The Lawrence Investment Group

March 23, 2015   One thing is certain: The FED will increase interest rates, sometime, by some                                                                       

                                     amount, or not  

We have spent the first three months of this year in extreme uncertainty.  In the first 14 trading days of March, we have experienced five days with greater than 100 point increases in the Dow and five days with 100 point decreases in the Dow.  Last week, the Fed removed the word “patience” from their outlook and told us in the subsequent news conference that they would remain patient.  It is no wonder that the markets are so volatile and in so much turmoil.  There seems be no way out; no path on which we can embark to continue to grow our retirement savings.  Or is the way out staring us in the face?

The reason we have so much volatility in this market is because trading today is dominated by short term traders and high frequency traders.  These traders, not investors, are constantly looking for that edge that will allow them to make a few cents on a very large volume of shares in a very short time.  They are watching the FED, and all the other headlines, and trying to find a trade that will beat everyone else in the market and provide a quick, large return.  Seemingly, retail investors like us do not stand a chance against them.  These traders are like racing from New York to California at 100 mph in a go cart.  Every bump in the road, every pebble, every sharp turn causes spine tingling gyrations that put them on the edge of control.  Meanwhile, long term investors, not traders, are like passengers flying from New York to California in a Boeing 787, enjoying a glass of wine while feeling nary a bump.  It is the latter investors that I am addressing today.

In this letter, I am returning to the issue that many of my readers are most concerned about:  investing for retirement.  Recall in my tutorial “Building and Preserving Wealth through Sound Investment 101”, which I have published several times, I broke down our investing strategies into three piles.  Pile one is for retirement savings, pile two is for wealth creation and pile three is for high risk investment that can win big or that we can afford to lose.  I am returning my focus to the pile one investors which is where most of you are.  The good news is that if you do a really good job of investing your pile one assets, the extra growth falls into pile two; and, you need only fine tune your strategy to move from retirement saving to growing wealth. 

The key to retirement investing is finding a spot on the risk/reward curve where you are comfortable and invest for the long term.  Do not fall prey to the temptation to make a quick buck in a volatile market.  You cannot beat the pros.  But, use the downturns to increase your ownership in quality investments and dollar cost average your holdings.  Let’s review the risk/reward charts that are key to this strategy.

From the Risk/Return Tradeoff chart, you recall the basic concept of this investment strategy.  Today, the lowest risk investment is money market funds in the lower left and corner of the chart.  They also have the lowest return of about 0.25% which is well below inflation and therefore would result in loss of purchasing power over time.  The upper right hand portion of this chart illustrates very high returns, but, of course, with very high risk, which means you may lose all or some of your investment.  It is clear that neither of these two points are suitable for our retirement investments.  The chart on the right takes this concept and overlays the type of investments we are most likely to make.  There are plenty of charts in the literature which include other investments such as gold coins, commodities, real-estate, oil and the like; but, I chose this one as it most reflects my reader base.  As you can see, the lowest in both risk and reward are the money market funds while the highest risk reward is sector funds.  Notice on this chart, the sweet spot seems to be domestic diversified stock funds.  That brings up the second most important fundamental in retirement investing:  diversification.  The key to success is to have a comfortable point of risk/reward with plenty of diversification to see you through years of investment in volatile markets.  I will come back to these curves.

So, a quick review of our retirement investing strategy gives three points of the Holy Grail:

1. Invest for the long term; time in the market is most important---timing the market is most dangerous.

2. Use the risk/reward curve to find your comfort point.  If your investments keep you awake at night, move down the risk curve.

3. Diversification is key.  You do not want all of your risks in one basket.

In the past month, two prominent investors have visited this topic and came up with the same conclusion.  The first was Jim Cramer who did an episode on retirement and retail investment.  His conclusion was that if you have the time and the knowledge to do the research and to watch the markets on an almost daily basis, you will do better by investing in quality, dividend paying stocks.  If you do not have the knowledge and time, you are best off in index mutual funds or ETFs.  Warren Buffet, in his recent annual letter to investors, stated that in his will he wants 90% of his investments to go into S&P index ETFs, preferably Vanguard.  He believes that will beat managed investments over the next decade. 

There are plenty of money management options out there with many different pricing schemes.  The hedge funds promise high returns but they charge on the 2 plus 20 plan.  That means they charge a fee of 2% of the money under management and 20% of all gains you make.  Traditional investment managers charge a fee based on the amount of money under management and usually average about 1% to 2.5%.  Many independent advisors may also get commissions on the funds they sell you; and, of course, annuities yield high commissions to the selling agent, often higher than several years of your returns.  All of these fees and commissions serve to reduce your returns as they subtract form your gains or losses.  That would be a good plan if the advisors actually earned you high returns; but, 86% of advisors did not beat the S&P 500 index in the past year and 89% have not beat it for the past three years.  Warren Buffet knows of what he speaks.

For years, I have been advocating the majority of your retirement investments should be in mutual funds and/or ETFs.  Save the individual stocks for your wealth creation.  As Warren and Jim suggested, an S&P 500 index fund is the best.  If we look at the right hand chart above, we see domestic diversified stock  funds in about the middle of the curve.  That is pretty close to what an S&P 500 index fund looks like.  I want a little more diversification; and, I want to fill out the blocks on the Morningstar Style Box to achieve that.  That means I want an international fund, a small cap fund, a REIT, and a blended fund as a starting point.  There are tons of ETFs out there and many of them are good.  But, as you move away from the S&P index funds to sector, or more unique subsets within sectors, in chasing yield, you are also increasing your risk.  Watch the curve and strike a comfortable balance between yield, risk and diversification.  And, referencing paragraph two above, I hope to find you cruising at 35,000 feet in a 787, well above the volatility and turmoil below that is tossing around the go cart riders.

Now, it is time to build a little wealth.  The downturn in the price of oil should have a major positive impact on consumer spending as the harsh winter finally comes to an end.  The decline in oil prices has given consumers a “tax cut” far beyond what our government could do.  With 70% of our economy based on consumer spending, I look forward to reasonable growth for the rest of the year.  I have reduced my oil holdings by about 10% but still think XOM, SLP, and COP are great stocks to hold.  Remember the refineries are doing just fine inputting low priced oil to make gas that is not under nearly as much price pressure as in the past.  I have also lightened up on CAT which still has some hope and IBM which needs a long time to heal.  With the advent of the strong dollar and high multiples, it is a little more difficult to pick stocks. But, there are still great opportunities out there.  Let me start with a couple I recommended in January of 2014, which I hope you got into.

DIS:  Disney is at an all-time high but is still a great investment after being up 46% since Jan 2014.  It is firing on all cylinders.  In movies, Frozen has grossed over $1.3B and merchandise has more than surpassed that.  There will be a Frozen Two.  Cinderella is now out and smashing records for young and old princess fans.  Still coming is yet another Star Wars sequel, which may well be the biggest retail hit this Christmas, pushing Frozen to the back shelf for a short time.  Theme parks are setting attendance records and a China park has just opened.  Low gas prices should ensure a robust summer season.  Disney cruise ships are constantly sold out and among the highest rated.  ESPN cannot fill the demand for sports enthusiasts.  ESPN commands a $6 a month charge per user to cable providers while the average channel gets 50 cents.  Buy now, maybe, but certainly on the dips.

BA:  Boeing remains a favorite even with a strong dollar.  Airlines are flush with cash as fares have remained high while fuel costs have fallen.  Boeing continues to increase production capacity and still their back log continues to grow.  Again, a high priced stock but one you should own.

AAPL:  I will let Jim Cramer address this one: “Do not trade Apple, own Apple!”

CMI:  Cummins is off of its 52 week peak, but still a good stock to hold.  They are a leader in the evolution of natural gas engines for truck and industrial use.

WFC:  Still my favorite financial stock and still paying 2.5% dividend.  As interest rates faintly do go up, the financials should fare well as they can actually make some money on the spread when making loans.  Accumulate and long term hold.

 I invite you to join me in building and preserving financial wealth to compliment “true” wealth:  faith, family and friends. 

Larry Hollatz, RFC®