Financial Architects

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Who Knows?

I wrote the following to our clients the morning after the election, but thought it was worth sharing more broadly here:

All,

Last night and this morning as I watched and thought about the election results, I was reminded of a Chinese parable from the second century BCE.

Here is the translation of the fable from wiktionary:

It can be difficult to foresee the twists and turns which compel misfortune to beget fortune, and vice versa.

There once was a (father), skilled in divination, who lived close to the frontier (with his son). One of his horses accidentally strayed into the lands of the Xiongnu, so everyone consoled him.

(But) the father said, “Why should I hastily (conclude) that this is not fortunate?”

After several months, the horse came back from the land of the Xiongnu, accompanied by another fine horse, so everyone congratulated him.

(But) the father said, “Why should I hastily (conclude) that this can not be unfortunate?”

His family had a wealth of fine horses, and his son loved riding them. One day (the son) fell off the horse, and broke his leg, so everyone consoled (the father).

(But) the father said, “Why should I hastily (conclude) that this is not fortunate?”

One year later, the Xiongnu invaded the frontier, and all able-bodied men took up arms and went to war. Of the men from the frontier (who volunteered), nine out of ten men perished (from the fighting). It was only because of (the son’s) broken leg, that the father and son were spared (this tragedy).

Therefore, misfortune begets fortune, and fortune begets misfortune. This goes on without end, and its depths can not be measured.

Some of you are undoubtedly pleased with the election results (you believe it is fortunate), others despairing (you believe it is unfortunate), but either way I think the fable is apt. We simply don’t know yet if, in the long run, the outcome was good or bad.

Subsequently, the market seems pleased with the election results. Tax cuts (or simply extensions of previous cuts) and deregulation are expected and would be good (in my opinion). The deficit/debt, as well as the funding of Social Security and Medicare, will be an issue at some point but politicians (on both sides) are happy to let it be someone else’s (larger) problem later. The primary (economic) danger in the short run is probably restrictions on the free flow of goods (tariffs) and people (immigration) – if taken too far.

It has been particularly hard lately to infer policies from what politicians say. They (again, on both sides) seem to just say anything to get elected even if they have no intention of following through (or, less charitably, are simply lying). Thus, we don’t know exactly what is in store for the country. For example, I expect the promises of no taxes on tips, overtime, Social Security, etc. to be very quickly memory-holed. Despite this, I am not particularly concerned (I’m always a little concerned!) at the moment and all of our client’s portfolios are very well diversified.

If you have any specific questions (or simply need to talk), of course, we’re happy to answer them (or listen).

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Efficient Markets

As wealth managers, we are frequently asked some variation of the question “So, what do you think the market is going to do?” or “What do you think of XYZ stock?” Those are difficult questions to answer, and this month’s post is an attempt to explain our perspective.

The reason that those questions are problematic is because no one knows. Certainly there is no shortage of prognosticators who pretend (or may even believe) they know, but the current price of a security, and by extension the market, generally incorporates all of the information possessed by millions of investors, most of whom are institutions. These market participants are intelligent, informed, and motivated. Thus the odds that any individual will consistently be able to find mispriced investment opportunities are extremely small. (Many excellent books have been written on this topic.  I heartily recommend Winning the Loser’s Game by Charles Ellis as an excellent introduction.)

In light of that, the answer I want to give to the first question is, “It will fluctuate.” (Credit to J.P. Morgan, possibly, for that bon mot.) and to the second, “It is probably correctly priced.”

This doesn’t mean that there is nothing that can be done to try to increase our client’s odds of success, but rather than the futile exercise of stock picking, here are the main things we focus on:

Risk Management. There are two aspects to this. First, the portfolio should be positioned so that the amount of risk is not greater than the client can bear. In a bad market we expect the value of risky assets (e.g., stocks) to decline by approximately half. Thus, most clients should not have all of their investments in risky assets. Second, the portfolio should be diversified among a variety of risky assets, not all of which will go up at the same time or by equivalent amounts. (Risky assets do have the unsettling tendency to all decline together however.)

Behavior Management. Keeping clients invested in an appropriate asset allocation during times of euphoria (the late 1990’s) or panic (early 2020) is probably the most important function of a good wealth manager. One of the differences between a salesperson and a quality investment manager is their willingness to go along with (or even encourage) client’s emotional investing impulses.

Even worse, some advisors are themselves not temperamentally suited to investing and get caught up in the emotion of the market. When I say behavior management is important, I don’t just mean the client’s behavior. I mean the advisor’s too.

Asset Class Opportunities. While individual securities tend to be correctly priced relative to similar securities, occasionally entire areas may be mispriced because of widespread emotion. This is one of the most difficult areas to exploit because while the mispricings are blindingly obvious in hindsight, they are almost impossible to see in real time. They also don’t exist all the time, so as an investment strategy this has low “breadth.” If a mispricing seems to be occurring, a small adjustment to a portfolio rather than a large adjustment is generally appropriate because of the level of uncertainty.

Costs. The outperformance of asset classes and active investment managers may come and go, but expenses are permanent. Controlling costs (both explicit and implicit) is crucial over time.

Factor Tilts. There is substantial evidence that some factor tilts can be advantageous. For example, value stocks are likely to outperform growth stocks over time (particularly in small companies and at current valuations).

To recap, “Is my porfolio constructed soundly to meet my long-term financial goals?” is a much more pertinent question than, “What’s the market going to do?”

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Letters of Instruction

Many people have prepared for the future and prepared a will, powers of attorney, etc.  A letter of instruction is not a legal document, but simply a letter that tells survivors where to find things, who to contact for various things, and any other information they will need that they may not know.  This may be particularly helpful in families where one person has managed most of the financial and administrative tasks and others may not be as knowledgeable in those areas.

Since letters of instruction are not legal documents, they do not have to follow any particular form.  You can include as much or as little information as you think necessary and change it at any time.  It would be best if it were signed and dated and stored in a safe place.  Also, be sure to let your loved ones know where it is.  Following are some typical sections you might include:

  1. Contact Information

In the event or your death or incapacity, your friends, family, and perhaps other people in your life will want to know.  You should list phone numbers with the names as well.

Primary contact.  Choose someone to be contacted first plus an alternate or two in case the primary person is not available.

Secondary contacts.  You will probably want to include your friends, relatives, employer, attorney, accountant, clergy member, etc.

Tertiary contacts.  If your executor or trustees do not fall into one of the categories above, they should be contacted as well.  These individuals will be selected through your will or trust document, listing them here does not alter those decisions.

  1. Documents

Appropriate people will need to know where to find crucial documents.  If these are in a safe deposit box, a safe, or are stored electronically, they may also need to know how to access them.  Essential documents typically include:

Personal Documents – birth certificate, Social Security card, marriage certificate, naturalization documents, last will and testament, any trust documents, etc.

Financial Documents – deeds, vehicle titles, credit card statements, investment and bank account information, insurance policies, pensions (including VA or other similar benefits), tax documents, and any other important financial documents or information.

  1. Financial Information

A list of when bills need to be paid and when income is expected will be helpful to your executor.  In addition, you should prepare a list of each financial account (bank account, credit card, investment, loan, etc.) that includes the name of the financial institution, the account numbers, titling, any TOD/POD (transfer on death, or pay on death) or beneficiary instructions.

  1. Property

Real property.  Identify any real estate you own and the location of related documents.  Include how that real estate should be cared for (including any lawn or pool services that may be in place), when property taxes and other bills must be paid, and landlord or tenant information.

Personal property.  While your will or trust control how assets are distributed after death, a LOI is frequently used to address personal items with little or no monetary value, but which may have significant emotional value.  These items typically include family heirlooms, sentimental items, family photo albums, and anything else that may have special meaning to someone.

Private property.  If you have anything of a personal, sensitive, or embarrassing nature, you can include instructions on disposing, protecting, or otherwise handling them.  If discretion is crucial, you can include a section or instructions that can only be read by your attorney or someone you trust completely.

  1. Digital Assets

Your letter should include an updated list with your passwords, subscriptions, along with how to access them, and what you want to happen to them.  Some online and social media platforms have policies and procedures for the transfer of these assets after the owner’s death or incapacity.  Online subscriptions, such as Netflix or Spotify, should be canceled.

You should also share the location of any photos, videos, or documents that may be on your phone, tablet, computer, external hard drive, memory stick, cloud storage, etc.  If you have private or personal photos or documents, be sure to identify these and be clear about how you want them handled.

If you have digital assets with substantial value, such as domain names, websites, e-commerce storefronts, etc., you should explain how these should be managed until they can be transferred to new owners.

  1. Children, Dependents, and Pets

If you are a parent or guardian for a minor, or you have adult children or other dependents with special needs, there is information the subsequent caregiver needs to know.  (I will use the term “child” for simplicity, but it could be a disabled sibling or other dependent.)

Child Support and Finances.  Record child support or other payments you’re receiving or making and the location of any related court documents.  Also supply the details if the child is the beneficiary of a trust, a custodial account, life insurance, or has (or is expecting) any other significant assets.

Education.  Information about the school, schedule, teacher, contact information, and coaches.  Also include information about extracurricular activities such as sports or music lessons.

Medical.  List any medications, care requirements, and medical needs as well as the name and contact information for their doctor, dentist, and any other health care providers.

Personal.  Information about your child, such as what activities they enjoy, food preferences, allergies, habits, fears, passions, and anything else a subsequent caregiver should know.  You might also include special messages to the child.

Documents.  Note the location of birth or adoption certificates, medical records, school records, etc.

Pets.  You may want to record similar information as above for any pets as well.

  1. Funeral Wishes

If you leave funeral wishes in your LOI, place the LOI in an easily accessible place.  Locations such as safe deposit boxes are usually not able to be accessed quickly enough for funeral and burial wishes to known to those making relevant decisions.  Clear instructions will help your family and loved ones in a time of stress and grieving.

Funeral Service Plans.  If you have already purchased funeral or cremation services, a burial plot, etc.  provide those details.  Even if you haven’t, list any preferences for a funeral home, services, and final resting place.

Donations.  If you desire monetary donations to a charity or something other than sending flowers, include that information along with the name and address or website of the charity.

Ceremony, Music, and Speakers.  Include desires for the funeral service or ceremony, such as location, music, and who you would like to speak at your service.

Personal Details.  Speakers and others may need details about your life, such as where you were born and where you went to school.

Photos and Personal Items.  List any photos, special items, or anything else you wish to be displayed or available at the funeral service, as well as where to find these items.

  1. Obituary & Epitaph

Include an obituary for publication purposes, as well as an epitaph for your final resting place.  If you want a photo published, provide that (or the location) as well.  Detail where you want your obituary published.  You may need different length versions of your obituary depending on the publication requirements.

  1. Personal Messages

You may want to leave behind personal messages or wishes to the significant people in your life.  This may take the form of individual letters just for them, or words to be read in public at the funeral.

You should update your LOI as you experience life changes.  Reviewing it annually, perhaps using the beginning of a new year or your birthday as a reminder, is usually easiest.  As you change it, follow the same instructions that were given regarding signing, dating, etc.