertainty, so investors must use their brains guided by education, experience and, hopefully, wisdom to guide their assessment of where to invest. When I have one-on-one conversations with successful seasoned investment managers, it seems a few key themes come through loud and clear: 

1) Be humble – Don’t assume, look deep enough, be excited to be wrong and move on. Don’t let your ego cause you to want to be right instead of making money.

2) Be assertive – When you know something is right – invest.
Don’t be timid.

3) Strive for excellence – Measure performance against what performed well. Measure performance against how well you’re helping your clients achieve their goals (for example, “staying retired by living off a consistent and, hopefully, growing income stream”). Also, let others measure your performance, otherwise you forget the key is what you do and not what you measure. Also, when your performance is great, don’t let the ego make you “cocky” (see #1 – be humble – above).

4) Think independently – If you look at the great investors like John Templeton, Peter Lynch, Warren Buffett, Chuck Royce, William Stewart, Andre Kostolany and others, you see an independence of mind – they were not herd followers, and they also had conviction.

5) Virtue and values count – While ethics and proper behavior are hot-button issues for me, the successful investors seem to be “just good people,” to quote a friend’s description of why she liked where she lived. At the peace conference, I handed out a postcard of the 13 virtues of Benjamin Franklin, and it was well-received (see sidebar). 

6) It seems simple, but it is not easy – 
Investing is complex, and the complexity must be embraced. We are always making decisions about an uncertain future with incomplete information. I find it amazing how newsletter writers, talk show hosts and such will say that investing is simple – “Just index it and forget it!” seems to be popular today. When they give such silly advice, I want to ask them, “Can you send me the record of performance on your own portfolio?” I actually have asked that a few times and have gotten blank stares in return. 

My wife Amy was part of a Rotary International polio immunization team in northern Nigeria a few years back. She traveled thousands of miles at relatively significant expense and risk of danger to do a job that tens of thousands of Nigerian health workers were already doing nearly every month. But she went with the sincerity of an American mother to dispel the myths … to try to convince parents that the polio vaccine is designed to save lives and preserve healthy childhoods, not sterilize their (Muslim) children. We see the same hysteria here, where rumors and misinformed science are causing scores of children to remain unvaccinated. The “don’t immunize” bloggers and the Muslim clerics are well-meaning folks, as are the “investing is simple” pundits. But, sadly, the consequences of oversimplified reporting or advice can be devastating.

The Science of Older and Wiser 

I don’t want to give a book report on Phyllis Korkki’s article in The New York Times titled “The Science of Older and Wiser.” However, I wish to point out a few key findings from this well-written article. First, it seems reasonable that experience equals more information in the brain to process and detect patterns and consequences, and allows for better decisions based on the more complete information, and better understanding on how to use the information. The article highlighted the concept of “accepting reality as it is, with equanimity” – in other words, being realistic and not letting our biases, opinions and such lead us astray. Wisdom allows us to be accepting of reality. Ursula Staudinger of Colombia University said in her interview for the article, “True personal wisdom involves five elements: self-insight; the ability to demonstrate personal growth; self-awareness in terms of your historical era and your family history; understanding that priorities and values, including your own, are not absolute, and an awareness of life’s ambiguities.”

When I study the greats in our business, I see this wisdom. Though I am now far from my teenage years (and have a teen of my own – Keeston – age 19), I still find the concept of “wisdom” and how it is attained, a fascinating subject. 

I feel blessed to work with a team of colleagues that strives to continually build our collective wisdom here at FIM Group. We challenge each other to grow both individually and as a team, and we seek the elements of true personal wisdom that Staudinger notes above in each of the new hires we bring on board.

Benjamin Franklin’s “13 Virtues,” formulated in the late 1720s as described in his autobiography (written 1771,
1784-85, 1788)
1. TEMPERANCE. Eat not to dullness; drink not to elevation [drunkenness].
2. SILENCE. Speak not but what may benefit others or yourself; avoid trifling conversation. 
3. ORDER. Let all your things have their places; let each part of your business have its time. 
4. RESOLUTION. Resolve to perform what you ought; perform without fail what you resolve. 
5. FRUGALITY. Make no expense but
to do good to others or yourself; i.e.,
waste nothing. 
6. INDUSTRY. Lose no time; be always employ’d in something useful; cut off
all unnecessary actions. 
7. SINCERITY. Use no hurtful deceit; think innocently and justly, and,
if you speak, speak accordingly. 
8. JUSTICE. Wrong none by doing injuries, or omitting the benefits that
are your duty. 
9. MODERATION. Avoid extremes; forbear resenting injuries so much
as you think they deserve. 
10. CLEANLINESS. Tolerate no uncleanliness in body, clothes
or habitation. 
11. TRANQUILLITY. Be not disturbed at trifles, or at accidents common
or unavoidable. 
12. CHASTITY. Rarely use venery [sexual intercourse] but for health or offspring, never to dullness, weakness,
or the injury of your own or another’s peace or reputation. 
13. HUMILITY. Imitate Jesus and Socrates.
Suzanne Stepan, CFA, CFP®
By: Suzanne Stepan, CFA, CFP®

Wheat from Chaff

I feel blessed to work with a team of colleagues that strives to continually build our collective wisdom here at FIM Group. We challenge each other to grow both individually and as a team, and we seek the elements of true personal wisdom that Staudinger notes above in each of the new hires we bring on board.While recently reading an article on preparing for a summer garden, I came across the idiomatic expression, “separating the wheat from the chaff.”

In many instances of life we persistently try to separate the wheat from the chaff. It is the act of dividing the information that is important from what is unimportant or unnecessary and efficiently getting down to the heart of the matter. And let’s face it: bombarded with information flow as we are in today’s “connected” world, separating out this chaff can be no easy feat!  

Legendary investor Warren Buffett is arguably one of the masters of separating wheat from the chaff when it comes to making successful investments. His 2013 Berkshire Hathaway annual report was discussed at a recent FIM Group investment team meeting, and one of his stories speaks quite literally to this theme.

A little more than halfway through the letter, Mr. Buffett begins to tell a story about a farm investment he made in the mid-’80s. He starts with some background on the late ’70s and early ’80s farmland boom that preceded his investment. During this era, small rural banks went on a lending spree as new technology encouraged farmers to borrow and expand their farmland holdings. Amid the leveraged land grab, prices for farmland spiked to levels far exceeding those justified by actual income earned by the farms. Then, as all bubbles eventually do, it burst, sending farmland prices plummeting, and putting many Midwest farmers and their bankers out of business.

Chug forward to 1986 when Mr. Buffett recognized an investment opportunity in one of those abandoned farms at a time when most investors had forever sworn off farmland as an investment.
He bought a 400-acre Nebraska farm from the FDIC (Federal Deposit Insurance Corporation) for $280,000, significantly less than what the earlier failed bank lent the previous owner. Mr. Buffett claims he did not have any prior know-how in farming, but learned a few key pointers from a relative. He estimated that over a cycle, normalizing the effects of good years and bad, the farm would generate an average cash return of 10% on his investment. In addition to this cash return, he also expected that the value of his land would increase as crop prices increased and productivity of the farm improved. Almost three decades later, the farm’s income is nearly 3x the level at the time of his investment and the farmland is estimated to be worth well north of $1 million.

In this story, Mr. Buffett illustrates the powerful benefits of separating wheat (in this case, the long-term cash flow generation from the farm) from the chaff (day-to-day noise surrounding farmland prices). He points out that just as he would pay little attention to a hypothetical farm neighbor shouting buy/sell prices for his farm based on his mood of the day, investors in any market should do the same. Focus on the fundamentals of the investment that matter and leave the day-to-day price fluctuations for others to worry about. As he puts it:  “A ‘flash crash’ or some other extreme market fluctuation can’t hurt an investor any more than an erratic and mouthy neighbor can hurt my farm investment.” 

Envisioning some amber waves of grain, my brain began to think of wheat. Upon an Internet search on the process taken to grow, harvest and separate the wheat from the chaff, I learned that the husk is the outer protective coating that encases the grain. Inside the husk lies the golden grain kernel. When the outside layer of the kernel is removed it is then referred to as the chaff. The chaff needs to be removed in order for the grain to be used as human food. The wheat in essence is the good stuff and the less desired chaff is used for animal feed. Some definitions describe chaff as “rubbish.”

Our goal as active managers at FIM Group is to seek out exactly what is important in the decision-making process. We have become experts at knowing how to sort through the flood
of information in the investing world to identify what is significant and what is not. Sticking with the agricultural theme, the case of Fyffes stands out as a FIM Group investment that illustrates this same power of separating wheat from the chaff. Fyffes is an Ireland-based distributor of fresh fruit, including bananas, pineapples and melons. We accumulated a significant portion of our Fyffes investment between 2008-2011 at a time when investors were still paralyzed over the shocks witnessed in global financial markets. Because of this fear toward stocks – especially toward European stocks – we were able to buy shares at only 5x-6x operating profit with a 4%+ dividend yield when Fyffes’ market value ranged from $150-$200 million. 

Figure 1.1We saw no reason to believe that people would stop buying fruit across Europe nor that the tailwinds behind Fyffes’ strategy of consolidating other distributors would face any major hurdles. In the last five years, Fyffes built a dominant position across Europe, sales per share grew 62% and operating profits per share more than doubled. While the European stock markets suffered through significant spats of volatility, we hung onto Fyffes, comfortable with the company’s sound fundamentals and very cheap price. Fast forward to March 10, 2014, and our patience has been rewarded. Chiquita Brands announced that it would acquire Fyffes for 13x operating profits, valuing the company at more than $500 million!

With all of our investments, our team works hard to separate out the short-term noise and human emotion that drives asset prices to silly levels. We leave this chaff for the financial media to sell ads against and the speculating herd to fight over. Instead, our team stays laser-focused on the long-term corporate fundamentals that ultimately drive investment value. After all, as Mr. Buffett says, “Games are won by players who focus on the playing field and not by those whose eyes are glued to the scoreboard.”

Alice McDermott, CFP®
By: Alice McDermott, CFP®

Time for College ... Already?

When my son, Matthew, was born, I began saving for his college education. I realize not every child goes to college, but being the natural “planner” I am, I felt it important to be prepared financially
in the event he did. 

When I began this commitment, I looked at the options available at the time. The most common was a Custodial Account, also referred to as a “UTMA” or “UGMA” account, where the income and gains
are taxed at the child’s rate, which is typically much lower than a parent’s tax rate. This choice sounded great at first glance, but I later learned that money saved in my child’s name – although a current tax benefit – could be detrimental down the road because even a small amount of money could greatly reduce his opportunity of obtaining a strong financial aid package. Also, even more detrimental, if he chose not to use the funds for college, he could have access and become entitled to those funds at the age of majority which, in the state of Hawaii, is 21 (in other states it’s 18). The bottom line is that once money is placed in a Custodial Account, the money belongs to the child, and to simply remove the funds would essentially be breaking the law. 

Now I’m not saying that monetary gifts for birthdays or money that children earn through allowance or working should not be placed in a savings account for them, because it should – it’s their money. But for a parent wanting to save their own money for their child’s education, in my opinion, that’s the last place one should put it. For clients who had chosen this route prior to hiring FIM Group, my guidance has been to use these funds first for needs such as braces, dance lessons, private school tuition, etc., so there is no money left in that child’s name when the time comes to apply for college. 

I’ve suggested they switch to a different method, such as saving money in their own name, maxing out a 401(k) plan to borrow from later or even funding a Roth IRA. There are other savings plan options for college, but most are restricted on how much one can fund each year, or are inflexible when it comes to investments. 

One savings plan that has become popular since introduced to the market is the 529 College Savings Plan. This allows saving between the annual gift exclusion each year (currently $14,000/year/person), up to $70,000 if you are able to front-load up to five years in one contribution – times two parents, that’s a whopping $140,000 to start! Personally, I feel this may be a more appropriate option for wealthy grandparents who need to reduce their estate and are adamant to fund college for their grandchildren. 

Yet again, there are restrictions and very limited options when it comes to how the money is invested. An advantage, however, is that the funds in the 529 are in the name of the donor, and the child is named the beneficiary. In addition, the donor can change the beneficiary (which means it’s not weighted much for financial need), in the event the child or grandchild decides to forgo college or higher education. However, if no one uses the funds for education, there are penalties and taxes down the road.

My preferred option to save for college was to fund money to my own Roth IRA. I began funding what I could when these first came out in the late ’90s. Currently, two parents – if they qualify based on their AGI – can fund a total of $11,000/year to a Roth ($5,500 each, plus another $1,000 catch-up if over age 50), and as long as they’ve held the Roth IRA for five years, they can begin drawing the contributions for whatever reason, with no tax or penalty. You do the math … the sooner it’s started, the higher the contribution total. 

The biggest benefits of funding a Roth IRA are: 1) It’s the funds in Mom or Dad’s name, and 2) the funds are not considered an asset for college funding when filing the FAFSA form each year. The downside (and there always seems to be some downside) is that when the time comes to pay your share, any assets removed from the Roth IRA for college will be counted as “income” on the FASFA form (but not your tax return). So unless you have other assets to draw from at least temporarily, you may need to report this as monies used to fund college costs. 

How and what form of college savings you choose is truly dependent on your personal financial situation as well as what’s most important to you in the short and long term. Having control and flexibility with investing was most important to me, thus the reason I chose the Roth IRA.

My son, Matthew, is currently a high school senior and will graduate in May. Of course I’ve known this day would come, so it’s certainly no surprise. Yet, it seems just the other day that he was well below my height – now at 6'1", he towers me and is a young man. I’m very proud of Matt and the young man he has become. Of course we have challenging moments as most children and parents do, but I know he’ll be okay – no matter what. He has a good head on his shoulders. He also knows that getting a college degree is a necessity for the field he’d like to study, which as of today anyway, is engineering.

In addition to saving money for college, parents should also understand the college application process when that day arrives. It was about a year ago, while Matt was still a junior in high school, that we began researching what was required to apply for college. We learned that a tremendous amount of patience and a good head start are best. The more you understand in advance of deadlines, the better prepared you will be when the time comes to apply – and everything is online. 

>span class="s2">Well, we’re past that stressful “did-we-do-everything-right?” application stage and are at the tail end of the sit-and-wait game. As of the writing of this article, Matt has heard back from all but one college. I’m very happy and proud to say he has received email notifications of “acceptance,” which is what I’d hoped for him and why I pressed him to work harder. (“Options are what you want, Matt, but you must work hard now!”) We should hear from the last college in the next week or two. We will then move to the decision stage. In the meantime, the colleges that have accepted him will send their financial aid packages soon, letting him know what he might receive in the way of scholarships (merit- or needs-based), students loans and (gulp) what we as parents need to pay out-of pocket. I’m hoping for the best, but have planned for the worst since his first year of life. 

Based on what I’ve read regarding the price tag for college, I feel the worst from my pocket might be $15,000-$20,000/year. This may seem low, but I’ve told my children I’m on board with paying for one-third of their education, with their Dad also paying one-third. How they pay their one-third can come from working while in college and/or summer jobs, student loans or scholarships. I remind them if they work hard, it’s likely they’ll qualify for scholarships and grants. Once Matt has heard from all six schools, we will sit down together and review the financial aid packages. The deadline to commit is May 1. 

No matter what happens, no matter where Matt goes, I’m prepared both mentally and financially for him to take that next milestone leap in life!

And I’m happy for him, yet I have to admit ... I’m still holding my breath!

If you have any questions regarding college savings plans for your children or grandchildren, please contact one of our Certified Financial Planners in Michigan, Wisconsin or Maui which savings plan is the right choice for you depends on your personal financial situation and goals.

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Michigan

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p: 231.929.4500
f: 231.995.7999

Wisconsin

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Onalaska, WI 54650
p: 608.779.0300
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