Considerations For Planning in the 2020s and Beyond

Transcript:

Jared Kizer: So today I’m going to take on a little bit of a different type of topic. A lot of these (Buckingham Weekly Perspective videos) were kind of either reacting to current market events – which of course makes a ton of sense when that’s appropriate – or focused on evergreen-related topics, like previewing a particular asset class or strategy, things that we think will basically always be true about that particular strategy or asset class that we’re talking about. But today I want to talk about a little bit of a longer-range kind of investment planning question, which is how to think about investing in the 2020s or some of the things that come to my mind when I think about long-term investors. So, this is not what might happen over the next year, even the next two to three years. But sitting where we are today into the 2020s at this point, what are some things to think about in contrast relative to past periods that investors have lived through? So, I’m going to touch on a few of those today and really do it by contrasting what we saw in the 2010s – not that long ago at this point – relative to what I think we’ll see over the long-term starting in the 2020s. Hopefully, this also goes without saying even though we’re talking about the longer term, we’re still kind of looking into the future. So, there’s no way to know for certain what exactly will happen, but I think these are reasonable things to think about going forward as we march forward into the 2020s.

The U.S. Market Did Extremely Well in the 2010s

Jared Kizer: So, let’s start by talking about the 2010s. When I think about the 2010s, one of the really good things about the 2010s, from an investment perspective, is the U.S. market did exceedingly, exceedingly well over the 2010s. No doubt from a risk-adjusted return perspective, one of the best decades that the U.S. market has ever had, and we’ve been tracking U.S. market data for a long time at this point. So that’s actually saying something, like one of the best decades risk-adjusted return wise that we’ve seen from the U.S. market. Bullet point here is out of all the developed and emerging market countries that are tracked by the well-known index providers like MSCI, the U.S. market was the single-best performing country out of all of them. We’re talking about 50-plus countries, so very, very good decade for the 2010s. Also we saw very low interest rates and low rates of inflation. Of course, we’ve seen that change, and I think that could be a somewhat persistent change relative to the 2010s. A second thing that comes to my mind is a period of very low interest rates. And then for the way that we think about investing, the third thing that comes to my mind is in the 2010s we saw growth stocks that are growing at higher earnings rates. The names that are typically more well known did quite a bit better than value stocks, but that’s counter to what we know that the long-term evidence shows.

What Challenges Will Investors Face in This Decade

Jared Kizer: So, when I think about translating those into some of the challenges that were put upon investors as we entered the 2020s, the fact that the best-performing asset class was the U.S. market certainly has tempted a lot of investors. I saw this in particular at the tail end of the 2010s – to abandon other parts of a diversified portfolio or to lessen exposure to things that were not U.S. equities. Because people kind of kept seeing the U.S. market to be so dominant, a lot of investors, of course, not all but many, let that influence, I think far too significantly, how they thought about investing on a go-forward basis. Effectively saying I just think they thought we were going to just keep seeing the U.S. market be very dominant on a go-forward basis. So, while it was good and with respect it definitely challenged investors to stay disciplined in investing in things that were not U.S. equities.

The Investment Landscape Looking Forward

Jared Kizer: So, when we look forward, I think the main thing that comes to mind if you wanted to summarize thoughts, for a long-term investor, is that it’s highly unlikely – nothing’s ever impossible – but highly unlikely that we’ll see the dominance of the U.S. market continue. Meaning in the sense of better than everything else over an extended period of time, just not something that tends to happen over consecutive decades, and I think that’s the first thing that I would say for investors looking forward. I’ve already hit on number two, which is again, we never know, but I think it’s certainly possible, that we will be in some type of higher interest rate environment and potentially higher inflationary environment over the longer term compared to both of those being very low in the 2010s. So that’s another thing to think about from an investment point of view. And then when I think about the broader stock markets, what comes to mind is remaining dedicated and thinking about if you don’t already have an allocation to international equities versus U.S., I think it’s very important going forward to be globally diversified and that we think about the value versus growth dimension. We kind of saw in the 2010s growth do really well. I think as we look forward from here, we’ve seen this occur a little bit already in the early 2020s. You can think about having some type of value-oriented allocation within a stock portfolio. So hopefully, those are some helpful kinds of longer-term thoughts, a little bit different topic than we typically touch on here. If you have other questions you’d like for us to tackle, feel free to reach out to your advisor and submit questions that way or click the link below and you can submit questions there as well. Thanks.

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The Depreciation of the U.S. Dollar

Summary:

There have been recent concerns about the depreciation of the U.S. dollar relative to foreign currencies. In this episode of Buckingham Weekly Perspectives, Head of Investment Research Jared Kizer shares the drivers for this fear, short-term implications and the potential economic and investment impacts on the marketplace.

Transcript:

Jared Kizer: Today I wanted to tackle an area that we’ve gotten a lot of questions on recently which is the depreciation of the U.S. dollar, or potentially foreign investors moving away from the U.S. dollar and toward other foreign currencies, and what impact that might have, either from an economic point of view or an investment strategy point of view.

What Are the Drivers for this Concern Around the Depreciation of the U.S. Dollar?

Jared Kizer: I’m going to talk about both those areas today. So, first thing I want to note, hard to say exactly what are all the drivers for these questions, a few things come to mind. If I had to guess though, one would be we’ve certainly seen very explosive growth in U.S. federal debt levels, driven by COVID-related reliefs, deficits related to income coming in for the Federal Government. No doubt, longer term concern for the dollar is the growth in the U.S. debt. It could be the fact that as we all know, we’ve seen high inflation rates of the last two or three years that could be driving concerns about the U.S. dollar. And then the other thing that specifically related to this year, we have seen the U.S. dollar depreciate relative to other foreign currencies say like the Euro this year, so probably a confluence of different factors that are driving questions. But I wanted to jump on and give our perspective on the economic side and then on the investment strategy side.

The Impact of a Depreciating U.S. Dollar on the Economic Side 

Jared Kizer: On the economic side, the key message would be while we have seen maybe an ever so slight reduction in foreign use of the U.S. dollar, say over the last 20 years, without a doubt the U.S. dollar still remains the dominant currency related to foreign trade. And then central bank reserve holdings – and that last term simply means if you look at other central banks so say the foreign versions of the Fed that we have here in the U.S. – assets that they hold they have to decide “Well, what assets are we going to hold as part of our reserves?”. U.S. Treasury holdings are very common and remain a dominant fraction of central bank reserve holdings. So, whether you look at trade or whether you look at those central banking reserve statistics, you see very dominant use of the U.S. dollar and really hard to say, what would the competitor be at this point. I guess if you had to pick one, it might be the Euro, but the Euro is just nowhere close to the dollar at this point in terms of foreign use both again in trade and central banking purposes. So that’s the overall message. We’ll get to some long-term concerns here in a second.

Jared Kizer: No doubt the U.S. dollar remains very dominant essentially regardless of what statistic that you look at. Let’s talk about some of those near-to-intermediate-term concerns. What are some things that are sitting out there that could drive particularly foreigners to move away from the U.S. dollar in some meaningful way? I think the big one is the growth in the U.S. debt. It’s projected to continue growing at very high rates due to deficits and lots of other factors there. So that would be the number one concern – can the U.S. federal government get its deficit spending under control? Can we tamp down potential growth in the U.S. debt? A lot there that could certainly drive intermediate term concerns, but you’re not really seeing that have an impact here recently. The other thing that comes to mind, which is one of the things that I’ve seen a lot in the recent story lines, which is no doubt there are some bigger emerging market economies like China, India, Russia, although Russia’s economy is not nearly as large as those two particularly at this point, but there are certainly a lot of countries that would like to move away from reliance on the U.S. dollar. I think that will always be a thing. It’ll be interesting to see if any of those countries are actually able to do that. But there is certainly some intermediate-term pressure and near-term pressure I think on that front in terms of certainly you’ve got those countries that would like to be able to move in a different direction and not be as reliant on the U.S. dollar.

The Impact of a Depreciating Dollar on the Investment Strategy Side  

Jared Kizer: Let’s move to the investment strategy side of things. What might the impact of these things be? I think that we see a lot of concern sometimes is fear of potential depreciation in the U.S. dollar. There’s not a clear relationship that says if that were to happen that it’s going to have some dramatically negative impact on lots of portions of the investable marketplace. It’s just not a clear relationship there. We don’t have a lot of historical instances to look at, but the one that we do have to look at which is the last time you had massive movement away from the predominant currency, was the investors moving from the pound to the dollar well over essentially a hundred years ago at this point. But you didn’t see that dramatically disrupt financial markets in and of itself. You didn’t see that UK equity returns were particularly poor. It’s not clear, say for the U.S. equity market, how a gradual or even faster movement away from the U.S. dollar would impact financial markets. If you do have concerns though, we do think generally it is good to diversify some of your foreign currency exposure, nevertheless. So, you can own international equities, which we think are an important part of a globally diversified portfolio. A lot of those funds that we would use – pretty much all the ones that we would typically use – do not hedge their currency exposure back to the dollar. So, it’s a way to kind of diversify an investor’s exposure to the U.S. dollar.

Jared Kizer: And then I think the legitimate investment strategy concern would be “Well, what if we had inflation rates back up again?”. You know we certainly tend to see the U.S. dollar appreciate; we’ve talked a lot about that in the past. Inflation protection is an important part of a portfolio, but you can use strategies like Treasury Inflation-Protected Securities to try to mitigate those risks. So, a couple things to think about on the investment strategy side, but the main takeaway is it’s not clear how any of this exactly would impact financial markets particularly in a negative way. So hopefully you have some helpful perspective on the U.S. dollar. If you have additional questions you’d like for us to tackle, feel free to reach out to your advisor and suggest those or click the link below and submit questions that way. Thanks.

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A High-Level View of Schwab

Summary:

Recent news stories have many concerned about the stability and safety of Schwab Bank and Schwab’s custodian/broker dealer business. In this episode of Buckingham Weekly Perspectives, Chief Investment Officer Kevin Grogan breaks down the issues at Schwab, how their circumstances are different than the Silicon Valley Bank failure and why we believe client assets are likely safe.

Transcript:

Recent articles in the news media have started to raise concerns about the stability and the safety of assets held at either Schwab Bank or Schwab’s custodian/broker dealer. And we of course here at Buckingham understand that whenever you read articles talking about issues at your custodian or at your bank, that can cause a lot of anxiety and stress because that’s where your life savings are in many cases. This video will attempt to bring some clarity to some of that discussion and hopefully put your mind at ease a bit about what’s going on at Schwab. This will cover high-level issues, but we did put out a longer article on this topic that was written by my colleagues Jake Fechter and Larry Swedroe. If you would like a deeper dive at the conclusion of this video, you can of course check out that article as well.

Our Predictions for Schwab

Kevin Grogan: I figured I’d start with the conclusion up front, which is that we think Schwab is likely to make it through these current challenges. And really the main high-level reasons for why we have confidence in Schwab is that it’s still a very profitable business, number one, and number two it has highly diversified sources of revenue. So, between those two factors, we think that Schwab will make it through current challenges that are facing lots of different financial services companies these days.

Why is there concern?

Kevin Grogan: Starting with the primary reason why there’s concern at all is because Schwab, kind of similar to Silicon Valley Bank, purchased longer term treasury securities, which have fallen in value as interest rates have increased. Schwab at the end of 2022 had unrealized losses of almost $29 billion, which is obviously a huge number in terms of unrealized losses on that treasury bond portfolio that they held.

The Performance of Schwab Stock vs. the Safety of Client Assets

Kevin Grogan: And in understanding what this means and putting it into context, I think it’s important to differentiate between the performance of Schwab’s stock and the safety of client assets at Schwab. These are two separate issues which of course are related to some degree, but many of the articles that you read in the media about Schwab are really talking about the performance of Schwab stock. Some analysts expect the price of Schwab stock may fall in the short term, which of course it could be true or could not be true. It’s very difficult to predict the performance of any individual stock. But if Schwab’s stock prices fall another 5 to 10%, that doesn’t really have a material impact on the safety of client assets at Schwab. So that’s the first important thing to differentiate.

Kevin Grogan: And then to make things even more complex, you also have to differentiate between Schwab’s bank and Schwab’s broker dealer. The broker dealer is where your mutual fund and stock assets are held, whereas the bank would be where you might have a deposit at Schwab Bank in a savings account or something along those lines. So those are two different business lines that are separate from one another. Starting with the broker dealer, it is important to note that Schwab is the largest public broker dealer in the United States, and all broker dealers in the United States are subject to certain regulatory requirements that help protect client assets. Number one, brokerage firms must meet minimum capital requirements to reduce the likelihood of a broker dealer becoming insolvent. Second, brokerage firms must keep customer securities separate from their own securities, so that they can’t be mixed together, that’s another safeguard in place. And then finally, a brokerage firm must be members of the SIPC, which is kind of the brokerage version of the FDIC which ensures customer securities up to about $500,000. These are some of the protections that are kind of baked into the regulatory framework here in the United States to protect customers from a broker dealer potentially failing.

Kevin Grogan: Moving over to the bank, I think one important difference between Schwab Bank and Silicon Valley Bank is just the nature of their depositors. Silicon Valley Bank’s depositors, almost all of them, were over FDIC limits with their deposits, meaning that they weren’t protected by the FDIC insurance because they held more than $250,000 per depositor. At Schwab Bank, more than 80% of their depositors are protected by FDIC insurance limits and are under those limits. It is just a totally kind of mirror image of each other with respect to what their depositor base looks like. So, if you think about Schwab Bank, there really isn’t incentive for those depositors to pull their money out if they’re under the FDIC insurance limit. So, you have those protections, and you aren’t as likely to see a bank run like we saw with Silicon Valley Bank. Now where things get a little bit blurry, if you are a customer of say Schwab’s custodian and you have holdings in the sweep money market account, those are actually held at Schwab Bank. You could in theory, and likely if you have your assets at Schwab, are a client of both Schwab Bank and Schwab’s broker dealer. But the Schwab Bank sweep account allocates that cash to two different banks; you have about $500,000 of FDIC insurance limits if you are a client of Schwab’s broker dealer.

Kevin Grogan: As I said to kick off the video, we think it’s highly unlikely that Schwab will become insolvent. But of course, you know , we never want to treat the unlikely as impossible. So, we do think about these things because of course, it affects our clients to a great degree if something bad were to happen to Schwab, which in turn would affect our business significantly. So we have thought through these issues, and I think it’s important to know looking back at history that there have been broker dealers that have failed historically. When a large broker dealer has failed, clients haven’t lost out from those failures. When Drexel Burnham Lambert failed in 1990, customers were made whole in that example. Bear Stearns failed in 2008. It was purchased by J.P. Morgan, again customers were made whole there as well. And then also when Lehman Brothers failed, it was wound down by SIPC, and again, customers were made whole with their holdings that they held at Lehman Brothers in that instance. And so again, none of these are fun.

Kevin Grogan: We think in the unlikely event that something bad were to happen to Schwab, customer assets are typically held separate from the custodian’s assets. And that is really your protection if something bad were to happen to your custodian, whether you’re a custodian of Schwab or any other custodian that you might be working with. And again, we understand that these issues can cause a lot of anxiety and stress, and so if you do have further questions don’t hesitate to reach out to your advisor.

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Investing in High Yield Corporate Bonds

Summary:

While high-yield corporate bonds may offer higher returns, they also come with a great deal of risk. In this episode of Buckingham Weekly Perspectives, Head of Investment Research Jared Kizer takes a deep dive into these securities and shares why we don’t recommend this fixed income strategy.

Transcript:

Jared Kizer:

So today we’re going to talk about high-yield corporate bonds, a type of fixed income investment that we frequently get asked about but don’t typically recommend or basically ever recommend in client portfolios. So, I wanted to jump in and talk about what high-yield corporate bonds are, then talk about some of the reasons historically that we haven’t recommended them in client portfolios.

What are high yield corporate bonds?

Jared Kizer: So high-yield corporate bonds, as the name might suggest, are relatively high yielding or high expected return forms of fixed income investing. So, they are fixed income, but on the riskier end of the scale and high-yield bonds almost always refers to higher-yielding corporate bond issuers. So, these are companies that are issuing bonds, but companies that are much much riskier typically than the typical company or what would be called an investment grade company. So, think of more distressed companies that are public companies, but more distressed and higher risk than the typical company that most of us are familiar with.

So therefore, when those companies are issuing bonds, they issue bonds at no doubt at much higher interest rates than say a Walmart or Google, Apple or Microsoft would be paying on their bonds because of that higher risk. So, we see investors can be attracted to high-yield corporate bonds because of those higher-yields and no doubt historically the bonds have had higher net returns than safer a fixed income, but we’ll touch on why that’s only part of the story and why we think is not enough to recommend them typically in client portfolios.

Higher returns = Higher risks

Jared Kizer: And we start there with yes returns a bit higher, but so is risk. So, you do see that on average about 1% to 2% of the yield that you’re earning on high-yield corporate bonds has been lost to defaults each year, so riskier companies. Yes, it’s fixed income but some of these companies will no doubt default over the course of a typical year. And of course, more of those companies will default during periods of prolonged stress and broader markets and the broader economy and that I think is the most important reason which we’ll touch on now while we haven’t recommended them historically. So, I think of high-yield corporate bonds almost as junior equities, so they’re very equity-like even though they are a fixed income investment. So, they’re not a great way to diversify a portfolio, said another way, most all clients that we work with and most investors in general will have some portion of their allocation dedicated to stocks. So, if you’ve got that part of your allocation, you’re kind of already getting what high-yield corporate bonds provide. So, if you separately then allocate what the high-yield corporate bonds provide, you’re kind of doubling up on risk that you’ve already got in your portfolio and doubling up on it in a way that’s not that tax efficient either. So, when we think about stocks, one of the nice characteristics they have is that they do tend to be relatively tax efficient. So in sensible stock strategies, you don’t lose a lot of return each year to tax related costs if you’re investing in a taxable account. Not true with fixed income – you’re taking equity like risks, but you’re going to be taking it in ways that would be taxed at traditional ordinary income rates. So just not a great diversification agent relative to other strategies that are out there in the marketplace. For example, some of the alternative strategies that we typically recommend and again in many ways you’re taking equity-like risk with less preferential tax treatment. So hopefully that’s a helpful kind of brief introduction to high-yield corporate bonds and the way that we think about them and why we don’t recommend them. If you have additional questions  you’d like for us to tackle, feel free to reach out to your advisor. Or click the link below and submit questions in that way. Thanks.

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