Going into Overtime

Swanson

Conflicting news reports, contradictory economic data, the Dow plunging 150 points one day and rallying 250 points the next. Investors these days face mixed signals everywhere and a market that churns with no real direction.

It reminds me of a football game late in the fourth quarter. One team advances into field goal range then fumbles the ball, which the other team recovers and scores. After that, an onside kick allows the first team to catch up, and the game goes into overtime.

Two steps forward, one step back

Late in 2015, a closely contested economic and market match is playing out before an audience of confused investors. Pessimists latch onto every bit of disappointing data as a sign of impending recession. Optimists focus on more positive releases and claim that the numbers are getting better.

In the past month alone, we’ve watched retail sales falter in the United States, only to see that piece of news followed by the announcement that total personal consumption (PCE) has actually accelerated. Similarly in China, we read more and more bad news about manufacturing and production. Within days, however, retail sales are reported to be rising at a 10% annual rate, and the service side of the Chinese economy appears to be doing fine. In Europe, though manufacturing remains in decline, we learn that the weaker currency has helped exports, and German and Italian consumers have ramped up their spending.

In interest rate space, we’re beset by worries that the Federal Reserve’s impending hike will slow the US economy and hinder global growth, and yet the markets continue to project that rates will be lower for longer.

Who is right and who is wrong? Are things getting better or worse?

Start making sense

Here’s how I suggest investors can make sense of this.

Above all, the risk of recession should be the biggest concern. The end of a business cycle means trouble for portfolios that aren’t totally bulletproof and risk-free. Recessions are episodes of sharply curtailed spending and deeply depressed profits. But recessions don’t happen without a reason. A shock has to occur that ends the expansion and takes the spending and profits away.

Since World War II, those shocks have been rate increases, oil price and currency displacements, or other excesses that need to be corrected. In most cases, we’ve suffered a combination of shocks —usually rising rates end up curing excesses or bubbles that have developed in the economy.

Right now we see no major excesses — not in the labor markets, not in the financial markets, not in the inflation numbers. Fed policymakers tell us that interest rates may go up but the adjustment will be gradual. Past recessions have involved oil shocks, though only price increases, never decreases. Oil is currently more than 50% below its peak.

If there are no major excesses that need to be corrected, then what can provide the energy needed to keep the economy going?

Drivers of momentum

Here’s what I think can push the US and global economy forward.

The US consumer matters to the world as the number-one source of final demand. The main drivers of momentum for US consumer spending are wages, hours worked and the number of workers. All three measures have been improving consistently, month over month, showing no signs of being dragged down. Corporations are mostly quite profitable, flush with cash and ready to spend again — albeit cautiously — on big-ticket items. That tends to raise the number of workers. Rising vehicle sales are further evidence of positive consumer sentiment, although home sales have been the big laggard of this cycle.

My conclusion is that the ebb and flow of good and bad economic news is netting out on the side of more of the same modest expansion that has been the hallmark of this business cycle since 2009. The moderate pace of the past six years may not be as invigorating for investors as the heady days of 3%, 4% and 5% annual real growth in the 1980s and 1990s. But a more measured rate of growth, without the uninhibited use of credit, just may get us a longer reprieve, buying us more time before the onslaught of the next recession. Which means this cycle may well go into overtime, and I don’t think we’ll mind that one bit.

James Swanson, CFA is the Chief Investment Strategist at MFS

 

No forecasts can be guaranteed. Past performance is no guarantee of future results. The views expressed are those of James Swanson and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation or solicitation or as investment advice from the Advisor.

The Pros and Cons of “Investing in What You Know”

Compass

“Invest in what you know” is a classic finance adage. It was the mantra of famed investor Peter Lynch, and is an approach followed by Warren Buffett. Indeed the general idea of investing in what you know makes a lot of sense and can help you avoid pitfalls that often bedevil investors. But taken too far even this seemingly common-sense philosophy can be counterproductive.

Let’s start with the benefits of investing in what you know. In recent years the number of financial products that investors can buy has proliferated, and many of them are complex and opaque. They often use derivatives or leverage or innovative investing strategies to try to outperform the market or mitigate a particular risk. In most cases these products are designed for a specific purpose, such as allowing hedge funds or professional traders to execute highly complex investment strategies.

While these types of products can seem sophisticated and alluring, they can also be risky if you don’t understand how they work. If the strategy they use isn’t consistent with your risk tolerance and time horizon, or you don’t understand how they interact with the other holdings in your portfolio, the results can be painful. For long-term investors simply trying to give themselves the best chance of reaching their financial goals, avoiding these newfangled products and sticking to what you know is often a better bet.

Yet investing only in what you know can backfire. Diversification is one of the keys to successfully managing your wealth, and focusing your investments only in the areas you know best can leave your portfolio insufficiently diversified.

An analysis by investing website OpenFolio found that investors tended to have more exposure to stock market sectors that were big employers in their part of the country. Investors in the western part of the US tended to own more technology stocks, for example, while investors in the Midwest tended to own more industrial stocks. While some of this effect could be due to employees receiving stock in their own company as part of their compensation, it’s also likely the result of investors being more comfortable with companies in the market sectors that they know more about.

This kind of “investing in what you know” can leave you over-exposed to a downturn in one particular industry. So while the philosophy of Lynch and Buffett can help you avoid some common investing mistakes, it shouldn’t come at the expense of a portfolio that’s well-diversified among different asset classes, market sectors, and regions of the world.

How the Social Security Reboot May Affect You

Arrows

You’ve probably heard the federal government has made changes that may affect the way you can take your Social Security retirement benefits. While there’s still potential for some “tweaking” of the language around these changes, I’d like to share some insight on what we know now and what it may mean for you.

WHAT is Changing with Social Security?

The two strategies affected by the new law (that law being the 2015 budget) are known as File and Suspend and Restricted Application.

File and Suspend allowed you (generally the higher earner in a couple) to file for, but suspend taking, your Social Security retirement benefits while permitting your spouse and/or eligible dependents to collect benefits based on your earnings record. In that way, you earned the 8 percent annual “raise” on your individual benefits, your spouse/dependents received their paychecks based on your earnings record, and the family collectively was able to maximize its Social Security income.

Under the maximization strategy known as Restricted Application, you could file for Social Security benefits at or after full retirement age (FRA), but elect to take only your eligible spousal benefits, allowing your individual benefits to grow until they max out at age 70. At that point, with a raise of up to 32 percent under your belt, you would switch to taking your individual benefits.

WHEN Are the Changes Effective?

Restricted Application is being phased out immediately for anyone born after 1953. You will still have the option to File and Suspend your benefits, but timing is important here, because after April 2016, there are consequences for requesting a suspension of your benefits.

First, the change means that if you request your suspension after April of next year, no one else can collect benefits on your earnings record. (As currently written, this includes ex-spouses. That is one nuance Congress may have to address so that a maximization strategy for married couples does not become a punitive strategy for use by ex-spouses.) Second, if your suspension is requested after April, you can no longer request retroactive payments of those suspended benefits, and that really makes File and Suspend unattractive vs. doing nothing at all.

Here’s why: Before, you could suspend your benefits and then request up to four years of retroactive payments (based on the length of your suspension, of course). Going forward, there will be no retroactive payments under File and Suspend. You may well be better off not filing for your benefits; at least then you have the option to request six months of retroactive payments should you have that need.

Essentially, File and Suspend goes from a “why wouldn’t I?” family maximization strategy to “why would I?” Under the new rules, there generally is no reason or incentive to file and immediately suspend benefits. Come May, the only practical use for suspending benefits would be if you started collecting early (maybe you needed the paychecks) and later wanted to halt those checks to begin earning your delayed retirement credits.

WHO Is Affected?

Restricted Application will be off the menu for anyone born after 1953. You will have to claim your individual benefit prior to collecting a spousal benefit, regardless of age. For those born in 1953 or earlier, Restricted Application remains an available option.

File and Suspend is more complicated. The short answer is that File and Suspend as we know it now will be void for new filers after April 2016. However, anyone who turns 66 by April 30 (perhaps even Aug. 31; we’ll know once the law is interpreted) and requests a suspension prior to April 30, 2016, will likely be grandfathered. The same is true for anyone currently using the strategy—the government is not expected to take away benefits already being received via this strategy.

HOW Should You Adjust?

If you’re among those with a 66th birthday in or before August (or already FRA and not yet collecting benefits), talk to your advisor about whether File and Suspend is an appropriate strategy for you. Do this prior to April, as your window of opportunity to lock in this strategy before it expires is small. Understand, of course, that if your 66th birthday is between May 1 and Aug. 31, that window is questionable. Your ability to use the strategy will depend on how Congress amends the law throughout the appropriations process and how the Social Security Administration (SSA) interprets the law in writing the procedures. (By way of background, the SSA now allows you to file a request four months before it can take effect; thus the potential August birthdate cut off. Keep in mind, August would be the cutoff for your 66th birthday, but you would still need to make the request by April 30, 2016.)

Ultimately, if you and your advisor determine File and Suspend would be a useful strategy for your circumstances, you may want to request it by April 30 even if you have a 66th birthday that falls in the questionable zone of May through August, as you do have a year to turn back the decision by submitting a request for withdrawal of application.

As for Restricted Application, if you’re born prior to 1954, there’s an opportunity to take advantage. I strongly suggest you talk with your financial advisor if you’re thinking about using one or both of these strategies.

For most of the rest of us, now may be a good time to reassess our retirement income strategy overall. Ultimately, Social Security is just one element of a successful retirement income plan, and it shouldn’t be the lynchpin. After all, annual Social Security payments averaged $16,000 for individuals and $25,000 for dual earners in 2014.

A financial advisor, armed with the most innovative tools in retirement income planning, can help you identify your income goal in retirement and assess where you stand today. From there, you can develop a plan to close any gap. And be sure to visit BlackRock’s Retirement Center for a wealth of information on retirement planning, including dedicated resources related to Social Security collection strategies.

WHY (Oh Why)?

Now that we’ve covered the what, when, who and how, you may be wondering why these changes are being implemented. It’s no secret the Social Security system is underfunded and in need of a lifeline. The 2015 Social Security Trustee Report estimates the combined Retirement and Disability Trust funds will be exhausted in 2034. At that point, if no changes are made, the report estimates the system will have enough incoming revenue to cover only 79 cents of every dollar owed.

The presumption is that these changes now on the table will increase the sustainability of the system. One estimate was that if every eligible person were taking advantage of these two collection options, it would cost the Social Security system roughly $9.5 billion a year. (As a point of reference, Social Security paid out approximately $725 billion in retirement-related benefits in 2014.)

That said, it is unclear how many people are actually using one or both of these options. In fact, I’ve been talking to people about Social Security for seven years now and a great many have been unaware that these strategies existed; the Social Security Administration doesn’t necessarily advertise them. So, in reality, the potential savings are yet to be determined, though the SSA Chief Actuary has offered a long term estimate.It is clear, however, that these changes alone won’t come close to addressing the magnitude of the problem. Congress still has a lot of work to do over the next 18 years.

Rob Kron, Managing Director, is the head of Investment and Retirement Education for BlackRock’s U.S. Wealth Advisory group. He provides practical information on topics that are important to every saver and investor of every age.

 

The above commentary is based on Social Security laws in effect as of November 2015. Congress has made changes to the laws in the past, and can do so at any time in the future.

This material is provided for educational purposes only and does not constitute investment advice. The information contained herein is based on current tax laws, which may change in the future. BlackRock cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. The information provided in these materials does not constitute any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

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How Rising Interest Rates Affect Your Bond Funds

Finance

The odds of an interest rate rise seem to be increasing. After the October jobs report revealed that the US economy added 271,000 jobs that month and the unemployment rate fell to 5%, predictions that the Federal Reserve would raise interest rates proliferated. Prices in futures markets currently imply that there’s almost a 75% chance that the Fed will hike interest rates in December.

As we’ve argued in the past, you probably shouldn’t fret too much about the Fed. Given the low inflation rate and struggling global economy, even if the Fed takes action in December it’s unlikely to raise rates very far or very fast.

But that doesn’t mean Fed policy will have no effect at all. In fact, the Fed’s actions can affect virtually every investment. One type of investment most likely to be affected will be bond funds. Bonds tend to hurt by rising interest rates since higher interest rates often increase bond yields, and bond yields move in the opposite direction of bond prices. Since bond funds are essentially just a collection of individual bonds, by this logic bond funds should be hurt by rising interest rates as well.

This relationship, however, isn’t quite that simple. Bond funds are indeed hurt if the bonds they hold fall in value due to higher yields. But bond funds are also continually buying new bonds, not just holding on to their existing ones. Over time, the gains from higher yields on these new bonds will partially compensate for the initial decline in bond prices. If you hold the bond fund long enough, your return is likely to be close to the fund’s yield when you first bought it, regardless of what happened to interest rates during that time.

How much you should worry about the effect of rising interest rates on your bond funds therefore depends not only on what the Fed does, but also on the length of your investment horizon. There are ways to minimize the risk of being hurt by rising interest rates, such as by shifting your bond holdings toward shorter-term bonds. But depending on factors such as your investment horizon and your risk tolerance, such tactics may not be necessary.

3 Steps for Better Retirement Saving and Investing Habits

Doors

Consider the following choices:

1. You are offered a snack to eat now—would you prefer a chocolate bar or an orange?

2. You are offered a snack now to eat next week—would you prefer a chocolate bar or an orange?

People predominantly choose the tasty but unhealthy snack for immediate consumption, but pick the healthy snack for the future. However, once that future date arrives, if given the option to switch, they again go for the high-sugar high-fat chocolate bar.

This example highlights one of the main behavioral challenges in saving for retirement: As humans, not only do we tend to overweight our experiences today at the expense of those in our future, veering towards instant gratification, but we also change our preferences over time. In effect, we make choices today that our future selves would prefer not to be making, whether it’s to eat healthier or quit smoking. This is known as the present bias. In today’s post, I’ll take a look at this phenomenon—and several others—that investors often face when saving and investing for retirement.

Common Saving and Investing Behavioral Derailers

In addition to present bias, behavioral mistakes in saving and investing for retirement include:

1. A lack of discipline to take the actions we know would be right for the longer term.

2. Procrastination and a preference for the current state of affairs, also known as the status quo bias. This can arise for a variety of rational and behavioral reasons including lack of motivation, greater sensitivity to losses than gains (loss aversion),and the fear of potentially making a wrong decision.

3. Rules of thumb such as anchoring, an over-reliance on the first piece of information offered, and naïve diversification rules.

4. Overconfidence and other biases that have been found to plague individual investors’ portfolios in general.

Financial Implications of Behavioral Biases

The above behavioral biases can meaningfully impact the ability to meet one’s financial retirement goals:

PROCRASTINATION AND THE STATUS QUO BIAS

These can delay or prevent people from signing up for retirement plans, even when tax advantageous and with added incentives such as company matching contributions. In an extreme example, a study found that in a sample of 25 defined benefit plans in the United Kingdom that were fully paid for by the employer, only about half of the eligible employees signed up. Further, the greater the number of funds offered by the plan, the lower the participation rate, presumably thanks to the added complexity of the decision problem.

ANCHORING

This can cause retirement plan participants to stick to the generally low default contribution rates, perhaps believing them to be an implicit plan recommendation. Other naïve rules of thumb, such as contributing just enough to maximize company matching contributions or simply picking the maximum allowed rate, are also blind to an individual’s true funding needs. As for asset allocation, people sometimes use diversification strategies such as dividing their savings equally across funds, or some other arithmetically simple rule. If plan participants are offered a large enough number of funds to cause a choice overload, they may simply give up and just go with the safest fund in the menu.

OVERCONFIDENCE

This and other types of biases that plague individual investors’ portfolios in general, which can lead to a heavy concentration in the employer’s stock and under-diversification, and poor stock market timing, have also been discovered in retirement portfolios.

The obvious risk of these poor saving and investing behaviors is insufficient income at retirement. Research shows that the average working US household has virtually no retirement savings, and even when considering not just retirement assets, but total net worth, around 65 percent of households fall short of conservative retirement savings targets for their age and income.

How to Mitigate the Impact of Biases

While financial education by itself hasn’t been found to be very successful in tackling behavioral biases, there are three steps investors can take to improve their retirement savings behavior:

TACKLE PROCRASTINATION

Address the inherent complexity in saving for retirement by breaking tasks into less intimidating components, getting financial advice in the process if needed. Set explicit rewards for completing individual tasks.

FRAME THE PROBLEM DIFFERENTLY

Focus in as much detail as possible on the happier retirement that can result from saving and investing today, rather than the immediate monetary loss from saving. The more vivid the picture of a happy retirement, the more powerful this method is likely to be in changing behaviors.

USE SOFTWARE TOOLS

Creating realistic depictions of aged versions of yourself can help bridge the gap between how much you care about yourself today vs. in the future.

This is where, as an investor, knowing yourself is especially valuable. You can read more about that in A First Step to Investing Success: Know Thyself.

Nelli Oster, PhD, is a Director and Investment Strategist at BlackRock. You can read more of her posts here.


This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 2015 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2015 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.

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The Case for Preferred Stocks

Fan

In a world where finding yield is a challenge, even a looming rate hike isn’t enough to get investors particularly excited about their bond portfolios. While some have turned to high yield bonds, preferred stocks have been mostly overlooked. But I think now may be a good time to take a closer look at preferred stocks.

Starting at the beginning

First thing’s first: what are preferred stocks? Put simply, they’re income-generating securities that have both stock and bond characteristics. When it comes to risk, they’re somewhere in the middle of the spectrum, between common stocks (more risky) and traditional bonds (less risky). Similar to a bond’s coupon payment, preferred stocks pay fixed or floating dividends. They can appreciate in value like a common stock, but they’re not as volatile as a common stock.

Preferred stocks may be most appropriate in a portfolio that is looking to achieve the following objectives:

1. According to Bloomberg, preferred stocks have historically experiencedthe highest yields in the investment grade universe, which makes them an attractive alternative or complement to corporate, municipal, and high yield debt securities.

2. Preferred stocks have lower historical correlations to traditional stocks and bonds, which means they tend to move in different directions when market conditions change.

3. Lower volatility. Because preferred stocks have a fixed dividend and may not fluctuate the way common stocks do when the market changes, they can potentially reduce the overall volatility of an equity or high yield portfolio. Keep in mind, however, that preferred stocks are more volatile than traditional fixed income and can carry more risk when financial sectors are under pressure.

Is now the time for preferred stocks?

Sometimes I’m asked if preferred stocks will remain an attractive asset class in a rising rate environment. While it is true that preferred stocks may see price declines as traditional long-term bonds would, the losses may be more than offset by the potential yield. Additionally, because we expect the rate rises to be gradual, we wouldn’t expect to see big downward spikes in preferred prices. Preferred stocks may also be attractive due to the fact that they’re issued mainly by financial companies, like banks. That’s because banks have historically tended to do well in rising rate environments, as they can benefit from making loans at higher interest rates.

If you’re looking for another source of income in your portfolio, you may want to consider preferred stocks.

Jane Leung is an iShares Asset Allocation Strategist for BlackRock.

 

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 2015 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

Preferred stocks are not necessarily correlated with securities markets generally. Rising interest rates may cause the value of an investment in preferred stocks to decline significantly.

©2015 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.

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The Recent Success of Growth Stocks

Growth Value

There’s been a recent divergence in the US stock market. Growth stocks (which are faster-growing companies that tend to have high stock prices relative to the fundamentals of their businesses) have done better than value stocks (which are slower-growing companies that tend to have low stock prices relative to the fundamentals of their businesses) by a sizable amount.

While faster-growing companies certainly sound like they’d be good investments, over the long term it’s actually value stocks that have done better. Yet it’s not unusual for growth and value to have cycles where one substantially outperforms the other for a few years at a time. During the late 1990’s growth stocks surged ahead of value stocks, for example. For much of the 2000’s the opposite was true.

In recent years growth stocks and value stocks had moved almost in lockstep until late 2014, when growth began to outperform. The gap widened in the past few weeks when a number of prominent growth stocks, such as Alphabet (formerly known as Google) and Amazon, reported better than expected third-quarter earnings.

Based on the history of growth/value cycles, it’s very possible that this could be the start of a trend that lasts a few more years. But that doesn’t mean that abandoning value stocks and investing only in growth stocks is a good idea. When the growth/value cycle turns, it can turn extremely quickly. After their success in the late 1990’s, growth stocks came crashing down in the early 2000’s even as value stocks barely budged. After surging in the mid-2000’s, value stocks fell much faster than growth stocks during the financial crisis in 2008.

As is often the case with investing, diversification is probably a better strategy than either only growth or only value. There’s nothing wrong with investing more in growth stocks to try to benefit from periods when they do better, or investing more in value stocks to try to take advantage of their long-term outperformance. But history suggests that having only one or the other can leave your portfolio exposed to extended periods of pain.