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2016 October Newsletter

General Investment Team Commentary (September 16, 2016)

After a surprising post-BREXIT period of relative summer calm, volatility made a return visit to financial markets during the first few weeks of September. This volatility was most noticeable with the bounce in interest rates and the price action in rate-sensitive investments like real estate investment trusts (REITs) and longer-term bonds. Noise surrounding upcoming Federal Reserve rate hike decisions and the contentious U.S. elections picked up a bit and injected some anxiety back into markets.

As we’ve noted in previous newsletters, our team at FIM Group has been trimming back investments benefitting from historically low interest rates this year and boosting “dry powder” positions, including shorter-term U.S. Treasury bonds. We have also maintained allocations in some of our strategies to variable rate loans and bonds that will generate an increasing income stream should short-term interest rates move higher.

On the equity side of things, our team continues to review a wide range of new stock ideas. Pending further due diligence and cooperative markets, some of these may find their way into client portfolios. As has been the case for several months now, it’s difficult to find compelling value in many U.S. stocks (value defined as the combination of quality and price that meets our criteria). This doesn’t really bother us, since we are finding good value in other places. And in certain cases, we are gaining “back door” access to U.S. companies (or U.S. consumers) via indirect routes. For example, appropriate accounts in two of our strategies own Japan-listed Softbank (noted below). Softbank is a unique conglomerate trading at a deep discount to its sum-of-parts. One of these parts (about 15% of Softbank’s value, on our estimates) is U.S. mobile phone company Sprint, a company undergoing a nice turnaround under Softbank’s direction.

Overall, we remain excited about the yet-to-surface value in our managed portfolios and our ample supply of dry powder to deploy into future opportunities. Should you have any questions about our strategies or your portfolio holdings, please never hesitate to be in touch.

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

The most FAQ — “When can I retire?”

The following is an updated excerpt from an article I wrote for our September 2013 newsletter. Here we are, three years later, and the most FAQ (Frequently Asked Question) remains the same. I include it again for those of you who are three years closer to retirement.

As you can imagine, this answer is different for everyone. Two factors in making this decision are after-retirement expenses and income at retirement. When the question arises, we discuss time frame to retirement and review what a budget at retirement might look like. What will the sources of income be? Will there be part-time earnings? Does it make sense to apply for Social Security benefits now, or to wait? These are important considerations before determining if one is ready (or financially able) to retire.

Let’s consider the case of Jack (age 63) and Jill (age 62): Current market value of combined investments = $1,200,000

Jack and Jill decide they’d like to retire when Jack turns 66. Because their time frame is just three years away, it makes sense to reduce their investment profile from a more “growth-oriented” to a more “income-oriented” position.

In addition, their goal is to withdraw the income earned by the portfolio’s investments, and preserve the principle for unanticipated expenses or long-term care needs. Jack enjoys staying active and keeping busy and would like to keep working maybe 10–15 hours a week as a consultant – his expected earnings will be approximately $30,000 per year. Jack will apply for Medicare at age 65, and Jill will continue on her employer’s medical plan until she retires and becomes eligible for Medicare the following year. They decide that it makes sense to forego Social Security benefits (and use their savings to help supplement other income) until at least Full Retirement Age (FRA), or age 66 for both. Their combined Social Security income when Sally applies at 66 will be $3,500/month.

They have worked on an after-retirement budget and decide they’ll need roughly $10,000 per month, which includes a $2,500 per month mortgage payment on their personal residence. They were able to refinance their $400,000 mortgage last year, locking in a 30-year loan at 3.5%, and they understand the benefit of leveraging and keeping the tax benefit. Although both are healthy, they’ve decided they will purchase supplemental Medicare coverage because they do not want to bear the cost of unexpected medical expenses should they arise. Jill’s income will remain at $50,000 per year until age 65, at which time she’d like to stop working and focus on her passion for gardening, as well as give back to her community. Another important piece of their planning is that they each have term life insurance policies of $500,000, which are due to expire when Jack turns 70 and Jill turns 69. They purchased the policies to protect each other and their children in the event of a premature death.

Based on this information, their projected household income when Jill turns 66 will be $6,000 per month ($2,500 per month from Jack’s part-time consulting and $3,500 monthly from their combined Social Security benefits), which means they’ll need to draw $4,000 per month from their investments to supplement the cost of their monthly expenses. Jack and Jill indicate they have no strong desire to leave a large inheritance to their three children because they are all doing well financially, yet they do like the idea of leaving a small legacy for their grandchildren’s education. Their primary goal is to stay active and healthy; they anticipate living into their 80s or even 90s due to longevity in their families. Based on these factors, if their investments are well-managed, and are invested for dividend income, they can expect to withdraw 4% per year, or $4,000 per month ($1.2 million x 4%/12 = $4,000), with some expected growth at the rate of inflation. Jack and Jill understand that to achieve their income need, in a 0% interest rate environment, they need to accept some volatility of market value.

In conclusion, the timing of one’s retirement is individual and extremely relative. The first step is to define one’s at-retirement budget. The second is to make sure that your investments are positioned appropriately to provide the supplemental income needed. Feel free to contact one of FIM Group’s Certified Financial Planners to discuss your retirement, and to make sure your investments are in line with your retirement goals.

NOK Corporate

Ticker: NOK Corporate

Website: www.nokia.com

Share Price/Market Capitalization (9/16/2016): US$5.44/US$31.7b

Company Description: Finland-based global communications company with leadership positions in mobile and fixed network infrastructure, software, and services.

Investment Thesis: Nokia is a high quality industry leader that is well placed to benefit from our increasingly “networked” world. Its shares look significantly undervalued relative to the double-digit profit growth we expect in the years ahead.

Nokia’s roots date back to 1865, when engineer Frederick Idestam set up a single paper mill in southern Finland. Today, following the recent acquisition of Alcatel-Lucent, it is the world’s largest communications infrastructure company. Nokia sells networking equipment, software, and services to customers in over 100 countries and should do more than US$23b in revenues this year.

Three major factors drive our enthusiasm for Nokia. The first is management’s reputation for effective cost-cutting and the opportunities to achieve more than EUR1b in cost synergies now that the Alcatel-Lucent deal is complete. These actions do not require an uplift in revenue growth, yet can have a meaningful impact on profit margins and therefore profit growth even if revenues stay flat (which we expect they will for the next year or two). Second, Nokia has an entire division devoted to technology licensing (given a significant patent portfolio) and is now in the negotiation process with companies, including Apple and LG Electronics, that use Nokia’s intellectual property in their products. Likely success in these negotiations should be a further boost to Nokia profitability in the years ahead as these revenues carry 90%+ margins. Third, Nokia’s major network equipment customers generally try to squeeze out what they can from the current generation of equipment before upgrading to the next. But if they wait too long, they risk losing share to competitors who embrace the latest and greatest innovations (such as higher Internet speeds). We expect that Nokia’s sales growth will stay sluggish until 2018-2019 and then begin to accelerate as spending on 5G equipment (fifth generation mobile networks promising lots of bells and whistles for an ultraconnected world) ramps up. As the Alcatel-Lucent integration should be complete by then, we expect profit margins to further benefit as scale efficiencies take hold.

We believe that many investors are overfocusing on the admittedly sluggish revenue growth that Nokia will report for the next couple of years and are underestimating the profit improvement story driven by cost synergies and technology licensing renewals. Amid an investing environment that has priced many highquality, industry-leading companies above our comfort zone, Nokia looks quite attractive to us. We have paid less than 10 times operating earnings for profit growth that should average well into the double digits in the years ahead.

We expect this profit growth to eventually drive a higher market value for the stock. While we wait, we estimate that Nokia can sustainably pay us dividends north of 4%.

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