In recent days, we have heard questions from a variety of people. I usually think that when a few people ask a good question, there are probably many more who think it but don’t give it voice. Here are some common ones along with my responses:
■ “Scott, is it time to buy XYZ stock?” — Dr. M.
Interestingly, this question is usually about a hot growth stock that has been hitting new highs. Stocks presenting good value rarely spark interest. Lately we have heard it being asked about tech stocks like Apple, Microsoft, Amazon, Tesla, etc., since they have been driving the market during the rebound from March. I like to recall the time back in 1985 when a broker told me “Scott, it’s never a bad time to buy IBM.” But then from late 1987 to 1993 IBM fell 77%. Those who invested during the run up enjoyed the gains; but the pain of such deep losses usually outweighs the staying power of most investors. We all know from history IBM later regained all that it had lost and multiplied the 1993 low 23 times by the time it reached an all-time high in 2013.
When someone asks me about whether it is a good time to buy a certain stock, I first want to know the purpose of the investment. I then want to know the person’s time frame for needing the money for that stated purpose. For example, if you are 63 years old and plan to retire in 2 years, and will need your investment for the next 30 years, the prospect of being on the front end of large downturn will likely be more significant than if you are 30 years old. We call it sequence-risk, and risk management takes on a bigger role as our time dimension gets shorter. The current market trend, and specifically the trend’s reversal, becomes your friend when deciding the time to buy.
We recommend looking to technical analysis to help you determine the timing of a purchase. I particularly like to use the MACD indicator and a point and figure chart. This is not market timing, eschewed by so many.
■ “Scott, my advisor keeps talking to me about ‘real return’ on investment. Does that mean that some of my returns are not real?” — Dr. C.
Not exactly. The advisor is talking about inflation adjusted return. In simple terms, if the calculated return on investment is 6% and inflation over the same period is 2.2%, then your “real” rate of return is 3.8%. As you probably know, inflation eats away at purchasing power over time. In other words, during periods of inflation, a dollar will not buy as much as it buys today. As planners, we focus attention on living standard (or spending power) of our clients. Most people want to at least sustain, if not improve, their living standard throughout their lifetimes. Having investments that beat inflation, taxes, and fees is key to meeting that goal. In casting a plan, it is important to know both the expected rate of return and the projected inflation rate. We like to include a sensitivity analysis in our plans to adjust one of the components up and down by 2%. In other words, if we project a real rate of 2.75% in the reference case of the plan, we will also consider scenarios that examine spending power if real return is 0.75% and another scenario at 4.75% real return. Of course, we already consider taxes, which will vary in each case based on earnings.
■ “Speaking of inflation, it seems that with all the money printing that is going on right now at the Federal Reserve that we will encounter serious inflation in years to come. Is that right?” — Dr. C.
That is a very interesting question, and before answering we must first clarify that you are talking about the same type of inflation that I refer to in the previous question, i.e., inflation/deflation of consumption goods. This is to be distinguished from inflation of financial assets or inflation of the price of your residence, which I think you would agree are both good things. Make no mistake about it, excessive inflation or deflation is bad for our stock and bond portfolio. Securities markets like a stable level of inflation.
Money printing and other inflationary events such as monetary easing or shifts in interest rates by the Fed, oil or other commodity shocks, disturbances to productivity, excess demand growth, and wage/price spirals, are all proximate causes of inflation. There are many of these but one ultimate cause of inflation. These inflationary/deflationary events only generate inflation to the extent that the event moves supply and demand. Consider that when additional money is printed, it will only cause inflation if it makes its way into the consumers’ checking accounts. That happens if it gets borrowed and spent. If consumers are not willing and able to borrow, there is not likely to be demand that will drive inflation. So, when a pundit suggests that we should fear inflation because X is happening, ask how that activity will impact supply and demand before reaching a conclusion. Incidentally, because the current spate of money printing has not reached the consumer and as long as consumers are still debt averse, it may be that it will not drive inflation. So far, it is entirely possible that the money has artificially propped up the stock market. That should generate another question about what happens when the printing ends. Maybe next month…
If these spark other questions, I invite you to call or write.
Scott Neal is president and CEO of D. Scott Neal, Inc., a fee-only financial planning and investment advisory firm with offices in Lexington and Louisville, KY. Call him with a question at 1-800-344-9098 or write to firstname.lastname@example.org.