Familiar Hard vs. Unfamiliar Hard

This weekend my wife ran the Run Rabbit Run 50 mile race in Steamboat Springs. It was her first race at such distance, and when she finished she said it was the hardest thing she’d ever done (“That was harder than childbirth” she said). I believed her. (For the record, my wife is an absolute rock star of whom I am insanely proud. Just in case there was any doubt).

This morning I went for a fairly typical mountain bike ride at the local hill, some version of which I’ve probably done 100 times.  Today’s ride included a climb up the service road, a 1+ mile climb that averages about 11%, and exceeds 15% for a few stretches. For those of you who don’t spend your free time calculating grades, that falls in the category of “awfully steep, but not impossibly steep” on a mountain bike.

Strava tells me that I have ridden the full stretch of the fire road 58 times in the last few years. Climbing the fire road is not easy. I’ve never ridden it and thought “well, that was no effort at all.” It is hard. But it is a familiar hard, and once again a bike ride has me thinking about investing.

My wife’s race this weekend was both hard AND unfamiliar. She’d never run 50 miles before. She had an idea of what it would be, how her body would respond, what she might eat, how she might feel, how much she might suffer. But she didn’t really know it until Saturday afternoon when she ran across the finish. For me, climbing the fire road is a hard thing that is familiar. I know what to expect. I know it’s steep right near the bottom and again by the tree and leg-screamingly steep into the last switchback. I know I may suffer, but I know for how long and to what extent. I know where the end is, where the grade levels off and my heart rate can return to some reasonable pace.

Investing is hard. For most of us, it can be a familiar hard, but we always have unfamiliar hards. The first time in your adult life the market drops over 25%, it’s an unfamiliar hard. The first time it drops 25% when you have real money in the markets, when the dollar value of the fall is a significant portion (or multiple) of your annual budget, that’s an unfamiliar hard.

For most people, the worst unfamiliar hard is the first bear market of your retirement. I’m always telling newly retired clients this – the first bear market is awful. You will want to panic. You don’t know what it is like yet to be retired, to have no more income, to be living off of this bucket of money, and then see it drop by A FIFTH OR MORE. Booms, 4-5 years of living expenses disappear in what feels like an instant. I can tell you all of this in advance, remind you that we’ve done the planning, the stress testing, the scenario modeling, and the portfolio survives all of this.  But that’s a bit like telling someone that childbirth is hard or an ultra endurance race is hard. Nice to have explained to you, but some knowledge is only truly acquired first hand.

The trick is to remember that unfamiliar hards become familiar hards. By the time of your third bear market in retirement, you’ll get it. Yes, it’s scary. Yes, it’s discouraging to see portfolio values fall. But you know how this ends. My wife’s second 50 miler will be hard, but it will be a familiar hard. She’ll know what the dark places feel like, how they come and go. The dark places will still come, but there will be a comfort in the familiarity that makes them a bit more tolerable.

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Shame, Status and the American Dream

Something has been rolling around in my head for a while, and it’s about our house, our lifestyle and our appearance among peers.

Our home is unimpressive. I love it, don’t get me wrong. We are very, very comfortable. It is way more than enough space for our family of 4. Right now we’re even doing a full remodel of the basement. But I know that compared to many of my peers, our house isn’t the massive, brick laden, towering McMansion that says “we’ve arrived.” We bought our home days before I quit my last job and launched this firm. We paid $265,000 and financed almost all of it as I was hoarding cash for us to live on since we had zero income.

I’ve had one client visit our home after our youngest daughter was born and I remember distinctly a feeling of anxiety that our modest home wouldn’t measure up to expectations. What I felt bordered on shame. Would people think I was “successful” if they saw our home? Does it present a picture of someone who is responsible, intelligent and capable? Does it represent someone who should be entrusted with managing client assets that now exceed $150M?

I’ve come to terms with it, but these ideas still creep into my head. I like that we live well within our means. It brings me immeasurable happiness, quite frankly. But there is a lingering social pressure. A fear of a stigma that occasionally whispers from some deep recess in my mind. In general I’m not a person who is given to care much what other people think about me. (Seriously, ask my wife about this one). But even with that as a core position, I feel some unspoken social pressure to consider a “nicer” house. A newer house. A bigger house. Vaulted ceilings, big bathrooms, big closets, all of the accouterments that prove that I’ve made it.

If I can feel these pressures, I imagine they could be stronger for many others. A house is a man’s castle, after all. A giant, expensive, cumbersome representation of your value to society. What would you think if your successful doctor or lawyer or local business owner lived in an average middle class house? Is s/he in financial trouble? Recently bankrupted? Paying off bad debts? How many Americans would think “Wow, good for them. They have figured out what makes them happy and are spending/saving money in that way.”  Can’t say I think it would be many.

There’s more to this story, like my super-reliable-but-recently-hail-damaged 14 year old Subaru that you can have from my cold, dead hands. And the bike on top of it that’s probably worth more than the car. We love our home, and our lifestyle. We do things, and spend money on things, that make us happy. I try hard to be intentional about that, and we’re doing okay there. Maybe, just maybe, the bigger-shinier-stainlessier (that’s right) pursuit of the American Dream isn’t the key to happiness for everyone. At least, not for us.


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2Q 2017 Market Overview

Market Overview

It has been another solid, steady quarter in the markets since the end of March. US stocks both large and small posted strong positive gains of 3.09% and 2.46% respectively.  Tech continued to dominate with the Nasdaq posting gains of 3.87% over the last 3 months.

Broad bond benchmarks were also again positive recently with the Barclays’ Aggregate Bond up 1.45% for the quarter but off slightly -0.31% for the last twelve months ending 6/30/17. Municipal bonds (via the Barclay’s Municipal Index) also gained 1.96% for the quarter. Longer term bonds with more interest rate exposure performed best as long-term rates declined and the yield curve flattened.

International stocks had a great quarter, with developed economies (MSCI EAFE) gaining 6.36% over the quarter and 22.20% over the last twelve months ending 6/30/17. Emerging markets were also positive for the quarter, up 4.34%.

2Q 2017 Markets

Economic Update

US economic trends remain relatively unchanged over the last quarter. Unemployment is low and job gains have moderated. The Bureau of Labor Statistics reported that in May the domestic economy added 138,000 jobs, dropping the unemployment rate modestly to 4.3%, the lowest level since 2001. Over twelve months ending in May, 2.23 million jobs were added, a solid if not exciting figure.

Aided by low mortgage rates and a healthy economy, mortgage delinquency rates continue to fall. Although still higher than pre-2007 levels, we are slowly approaching historical averages.

Delinquency Rate

National home prices continue to move upwards. The S&P Case/Shiller National Home Price Index gained 5.5% year over year through April 2017. Current national average values are now above the 2007 peak.

Case Shiller National

In June the Federal Reserve Open Market Committee (FOMC) voted to increase the target Federal Funds rate 0.25% to 1.00-1.25%. While inflation concerns remain subdued, the FOMC saw reason enough to continue to increase rates in strengthening household spending and continued improvement in labor market conditions.

Inflation remains very low, with the seasonally adjusted Consumer Price Index coming in a just 1.87% year over year change in May, below the Fed’s 2% target for inflation.


In line with the FOMC’s reasoning to raise rates, average hourly earnings of non-supervisory employees was modestly above inflation and the Fed’s 2% inflation target, with year-over-year increase through May of 2.42%. The Kansas City Fed’s Labor Market Conditions Index (LMCI) has shown a gradual increase in labor market conditions over the past several years, with a modestly positive position currently. The LMCI is an aggregation of data points on unemployment, wage, job quits, long-term unemployment, initial claims, labor force participation and several other inputs. It is a tool used to guide the Fed’s policy making.


Even with the FOMC raising short-term rates, long-term rates have not responded in kind. 30-year mortgage rates have been on the decline again, down to a national average of 3.90% through the third week of June 2017.

30 Yr

One worthwhile note on inflation: it’s low. And that is important when we are considering financial asset returns. We can bemoan l0w interest rates on savings accounts and from bond yields, but we have to remember to adjust these figures for inflation. Sure, banks paid 18% in the 80’s but inflation was extremely high as well. In fact, the period of high real interest rates from 1980 – 2000 looks as though it may be more of an outlier than lower real rates today. 2-3% real rates were the norm before inflation and rates took off around 1980.

Real 10 Year

More on this topic in a long-term context from the New York Times’ Neil Irwin a few years ago:

Very low rates have often persisted for decades upon decades, pretty much whenever inflation is quiescent, as it is now. The interest rate on a 10-year Treasury note was below 4 percent every year from 1876 to 1919, then again from 1924 to 1958. The record is even clearer in Britain, where long-term rates were under 4 percent for nearly a century straight, from 1820 until the onset of World War I.

Our perspective is distorted by anchoring, and for many investors late in their careers, the exceptionally high rates of the 1980’s coincided with early working formative years. A longer view of history makes the current environment less extreme.

Tax and Legislative Updates

Legislative priorities in Washing D.C. have shifted from the beginning of this year from health care, to tax reform, to infrastructure and now at the end of June 2017 we are back to health care reform. The Republican party controls the House, Senate and White House, and have been outspoken in their desire to replace the Affordable Care Act with their own legislation.

As of this writing, the House of Representatives has passed its version of a bill, known as the American Health Care Act (AHCA). The House version of the bill would end individual coverage mandates, employer mandates, income-based premium subsidies and the 3.8% tax on net investment income, the 0.9% additional tax for high income earners and medical device taxes. The House bill also increases the annual allowable HSA contribution limits, increases the allowable difference between premiums paid by younger vs. older consumers and brings back lifetime benefit limit caps.

Right now the Senate version is similar, as far as we know. A vote originally scheduled for Thursday June 29th was delayed so that the Senate bill could be revised after several Republican Senators voiced opposition. It is, right now, too early to say what final legislation could look like, even if the Senate version can garner the 50 votes (assuming a Vice-Presidential tiebreak) to pass a reconciled bill.

The most likely outcomes of a passed bill affecting financial planning decisions of my readers include:

  • Eliminating the taxes introduced by the ACA, including the 3.8% investment income surtax;
  • Revocation of individual and employer mandates (with incentives for coverage in some penalty form);
  • Some change to HSA contribution rules, with likely higher limits;
  • A larger gap between premiums paid by younger vs. older consumers, where older consumer would expect private-market premiums to increase;
  • Changes to treatment and coverage of pre-existing conditions and lifetime limits.

Right now this remains speculation, as a vote will not occur until after the July 4th recess, and then we do not know what specifics the bill will contain, what could pass, and what could be reconciled with the House bill. For now, we have to take a wait-and-see approach, but it is possible that material tax planning opportunities may arise before year-end 2017, and that individuals purchasing private market insurance will have new rules to navigate when making selections.


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The IPO 10-Bagger Chase

It’s been 20 years since Amazon went public at $18 per share in 1997. The web today is littered with stories about how a small investment at the IPO would have turned us all into millionaires. These stories play on our most basic desires as investors: to have the once-in-a-lifetime shot at getting filthy, stinking rich without effort. “If only!” we cry out. If only we’d gotten in on Amazon or Microsoft or Apple at the right time. If only we’d stuck it out through the insane drawdowns these stocks went through. We’d be rich!

What’s missing from these get-rich-on-IPOs stories is all of the ones that don’t make you rich. Of course, Amazon wasn’t the only company to go public in 1997. Here’s a few that I found via a quick web search.

Metromedia Fiber Network. Backed by billionaire John Kludge, MFN had its sights set on bringing high speed internet to most major urban areas in the country. The company had less than $3 million in revenue in 1997 but high hopes. By 1999 the stock had risen to $42 per share, after splitting THREE TIMES in 1998 and 1999.

Metromedia filed for bankruptcy in 2002.

JD Edwards, a packaged software company, filed a $300M+ IPO in 1997. JDE was one of the first companies to develop a strong Enterprise Resource Planning program that was quickly adopted. The stock priced at $23 per share on 9/24/97. In 2003, after the tech bubble burst, competitor Peoplesoft bought out JD Edwards at $19 per share, at the time nearly a 20% premium over where the stock traded. Not exactly a home run.

On November 4th, 1997, AMF Bowling priced its IPO at $19.50, making it a $263M offering. AMF was the source and target of constant buyouts, sales, restructurings and conglomerates. By 2000 this company that was valued over $1B at the time of its IPO was delisted from the NYSE and moved to OTC trading as the stock fell to $1.

In 2001 AMF Bowling, sitting on over $1.3B in debt, filed for bankruptcy.

Here’s the thing: capitalism is hard. Business is competitive. Growing a large, scaled, public business is risky. Buying stocks in a single company is risky. Sure, if you throw some money at an IPO (and you can ride it through several near-failures), there’s a chance it will end up as the next Amazon. There’s an even better chance it will fail, end up in bankruptcy or be saved at the brink after huge losses by a bigger rival picking up scraps. Do yourself a favor: let go of the notion that you’re going to find the next Amazon. It is not doing you any good to read these stories. Quit it, and get back to the real work of building your financial future.



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Feature in Financial Advisor Magazine

I was pleasantly surprised to learn that I was nominated for Financial Advisor magazine’s “10 Young Advisors to Watch” piece in the May issue. I’m not sure I’m all that exciting to watch, but you can find the piece here:

Young Advisors To Watch


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This is the easy part

These are our girls, 6 and just-a-few-weeks-shy-of-4.

20170310_165923 20170415_102435 20170310_163751

Yes, they are unspeakably adorable. I know.

It struck me this weekend that, all things considered, this is the easy part. To date we’ve had no broken bones. No broken hearts. No Ds and Fs on report cards. No friendships ended in a fiery blaze. No fighting over boys or clothes or jewelry. No cars backed into garage doors. Sure, we have daily temper tantrums and tears and complaints about dinner and incessant bedtime struggles. But in the grand scheme of things, this has to be the easy part. We get to camp and go for bike rides and fly kites and tell stories and read books. They WANT to spend time together and do fun stuff with mom and dad. They love Sunday morning bagels and chasing lizards in the desert. And, we’re past diapers and naps and all of the exhausting parts of babyhood. We’re in a nice spot.

I can’t remember the last time I had a conversation with a client concerned about recent portfolio performance. And for good reason – this is the easy part. Diversified portfolios of all stripes are having a nice stretch. Whether you’re 35 and super aggressive or 60 and dialing things back, it’s hard not to be happy, or at least satisfied, right now.

Year to date nearly every major asset class is up; some equity classes are up double figures. Most are building on top of a really wonderful 2016 return. Here’s a quick rundown:

Index YTD Return 2016 Return
S&P 500 7.16% 11.96%
Russell 2000 3.59% 21.31%
MSCI EAFE 9.97% 1.00%
MSCI Emerging Markets 13.42% 11.60%
Morningstar US Real Estate 2.52% 8.02%

And bonds are still holding their own. The Great Big Scary Bond Bear Market™ we’ve been expecting since 2008 is apparently still hiding out somewhere, as the Barclay’s Aggregate Bond benchmark is up 1.59% year to date and gained 2.65% in 2016.

To be sure, we’ve had some frights along the way. Brexit and a unexpected US election outcome last year weren’t the “certainty” the market allegedly loves. But I feel pretty confident saying it’s been easy going. So what do we do with this information?

  1. Acknowledge it. Practice some mindfulness about your portfolio. Just reflect on the general lack of anxiety you’ve felt about your investments over the last 18 months or so.  It’s been nice, no?
  2. Despite headlines and your memory, this is what the market does over time. It goes up more than it goes down. Perhaps we’ve had less volatility along the way in the last year or so, but most years end green, not red. So while we won’t expect things to always be so rosy, this isn’t an abnormality.
  3. Prepare yourself for when these occasional market tantrums and teary eyes turn into door-slamming, hate-proclaiming, top-of-your-lungs screaming real life bear markets. They’ll be here, and you’ll wonder what happened. There’s no avoiding those phases, and the more you recognize that and plan for it now, the less hair-tearing you’ll put yourself through.

Successful long-run investing is a mental game more than anything else. While you need a sensible portfolio, most of your success is going to come down to your ability to get perspective on the current moment in market history, good or bad, and have a plan for wherever you find yourself.

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Bason Asset Management is Moving!

I’m happy to announce that the office is making a short move to a new office space in Lakewood, just a few miles from the old office. I hope that clients will find that the new office is more accessible and a much more comfortable meeting space.  The new office is located in the Belmar shopping area on the southeast corner of Wadsworth Blvd. and Alameda Ave.

Bason Asset Management
355 S. Teller St.
Suite 200
Lakewood, CO 80226

There is free parking behind the building and paid on-street parking out front. The easiest access is to enter Belmar on Teller St. from Alameda and make your first right (West) into the parking area.   The main entrance to the building is on the West side of S. Teller Street in between Sur La Table and U.S. Bank, then take the elevator to the 2nd floor. A map below shows the parking lot and main entrance.


Of course if you need coffee, breakfast or lunch before or after a meeting, plentiful options abound in Belmar! I hope you’ll enjoy the new space.

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1Q 2017 Market Overview

Market Overview

The rally that began shortly after last November’s election continued early this year, with US large cap stocks yet again posting a very strong quarter, up over 6%.  International stocks fared even better, including Emerging Market stocks really turning a corner after years of significantly underperforming the S&P 500;  up 11.14% for the quarter. Emerging Market currencies have gained on the US Dollar year to date, further boosting returns for US investors in emerging markets. Bond returns were flat, despite continuous fears of rising rates, as the 10-year Treasury has remained largely unchanged. My takeaway remains the same: there’s no predicting what comes next. Markets and asset classes turn on a whim and we won’t ever accurately predict when and to what degree. We’ll have gains when the markets offer them and rebalance into underperforming asset classes as dictated by our investment policy statements. All else is madness!


Economic Update

What’s new in the economy? Not a whole lot. Fourth quarter Gross Domestic Product was revised slightly higher in March to 2.1%, down from the 3.5% year-over-year change in the third quarter. The fourth quarter brought full year economic growth up to just 1.6%, a lackluster result and the worst year since 2011. Growth in real personal spending remains positive, although slightly down from its recent peak rate.

Real PCE

The pace of borrowing from households has simply not come close to resuming its previous growth rate. For nearly two decades before the recession, liabilities grew at 5-10% per year steadily. Even now, 9 years out from the recession, we’re now only just above 2.5% annual growth in debt.

Debt Levels Growth

As we could expect in the latter half of an economic cycle, wage growth has been slowly ticking up over the past few years, putting the average worker on better financial footing.


This coincides with steadily falling initial jobless claims as the labor market is as robust as it has been in years, and well-below pre-recession levels.

Weekly Claims

The personal savings rate in the United States has remained steady and reasonably healthy.

fredgraph (3)

As mentioned above, the US Dollar has slowed its long term trend, peaking in late 2016. While we cannot know what happens next, what we’ve seen year to date is that this relative weakening in the Dollar relative to other currencies has been a boost to international investments for US investors.


Tax and Legislative Updates

Despite Republican majorities in both congressional houses and a sitting Republican president, we’ve seen little legislative impact to date. Republican plans to replace the Affordable Care Act (aka Obamacare) fell flat as house speaker Paul Ryan pulled the bill (the American Health Care Act) shortly before a scheduled vote after it became apparent the bill lacked support to get out of the House. According to Speaker Ryan as of late March, repealing the ACA will not continue to be a near-term legislative priority.

While it seems likely that tax reform would be the next priority, it is unclear how much consensus currently exists among various arms of the Republican party to get significant legislation passed. Because of the slim 51 vote majority in the Senate, a full bill requiring 60 votes is unlikely, and the more limited reconciliation process is probably the only way to get a legislative change passed in this environment.

President Trump also released his proposed budget in March. As expected, the proposal included large cuts to nearly all non-military discretionary programs alongside a $50 Billion increase in defense spending. Left out of the budget were President Trump’s announced plans for a $1 Trillion infrastructure spending program, details of which are allegedly forthcoming later this year.

It’s important to remember that a sitting president’s proposed budget is just that – a proposal. It is an advisory document at most. Ultimately Congress must define and pass a federal budget (or, as has been the case recently, operate under a continuing resolution without an officially passed new comprehensive federal budget).

If we’ve learned anything over the past 8 years, it is that it is really, really hard to get things done in Washington. Even with single party control over the White House, House and Senate, coming to consensus on spending, legislative and tax priorities may be harder than it once appeared. We may see tax reform this year or next, but trying to plan around such speculation is risky business. We can debate whether this fact is a feature or a bug, but for planning purposes, it is often best to assume the status quo.


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Tax Loss Harvesting: Enough is Enough

I recently had a conversation about the benefits of tax-loss harvesting, specifically about the benefits offered by several leading robo-advisors who perform “daily” tax loss harvesting, and if “traditional” human financial advisors are losing their edge in this space. Tax loss harvesting (TLH) and specifically aggressive TLH, is one of the primary selling points of robo-advisors.

Most of the robo-advisors claim that their aggressive TLH strategy will add nearly 1% per year (right now on Wealthfront’s website they are claiming a whopping 1.55% per year!) in additional risk-free return. I’m not going to take too much time taking apart their assumptions, but needless to say you need to be fairly creative with the math to get to that high of a number. And of course, tax loss harvesting isn’t perfect or free; there are costs and risks involved.

What costs and risks? Well here is just part of Wealthfront’s disclosure about their tax loss harvesting process.

Wealthfront’s investment strategies, including portfolio rebalancing and tax loss harvesting, can lead to high levels of trading. High levels of trading could result in (a) bid-ask spread expense; (b) trade executions that may occur at prices beyond the bid ask spread (if quantity demanded exceeds quantity available at the bid or ask); (c) trading that may adversely move prices, such that subsequent transactions occur at worse prices; (d) trading that may disqualify some dividends from qualified dividend treatment; (e) unfulfilled orders or portfolio drift, in the event that markets are disorderly or trading halts altogether; and (f) unforeseen trading errors.

Most major robos are quick to admit that:

1) One of the primary benefits, the ordinary income offset, is capped at $3,000 per year and

2) You would have to have annual realized short-term capital gains every year in the amount of the loss harvested to “maximize” the benefits of TLH.  So, basically no one. I have never had a client who has regularly generated a large amount of short-term capital gains. We’re long-term investors, why would we have so many short-term capital gains?

One thing missing from much of the discussion around TLH from the robo advisors is that over time, you run out of opportunities to take tax losses. Unless you are aggressively and substantially saving huge dollar amounts into an after-tax account each year, benefits as a percentage of your overall after-tax account are going to decline for a very simple reason: markets go up over time. You can take losses and reset your cost basis lower and lower, but eventually, markets go up. Eventually, your basis will be equal to the lowest point in the markets over a several-year period. You only have to look at a portfolio that has been invested for 10 years to see this: there aren’t going to be losses to harvest. So the idea that you will, forever, get a 1% or higher benefit from tax-loss harvesting is a misstatement at best.

My question ultimately is this: How much is enough? Do you need to be constantly turning over your portfolio to try to wring out every $15 tax loss from every position you own, and in the process generate a 40 page 1099 each spring? Or is there a “good enough” level of tax loss harvesting for most investors?

Out of curiosity I pulled some figures from actual clients over the past few years to see what kind of losses we had harvested in a large, very broadly diversified taxable portfolio. To give you an idea of where these opportunities were, let’s look at annual returns for some popular asset classes (note that these are not representative of actual client portfolios).

Fund 2013 2014 2015 2016
SPY 32.31% 13.46% 1.25% 12.00%
VB 37.70% 7.63% -3.76% 18.44%
VXUS 14.61% -4.74% -4.19% 4.81%
VWO -4.92% -0.07% -15.81% 12.21%
VNQ 2.31% 30.36% 2.42% 8.60%
VWIUX -1.48% 7.33% 2.94% 0.19%

You can see there were some funds with annual losses, and this doesn’t even take into account intra-year declines, which by default are nearly always worse than an annual return. If you owned international stocks or small caps or bonds, you probably had some chance to take losses in the last several years. That’s all I’m driving at.

Okay, time for some math. I pulled a handful of client account that had been around for at least a few years and looked at what amount of losses were harvested. For the random accounts sampled, in 2015 I harvested between 2% and 4% of the account value, and in 2016 between 1.5% and 4%. The variance depended primarily on asset allocation and inception dates. So in each of 2015 and 2016 you could estimate that we were taking around 3% of account value in harvested losses ($3,000 on every $100,000 in the portfolio). If you want to use some of the ridiculous math supported by certain robo advisors, you can get pretty close to that translating to 1.5% in tax alpha. But I think that’s absurd.

What you really get is a $3,000 current year ordinary income tax deduction, which is valuable. Yay! And then you get to bank any losses over and above that amount to offset future gains. Gains that you might take from rebalancing or from freeing up cash in a portfolio for retirement expenses. Again, this is a very good thing. You’re creating tax deferral in a taxable environment. Big win. But we arrived at these figures without constant daily trading of ETFs to pick up $10-$15 losses, risking bid/ask spreads, portfolio drift, trade execution risks and paying brokerage commissions. These figures were the result of reasonable, intra-year harvesting of substantive losses. No 40 page 1099-Bs required. Tax loss harvesting is great, but the presumed benefits of aggressive daily loss harvesting over a more “traditional” strategy are likely highly overstated.

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Knowing the count

I just finished Ed Thorp’s new autobiography A Man for All Markets and I really enjoyed it. Thorp is, among other things, the man who wrote Beat the Dealer in 1962, the first truly mathematical approach to beating blackjack. He was first to calculate that while betting strategy was important, it had to go along with the cards as they were dealt. It mattered what cards had been dealt, and what was left in the deck. Thorp’s research proved that the more 10s, face cards and Aces that were left, the better the player’s odds became over the dealer, moving from a basic house advantage to, at times, a significant player advantage. Thus card counting was born, a system of tracking which high cards (lowers the count) and low cards (raises the count) have been dealt. Beat the Dealer changed America’s fascination with gambling, created leagues of professional blackjack players and inspired stories like Bringing Down the House, the book that later became the movie 21 with Kevin Spacey.

As a guy who likes math and card games, I loved the first half of A Man for All Markets. Thorp opines on risk, betting and tradeoffs and eventually made his professional career in running a hedge fund trading strategy after he discovered how wildly mispriced the options market was before the advent of the Black/Scholes option pricing model (which Thorp himself essentially discovered a few years before the Nobel prize winners).

While there are parallels between betting at the tables and the investment markets, most people’s experience won’t be Thorp’s. For one, the low hanging fruit in options pricing that Thorp uncovered is now nowhere to be found.

But more importantly, making long-term investments isn’t playing Blackjack. At the table, several things need to happen to make counting cards work for the player. First, like any system built on probability, you need to play over and over and over again to effectively build a large enough sample set and eliminate noise. That means having a fairly large bankroll and lots and lots of patience. Even when the odds are well in your favor, you’re going to lose many bets. Thorp parlayed this into the hedge fund business because he could identify his opportunities (there were many!) and make multiple bets on multiple positions over and over and over again each day. Some went against him, but enough went for him.

For most investors, we only really get a few chances. A long-term stock investor in the prime of his/her earning and savings years will probably see 3-4 major market cycles for the rest of their investment lives. Not exactly a huge sample set for making probabilistic bets.

Counting cards in Blackjack works so well because it is a known, closed system. You know how many decks are in the shoe. You know how many of each card is in each deck. You know when the dealer re-shuffles the decks. You know the odds on each hand based on the dealer’s Up card. You can even sit with a cheat sheet that tells you how to act based on cards on the table!

Markets aren’t anything like this. There’s no closed system. You don’t know how many decks are in play, or if the dealer might add a few more without your knowledge. You could be “up big in the count” (let’s say that’s really cheap stocks by P/E or something similar) and the dealer could keep drawing 2s and 3s because his deck is essentially limitless. Remember, markets can remain irrational longer than you can remain solvent. You can go from stocks being worth 15x earnings to 10x to 7x to 5x. There aren’t any rules about how markets work. It’s not a card game.

Once more, think about how often “the count” is big enough to bet big. It’s less often than you think. At the table, you could reasonably expect the count to get above +5 or +10 on a somewhat regular basis depending on how many decks are being dealt. So your opportunities to increase your bet size come across pretty regularly. But big delicious fat pitches in the markets, if we’re talking about massively undervalued or overvalued stocks, aren’t so readily apparent. Most of the time we’re middling in the parallel of -3 to +3. Nothing too exciting to make a big bet on.

My advice is: don’t get overconfident about your ability to beat the dealer. Investment markets aren’t a closed, rule-based system. They are complex, messy organisms driven by the whims of humans.

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A most unusually average year

By now 2016 is far off in the mirror and everyone is focused on more current events, but I want to take us back a few weeks to reflect on the year that was, at least as it pertains to portfolio performance.

First, US stocks, measured by the S&P 500, finished the year up 11.96%, a wonderfully solid year. Long term average compounded returns for US stocks are in the 9-10% range (depending on how you’re counting), so this ended up being an average, slightly better than average year. Thanks to data from Aswath Damodaran at NYU, we know that the arithmetic average from 1928 is 11.42%, and the geometric average is 9.52%. So we’re right in the mix at just under 12%.  And while that’s roughly average, average isn’t all that normal.

This chart shows how common each range of annual returns has been over the last 89 years, with intervals of 5%.

SPY Histogram

So you can see that we do get annual returns of 10-15%, but it happens about 12% of the time. We’re practically just as likely to get returns of 0-5% and returns of 25-30%, and nearly as likely to get returns of -10 to -15%!

What’s more, many diversified investors found that in 2016, their balanced portfolio landed quite close to what they might like to see for long-term results. An overly simplified portfolio of 60% MSCI All-World Ex-US and 40% Barclay’s aggregate bond returned 5.92% in 2016. For balanced investors looking for a 6-7% return, that ain’t bad!  Of course, individual portfolios won’t look just like this, and varying allocations to real estate, small caps, emerging markets and changes in bond portfolio duration will affect returns somewhat.

The best thing about 2016 for diversified investors is that returns didn’t all come from the same place. We saw significant divergence among market, asset class and sector performance. Sure, US large cap stocks were up a nice middle-of-the-road number, but small caps (Russell 2000) were up over 21%, while developed foreign stocks (MSCI EAFE) were essentially flat at 1.5%, and bond returns were all over the map depending on credit quality and duration. Broadly allocated investors should rejoice, as this means that the broad idea of diversification is working. Some things (US small value, anyone?) we loved, others (Europe?!) we hated. Huzzah!

The other apparent risk from a year like 2016 for investors is complacency. I’ll admit, I heard very, very few calls after year-end reports went out. Nobody is complaining. “Finally, it’s working like it is supposed to!”  But I gotta tell you – yes, 2016 is how it is supposed to work. But so was 2014, when diversified investors were disappointed at best. Or 2015 when anything outside of US stocks wiped out what meager gains were to be had. This is how it always works – returns are lumpy, not smooth. We don’t get to choose when they come, how they come, whether we’re excited first and disappointed later or vice versa. Being a long term investor means passing up convenient, predictable, steady returns. Lackluster markets can and will stick around longer than you’d like. So while we get to be thankful for a year like 2016, we don’t have the luxury of assuming we’ll see anything like that on a regular basis.

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Remaking Retirement Savings in America

I think a lot about retirement savings. I do retirement planning for individuals, I manage individual and family retirement portfolios, I recommend and manage retirement accounts for small businesses. I help individuals work with their CPAs and TPAs to determine the right retirement plan for them. I deal with salaried employees and independent contractors. Small business owners and 401(k) plan participants. Private sector and public sector employees. The consensus among all of these individuals and groups is that retirement savings in America is a mess. A total mess.

If you’re a business owner, you have an absurd amount of decisions to make about retirement plans. Should I offer a plan? Who does it cover? Should I do a SEP, SIMPLE, or 401(k)? Should it have a Roth provision? Should it have a loan provision? What formula for profit-sharing calculations should I use? What formula for matching contributions should I use? How does the match affect my ability to contribute as the owner? Do I have to make contributions every year? What is all of this going to cost me? What is my liability with each plan type and subsequent decision? How does having a retirement plan incentivize me to hire full time vs. part-time staff? Am I responsible for helping staff make investment decisions? To what extent?

Not only that, but we have different plans for private vs. public sector employees. Different plans for sole proprietors/independent contractors, small businesses and large businesses. Public sector employees often have to choose between 403(b), 457 and possibly 401(k) plans, and then choose different investment platforms within those plans! Plan participants in all markets have to figure out how to enroll, what to defer, Roth vs. pre-tax, and how to invest. Then they get a new job and leave a trail of legacy 401(k) accounts everywhere they go. Or worse, they have to figure out how to get that money out, how to get it into a new plan or an IRA and do so according to the rules so they don’t get hit with taxes and penalties.

This is stupid, people. It’s stupid. So here is my grand, sweeping, start-all-over-again plan for retirement savings plans. You ready?

Sever the link between employment and retirement savings. No more company retirement defined contribution plans. As of 1/1/2018, every SEP, SIMPLE, 401(k), solo 401(k), 403(b), 457, etc.  gets converted to the new American Retirement Plan (ARP). By default, every dollar in a workplace plan will get rolled into the Thrift Savings Plan into a target date fund according to the owner’s date of birth. The average expense ratio in the TSP for 2015 was 0.029%. Less than 3 basis points. Cheaper than Vanguard. Starting in 2018, there are no more workplace plans. If you do not want to invest in the TSP, you can open an ARP at every major brokerage in the country.

Your employer is only required to set up payroll deposits into the Thrift Savings Plan. If you want to make regular contributions to your brokerage ARP, it’s on you. The tax treatment is identical. You can make Traditional (pre-tax) or Roth (after-tax contributions). The current Defined Contribution dollar limit for annual contributions is $54,000, so that’s the new limit. There is no limit on what percentage of salary you can contribute. If you want to save half of your taxable income into the ARP, go for it. A self-employed person can currently contribute $54,000 to a SEP or solo 401(k), so we’re going to make that the limit for everyone.

Every small business, large business, school, hospital and municipality in the country is immediately relieved of the administrative headache of offering a retirement plan. No more fiduciary responsibility for the dentist, baker, mechanic and restaurateur who want/need to offer employees a 401(k) plan. Every person in the country who receives a W-2 is automatically enrolled in the ARP at the Thrift Savings Plan the day they get their first paycheck, starting with a 3% deferral and an automatic annual escalation, eventually to 10%. Everyone can opt out of this or increase the deferral rate, but auto enrollment is the default setting.

Now, if this ever happened, I would lose business. I manage several small business 401(k) plans that would be eliminated by this plan. Lots of Third-Party Administrators would suddenly go out of business. Tax planning with your CPA would be simplified. People who benefit from information asymmetry in an absurdly complex system, including myself, including people who sell insanely expensive annuity platforms to school districts, would lose their advantage. Small business owners and school superintendents and self employed individuals could go focus on their work instead of the tax code. What a world!

The odds of this ever happening are rapidly approaching zero. But a man can dream, right?

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