“Why should I hire a financial advisor when I can just buy the S&P?” If I only I received a dime every time I heard that question, I could quit writing this blog post and retire early. To be fair, it’s a good a question and one you should ask any financial advisor you are considering hiring. There are many acceptable answers, such as “I will help you save money on taxes”, “‘Buying the SP500’ is not a comprehensive financial plan”, and “There’s a lot more to invest in than just the SP500”.
For the purpose of this blog, though, I am going to focus on a particular situation that I encounter often. Ironically, the potential client most likely to ask this question is the one sitting on the biggest pile of cash. I encounter it all the time, hundreds of thousands of dollars in a high yield savings account, or, worse, checking, and they cannot fathom the idea of paying 1% of their investment to a financial advisor each year. My question is always, “If you can just buy the SP500, why haven’t you?”.
Inertia is a powerful force, and not doing anything and keeping the status quo can feel powerfully comfortable. They often know that cash loses purchasing power to inflation and that owning the SP500 over the long term builds wealth, but they don’t know how much or when to invest. Seeing the market go up and down creates both anxiety about losing money and FOMO (fear of missing out) on gains, so they just keep waiting for the right time. The word clients use most often to describe this feeling is “paralysis”.
A good financial advisor will help clarify the best path forward. Rarely that involves keeping the cash as cash, and most often it involves investing a portion of the cash and keeping the rest safe, and this balance will be different for everybody. For many, just buying the S&P makes sense in theory, but is in fact too overwhelming to execute. In this context, paying a 1% management fee is pennies compared to the wealth building power of a uniquely tailored financial plan and investment strategy. If this sounds like you, now is always the best time to do something about it!
I read an article that described structured notes as “Boomer Candy”. Retirees seem to eat up the idea that they can participate in positive market returns while still protecting principal. What are structured notes and are they something you should incorporate into your portfolio?
Structured notes are debt securities issued by financial institutions that combine traditional fixed-income instruments with derivatives. They are designed to meet specific investment strategies and can be linked to various underlying assets, such as stocks, indices, currencies, or commodities. Unlike traditional bonds, structured notes offer the potential for higher returns, but they also come with unique risks.
Structured notes typically have several key components. Most structured notes offer a degree of principal protection, meaning investors may receive at least part of their initial investment back at maturity, depending on the structure of the note. However, this is not guaranteed for all notes. The performance of a structured note is tied to an underlying asset, which can affect the return on investment. For example, a note linked to a stock index may provide returns based on the performance of that index over a specified period. Structured notes come with a defined maturity date, at which point investors may receive their initial investment plus any additional returns based on the performance of the underlying asset. The payout structure varies widely among notes, with some offering capped returns, while others may provide leveraged exposure to the underlying asset.
Structured notes have the potential for higher returns than traditional fixed income investments, and may offer additional diversification than holding just traditional stocks and bonds. However, they come with significant drawbacks. Structured notes can be complex financial instruments, and understanding their structure, features, and risks is crucial. Investors must carefully review the terms and conditions of each note. Also, because structured notes are issued by financial institutions, investors face credit risk. If the issuer defaults, investors may lose some or all of their investment (Lehman, anyone?). Most importantly, many structured notes are not traded on secondary markets, which can limit liquidity. Investors may have difficulty selling their notes before maturity without incurring steep losses.
Take for example an excerpt from the prospectus of a structure note issued by Goldman Sachs and distributed by Chase Private Client: “The estimated value of your notes at the time the terms of your notes are set on the trade date… is expected to be between $900 and $930 per $1,000 face amount, which is less than the original issue price.” $900 per $1000 face amount?! That is literally a 10% loss on day 1 of the investment. Why such a steep decline? Because Goldman Sachs and JP Morgan Chase have to get paid!
What most investors don’t realize is that these structured notes can often be replicated through simple options structures, at a fraction of the cost. The most popular structure is a note linked the SP500 with protected downside and capped upside. Before buying one of these notes, compare the upside potential on the structured note to the upside potential on an index collar strategy that Komich Capital could build for you. Let’s talk!
Did you take my advice and buy series I bonds between May of 2022 and November of 2022 and earn 9.62% for the first six months and then 6.48% for the second 6 months? Great trade! But itʼs time to reevaluate the fixed income landscape.
These Series I bonds purchased between May and November of 2022 now only yield 3.94%. This yield is made up of a 0% fixed rate plus an inflation rate of 3.94%. Compare that to a yield of 5.27% for newly issued Series I bonds made up of a fixed rate of 1.3% plus inflation of 3.97%. In other words, the old Series I bonds have a “real return”, or return adjusted for inflation, of 0% and the new ones have a real return of 1.3%. A plain vanilla 3 month Treasury bill without any liquidity restrictions is currently yielding between 5.3 and 5.4%.
Powell and the Fed seem confident they will be able to successfully bring inflation down to the 2% target without tipping the economy into recession, so holding a Series I bond that pays only inflation is essentially fighting the Fed, which typically doesnʼt bode well for investments. Depending on your unique situation, it may be time to cash in and move the money to more productive investments.
Saving for college or a disabled family member? You may be able to avoid paying income tax on the interest! Schedule a meeting to find out: calendly.com/komichcapital/30min
In Marvin Gaye’s cool jam, “Trouble Man”, he sings, “There are only three things for sure, taxes, death, and trouble, oh this I know.” Financial advisors help us avoid taxes, and life insurance policies protect our families’ finances from unexpected death, but how do we prepare for trouble? I start every financial plan with the Safety Net because it is the foundation upon which the rest of the plan is built, and it is also the foundation upon which we can confidently stand and take wealth-building risks in other parts of our portfolio. Let’s explore the appropriate size of the Safety Net and its potential components.
The general rule of thumb measures the size of a proper emergency fund as six to twelve months’ worth of expenses. For example, if your mortgage payment, car payment, utilities groceries, and miscellaneous spending add up to $10,000/month, your emergency fund should have somewhere between $60,000 and $120,000. Like all personal finance, determining the size of an emergency fund is a combination of mathematical formulas and personal reflection.
Risk-averse people may want twelve months or more whereas a risk seeker may only want six months. Investors should also consider how reliable and consistent their sources of income are. For example, a salesperson with little or no base salary and inconsistent commissions should opt for a much larger emergency fund. A federal employee with a steady paycheck and future pension may opt for a lower emergency fund.
Let’s assume you work with your financial advisor and together you determine that your emergency fund should be 10 months, or $100,000. That does not mean that you let $100,000 sit in your checking account earning zero interest. In fact, I recommend only keeping two, or three months at most, worth of expenses in a checking account to smooth out the variability in month-to-month spending. We would use the remaining $70,0000 to $80,000 to buy safe and easily accessible assets, such as short-term US treasuries and CDs, which, at the time of this writing yield over 5%.
Having sufficient safe, liquid assets in your Safety Net will cover unexpected expenses and losses of income when trouble inevitably comes. It will also give you the necessary cushion so you do not have to dip into your long-term investments, which will almost certainly be down when you face trouble personally. Now is a great time to get your Safety Net in order, and you may feel like Marvin Gaye at the end of the song, “Don't care what the weather. Don't care 'bout no trouble, got me together, I feel the kind of protection that's all around me.”
Tune in next month when we explore another component of the Safety Net, a HELOC!
In last month’s article, we explored the relationship between financial planning and investment management, and how any investment necessitates a well-defined financial plan to determine the investment time horizon. This time horizon dictates the ability to take risks, and this month we will talk about a saver’s willingness to take risks.
A person’s willingness to take risks is a personality trait just as much as agreeableness or openness. Although education and knowledge can demystify risky investments, a person’s willingness to take risks is deeply personal and often difficult to change. All people land on a spectrum from totally risk averse to totally risk seeking. Taking the time to determine where you land on this spectrum will help you build a portfolio that you can live with and will avoid unnecessary anxiety and sleepless nights in the future.
How do you know where you land on the willingness-to-take-risk spectrum? Some questions to ask yourself, what would you do and how would you feel if you woke up one day and your account value was cut in half due to a market crash? What would you do and how would you feel if the market was up 20% in a year and you were only up 11%? Given the choice between a sure $100 or the chance to win $0 or $250 in a coin flip, which do you choose? What if it were a sure $100 or the chance to win $0 or $195 in a coin flip? When you hear the word “risk”, what other words come to mind?
As a fiduciary, I would never recommend taking more risks than your time horizon would allow. However, if you are a more risk-averse person, then it makes sense to dial back your risk lower than what your time horizon would allow. The other thing to keep in mind is that if you do not have a lot of experience investing, you may be more risk-averse than you think if you’ve only experienced a bull market or more risk-seeking than you realize if you’ve only experienced a bear market. Given the multidimensional factors that determine a person’s willingness to take risks, it always helps to have an independent, unbiased, and experienced investment professional evaluate both your ability and willingness to take risks before making any investment.
Tune in next month when we talk about the foundation of every financial plan, the Safety Net!
