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FRANKLIN: RETIREMENT ESSENTIALS TRANSCRIPT

September 4, 2015

CONSUELO MACK: This week on WEALTHTRACK, the new retirement pyramid that’s built to last. Retirement and Social Security guide Mary Beth Franklin takes us on a tour of plans that will last through the ages… next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. No question about it, even the “me generation” baby boomers have to face the facts. They are becoming senior citizens. And that transition is bringing another major reality shift. Increasing numbers of boomers are moving from the accumulation phase of their savings to what’s known as the distribution phase. They have to spend what they have saved, earned and possibly inherited to fund their retirement.

It’s a daunting challenge. There are an estimated 76 million baby boomers in the U.S., born between 1946 and 1964 and now ranging between 69 and 51 years of age. They represent about 25% of the U.S. population and about 68% of them are still in the work forces.

And according to a Gallup poll many of them are reluctant to retire. Nearly half of boomers still working say they don’t expect to retire until they are 66 or older. That compares to the average retirement age of 61 among current retirees. And one in ten boomers predicts they will never retire. Concerns about money play a significant role in boomer’s plans to postpone retirement.

No matter what your personal goals are this new phase requires new thinking and planning. There are few more qualified to advise us than this week’s guest, whom we are delighted to have as a WEALTHTRACK regular. She is Mary Beth Franklin, now a Contributing Editor at InvestmentNews, a leading publication for financial advisors. She is a Certified Financial Planner, an award winning personal finance journalist who has been covering retirement issues for most of her career and is a recognized expert on Social Security. Her latest book is “Maximizing Your Social Security Retirement Benefits” which is a recommendation on WEALTHTRACK’s Bookshelf.

I started the conversation with a basic question. What is the first thing we need to do as we approach retirement?

MARY BETH FRANKLIN: When people are saving for retirement they tend to use these broad rules of thumb. “Gee, I should save 10 or 15 percent of my gross income,” but when you get to the point you’re going to start tapping those investments for income, you need to know what your expenses are and what your sources of income are and how they match up. You know many of us can go through our entire lives with never creating a budget, but at least having a starting point, a plan for retirement is critical. What are your fixed costs in retirement? What are your discretionary costs? Do I have guaranteed or predictable sources of income to at least cover those fixed costs, whether it’s taxes or mortgage, food, insurance. Get those big-ticket items covered, and then the rest of your investments can have a little more flexibility because if you needed to cut back on those discretionary items you could.

CONSUELO MACK: Here we’ve gone through this phase hopefully of saving for retirement and investing, and now it’s all about distributing. It’s called the distribution phase, and it really is all about you know, looking at your investments and not necessarily how’s the portfolio growing every year or what my performance is versus the market, but it really is what kind of income it can generate, right? So that’s the whole new ball game.

MARY BETH FRANKLIN: Exactly, and it’s putting the retirement income puzzle pieces together. We used to talk about the old reliable three-legged stool of retirement security. It was pensions, personal savings and Social Security. Well, pensions unfortunately are history for a lot of people.

CONSUELO MACK: Most people. Right.

MARY BETH FRANKLIN: Personal savings may be inadequate for a lot of people, and Social Security, while extremely important for so many Americans, has some long-term financing problems. So we’ve gone from this nice, solid, three-legged stool to essentially a pogo stick. That’s just not going to work for most people going forward.

CONSUELO MACK: So what’s the pogo stick?

MARY BETH FRANKLIN: Well, the pogo stick is Social Security that’s a little wobbly. So now we need a new image, and I tell people let’s think of retirement security like a pyramid, and the base of that pyramid for most people would be Social Security, and you layer on top of that retirement savings, whether it’s your 401(k), your IRA, your 457, et cetera. On top of that for a lot of people it’s going to be home equity, whether it’s paying off your house and living mortgage free or selling the big house, buying something smaller and banking the difference or maybe even a reverse mortgage. You layer on top of that. For some people it’s continued employment. We’re going to live a very long time. Does it necessarily make sense for everybody to retire at 65 and live 30 more years with no work? Maybe there’s consulting work. There could be part time or seasonal work, and then at the very top of that pyramid, the pinnacle is everything else. It’s your investments. It might be an inheritance. It might be rental income from a rental property. But now’s the hard part. You’ve got this pyramid, and everybody’s pyramid is going to look a little bit different, and then a financial advisor is going to ask you the important question. Are you healthy? Are you married? Are you single?

CONSUELO MACK: Or they should ask you these important questions.

MARY BETH FRANKLIN: They should ask you these questions. Are you supporting an elderly parent? Do you have a boomerang kid in your basement? The answers to all those questions are going to be the result that will create your unique retirement income plan, and it’s going to take a lot of work and, many cases, a lot of help.

CONSUELO MACK: And I was going to say, so it sounds like it’s complicated. How important is getting financial advice?

MARY BETH FRANKLIN: I think it’s critical and it’s also important that you interview several financial planners because this is new to the financial advice community as well. A decade ago they were still all about investment advice, accumulating assets.

CONSUELO MACK: Right, a lot of them were from broker-dealers.

MARY BETH FRANKLIN: Exactly.

CONSUELO MACK: And so they basically ran your investment portfolio.

MARY BETH FRANKLIN: And this is a whole new ball game.

CONSUELO MACK: Right. Now it’s turning that investment portfolio into an income stream that suits your specific individual needs and that’s a tougher problem.

MARY BETH FRANKLIN: How do you pull these other levels like Social Security? When should you claim that? What’s your impact on Medicare? Do you have a retiree health benefit? These are more holistic financial planning questions that are going to be really important to retirees.

CONSUELO MACK: Let’s talk about Social Security which you have turned into a full-time career industry. You’re very much in demand all over the country. And you have some of the magic strategies to maximize Social Security benefits. What are some of the magic strategies?

MARY BETH FRANKLIN: Well, there’s essentially two magic strategies. The first important thing is 66 is the magic age. That means 66 is the current full retirement age benefit. You can claim Social Security benefits before 66, but you can’t do anything fancy. If you want to maximize your benefits with some of these magic strategies, you must wait until 66 to claim. The first magic strategy is called file and suspend. What that says to Social Security is now that I’m full retirement age I want to file for my benefits but hold on.

CONSUELO MACK: Now that I’m 66, full retirement age.

MARY BETH FRANKLIN: Now that I’m 66 I’m filing for my benefits but don’t pay me. Now why would you file and not want your benefits? Well, it’s because for every year I postpone collecting them, they’re going to grow by an extra eight percent per year up until age 70. So that means if I wait until 70 instead of getting 100 percent of my benefits at 66, I get 132 percent. That’s huge.

CONSUELO MACK: Eight percent for four years. And why do you have to file? Why not just wait until 70 to file?

MARY BETH FRANKLIN: Great point. If I do nothing and just collect at 70, I’m still going to get the automatic eight percent a year, but I might want to file and suspend for three reasons. One, I might have a spouse who is entitled to spousal benefits. A spousal benefit is worth half of my benefit, but I have to do something to trigger that spousal benefit. I either have to claim my own benefits or file and suspend. Or as I’m seeing increasingly, I’m seeing older parents in second or third marriages with young families. What so many people do not realize is if a parent is collecting a Social Security benefit and you have a minor dependent child under age 18 in your household …

CONSUELO MACK: It doesn’t have to be your own child. It could be a grandchild or … ?

MARY BETH FRANKLIN: Well, in most cases it’s your biological child, your stepchild.

CONSUELO MACK: Stepchild.

MARY BETH FRANKLIN: Your adopted child and, in rare circumstances, it could be a grandchild, but the idea is if you are collecting a Social Security benefit, the child is entitled to a benefit worth 50 percent of your amount.

CONSUELO MACK: Wow.

MARY BETH FRANKLIN: Which is huge. So let’s say you’re a 66-year-old father who has remarried and now you have a two-year-old. You know you should probably delay until 70 because you’re paying for college in 16 years. So you might want to file and suspend at 66 so your own benefits keep growing but you have now triggered a benefit for your minor child. I like to call that the Viagra College fund. You put that money in a 529 plan and you’ve paid for Harvard. The third reason you might want to file and suspend … and this works particularly well for single people. When you file and suspend, you’ve actually filed for your benefits even though you’re not collecting them. So it acts as an insurance policy. Imagine this. I’m single. I’m 66. I file and suspend. Two years later I’m 68 years old, and I get a terminal medical diagnosis. Well, now longevity is the least of my concerns.

I’m not married so there’s no survivor benefit because there’s no surviving spouse. I could say, because I filed and suspended, “I’ve changed my mind. Please pay me in a lump sum my two years of suspended benefits instead of getting that eight percent delayed retirement credit and going forward. Pay me as if I claimed at 66.” So say I was entitled to a benefit of $2,000 a month. That’s $24,000 a year. I file and suspend at 66. I change my mind at 68. Please pay me $48,000 in a lump sum. That’s a pretty magnificent strategy for a single person.

CONSUELO MACK: It sure is, and you couldn’t get that if you hadn’t filed and suspended at 66?

MARY BETH FRANKLIN: That’s correct because under normal circumstances the maximum retroactive lump sum benefit you can get from Social Security is six months, and it cannot start before your full retirement age of 66, but in this odd case Social Security doesn’t consider this a retroactive benefit because you have filed for benefits even though you didn’t collect them. So you can request a lump sum of your suspended benefits.

 

CONSUELO MACK: What are some of the biggest mistakes that people make?

MARY BETH FRANKLIN: Oh, I think a lot of people claim at 62 just because they can, perhaps not realizing that their benefits are permanently reduced by 25 percent or more for the rest of their lives, and they also don’t realize that if you claim benefits before your full retirement age and you continue to work and you have earnings from a job, you’re going to give back some of your Social Security benefits, some or even all of them if you earn too much money, and this year too much money is defined as $15,720 a year.

CONSUELO MACK: Wow.

MARY BETH FRANKLIN: Now, they’re not gone forever. If you lose benefits to this earnings cap, they will be restored once you get to your full retirement age, but at the same time you’ve also forfeited the opportunity to engage in these creative claiming strategies. So my number one rule to most people is, if you plan to keep working beyond age 62, don’t claim early. Wait until your magic age of 66. Now there is one other strategy. It works for married couples and in some cases divorced couples. It’s called restricting your claim to spousal benefits. Now this assumes your spouse has already claimed Social Security. You are now 66. You can say to Social Security, “Not that I am full retirement age, I want to restrict my claim to spousal benefits. Don’t pay me mine. Let them keep growing at eight percent a year. Pay me half of my spouse’s benefits.” This is really valuable because for most people whose own benefits are larger than a spousal benefit goes completely to waste. They never get that spousal benefit, but if they use this strategy, they could collect a spousal benefit for up to four years and then at 70 switch to their own benefit that’s now worth 132 percent of their full retirement age amount.

CONSUELO MACK: That is huge then. It really is. Now one of the things as well that I’ve been reading about is that the role of Medicare and paying for Medicare is going to be more and more onerous as time goes on, and that as a matter of fact I read an article I think that you sent me that health care costs will devour Social Security. That’s what the headline was. What’s going on?

MARY BETH FRANKLIN: Well, again a lot of people don’t realize that their Medicare Part B premium which pays for outpatient services is deducted directly from your Social Security check. What people also don’t realize is those Medicare premiums are means tested. In other words, depending on your income, you may be paying more for Medicare Part B premiums for the exact same service, and in some cases you may be paying a whole lot more. Most people are now paying roughly $105 a month, but depending on your income you might be paying $335 per month per person for a married couple.

CONSUELO MACK: And that comes out of your Social Security check.

MARY BETH FRANKLIN: And that comes out of your Social Security check, and I will often get questions from readers saying, “I don’t understand. Why did my Social Security check go down?”

CONSUELO MACK: Go down.

MARY BETH FRANKLIN: And I’d say, “Well, did you collect before full retirement age and you’re working?” “No, no. I’m 66 and my check went down.” Then I’ll say, “Did you income go up?” “Oh, yeah. I sold a vacation house,” or “I liquidated a stock portfolio.” Aha. That’s what happened. Your modified adjusted gross income increased and consequently the amount you’re paying for Medicare went up as well, and it’s been deducted from your Social Security check. There are currently five income brackets that trigger higher Medicare benefits. Starting in 2018 there will still be five brackets, but they’re going to kick in at lower income levels which means more people will be paying higher Medicare premiums. What they don’t realize is it’s going to be based on their 2016 tax return. So this is a time now for people to be looking at their sources of income, and is there anything they can do to move some of their income into a tax-free column that might hold down future Medicare premiums.

CONSUELO MACK: So that’s really important, and we should start doing it now because it’s going to be based on the 2016 tax returns. Right?

MARY BETH FRANKLIN: Right, and it will trigger a higher premium 2018. Now the one thing to keep in mind, this can change on a year-by-year basis, so if you get …

CONSUELO MACK: You mean Congress could change it or …

MARY BETH FRANKLIN: No, that your tax situation and what you pay for Medicare could change on an annual basis. Maybe you have a big income hit one year where your income goes up. Then you’re going to pay a higher Medicare premium, but that doesn’t go on forever if your income goes back to its normal levels.

CONSUELO MACK: I see, and so they’ll keep current with whatever your tax returns are.

MARY BETH FRANKLIN: Exactly.

CONSUELO MACK: So therefore, how do we maximize our Medicare benefits and reduce as much as we can the costs of Medicare?

MARY BETH FRANKLIN: Well, this is where …

CONSUELO MACK: Are there some general rules there as well?

MARY BETH FRANKLIN: … where Medicare and Social Security are so linked at this point, and it all comes down to how do we reduce our taxable retirement income. What’s very interesting in this modified adjusted gross income calculation that triggers Medicare premium, everything counts. Your entire adjusted gross income from your tax return plus any tax-free interest like you might earn from a municipal bond.

CONSUELO MACK: Wow. They’re including tax-free interest.

MARY BETH FRANKLIN: That’s with the modified adjusted gross income, MAGI. It is not the gift of the Magi I guarantee, but there are five sources of retirement income that don’t count in that calculation: distributions from a Roth IRA, distributions from a Health Savings Account, annuities in a non-retirement plan, cash value life insurance and reverse mortgages. I think these tools are going to be utilized more frequently going forward. Another thing is maybe this is a good reason we should think about converting some of our traditional IRAs to a Roth IRA.

CONSUELO MACK: Roth.

MARY BETH FRANKLIN: Now people don’t like the idea of having to pay the tax on the conversion, but don’t do it all at once. Take a little bit each year. Fill up your tax bracket. If you’re in the 25 percent federal income tax bracket and you know there’s five or ten thousand dollars before you hit the top, convert that amount to a Roth IRA that year. You’re still in the same tax bracket, and do it each year and then you will be building up these tax-free sources of income in retirement which means it will hold down your income tax bill and it may also hold down your Medicare premiums.

CONSUELO MACK: So smart, Mary Beth.

MARY BETH FRANKLIN: I learn from the best.

CONSUELO MACK: Great, great tips. All right, let’s talk about other income sources as well. You mentioned reverse mortgages. You mentioned your mortgages. At one point those were definitely a no-no.

MARY BETH FRANKLIN: They were definitely a no-no.

CONSUELO MACK: Make more sense now?

MARY BETH FRANKLIN: They’re probably not the smart choice for your first move, but I think for certain people who are truly house-rich and cash-poor, this can be a good alternative for them. The concern I have is people sometimes get them at too young of an age. You can qualify for a reverse mortgage as early as age 62, but you probably don’t want to be tapping that money then. Again, people’s major concern of retirement is running out of money. Wouldn’t you rather have that be an ace in the hole in your later years in retirement in case you needed it? I think the other thing is we always talk about diversifying our investments as we’re accumulating them, but it’s a whole different mindset to how do we take this lump sum and turn it into a stream of income? Now I know annuities get a really bad rap, and there are some bad ones and some expensive ones, but if your purpose is I want to take some of my assets and create a guaranteed stream of income, there are good ways to do it, and one of the popular ways now is called a Deferred Income Annuity. It’s very straightforward. It’s like buying yourself a personal pension. Take a chunk of money maybe at age 55 and say starting at age 65 or 70 I want an income stream.

CONSUELO MACK: So you can determine when the income stream starts.

MARY BETH FRANKLIN: Exactly.

CONSUELO MACK: All right, and so that’s different than longevity insurance. Right? Longevity insurance starts paying out at 80 or 85? Is that right?

MARY BETH FRANKLIN: Well, longevity insurance is an extreme example of this.

CONSUELO MACK: Of Deferred Income Annuity.

MARY BETH FRANKLIN: Same idea that you invest a chunk of money and it pays off at a later date, but in the case of pure longevity insurance, it usually is much later, say 85, and if you die before 85 …

CONSUELO MACK: You lose it.

MARY BETH FRANKLIN: You and your heirs get nothing. It is the pure roulette wheel of insurance, but if you do live until 85 or beyond if that’s your start date, it’s a big payoff, and this is where we need to find new tools because so many of us are going to be living a lot longer.

CONSUELO MACK: A lot longer.

MARY BETH FRANKLIN: And since we’ve lost these traditional pensions and for many people the only guaranteed form of income is Social Security, maybe you might want to take some of your other assets and add to that guaranteed pot, but having said that, you don’t want to tie up all your money in guarantees. You’re going to be living a long time in retirement. You’re still a long-term investor. You want a chunk of your money still invested in stocks, and in fact there’s some very controversial research that says we always thought traditionally that the older we got, the more we should reduce our exposure to stocks.

CONSUELO MACK: Stock exposure and increase our bond exposure.

MARY BETH FRANKLIN: But now there is a certain theory that if you have your fixed costs in retirement covered with things like an annuity and Social Security or maybe a pension, you might want to be more aggressive in the stock because it’s representing a smaller percentage of your portfolio but it has a chance to win big over the long term.

 

CONSUELO MACK: An investment for a long-term diversified portfolio. What’s the one thing that we should do in a long-term diversified portfolio do you think?

MARY BETH FRANKLIN: Well, I’m going to say Social Security is like a personal pension. So I don’t care what decision people make. I just want them to make an informed decision, and if they’re married the one thing they should think about is, how do I maximize the survivor benefit for this spouse I leave behind? And the best way to do that is to make sure the higher-earning spouse, the one with the bigger benefit waits as long as possible to collect.

CONSUELO MACK: All right, and you’ve got to start collecting at 70.

MARY BETH FRANKLIN: Right. It makes no sense to delay beyond that because these very generous delayed retirement credits cease at age 70.

CONSUELO MACK: Right, I guess the final thing is as far as your financial advisor, the person who has been advising you in your investments. How equipped are financial advisors now to advise us on this distribution phase?

MARY BETH FRANKLIN: Well, there’s a small but growing segment of the financial advice community that are really becoming retirement income specialists, and over the past decade we could see that these were people that were conversant in things like what’s a good annuity perhaps or what kind of insurance do you need, or even how and when to claim Social Security benefits, but now we are going to see as Baby Boomers will be living for a long time in retirement, they’re going to be looking for additional references. Gee, Mom needs to go into a continuing care retirement community. Can you make a recommendation?

CONSUELO MACK: All right. We’ll leave it there. This is going to be an ongoing conversation with your, Mary Beth Franklin. So thanks so much for joining us once again on WEALTHTRACK.

MARY BETH FRANKLIN: Thank you.

At the close of every WEALTHTRACK we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is consult a financial planner at least once about your retirement plans. As Franklin and others have explained numerous times on WEALTHTRACK retirement is a complex process requiring decisions unique to you and your family that go far beyond an investment portfolio.

You can do it in person or online. You just want to make sure the financial planner is qualified to advise you on the important broader issues. Here are some recommended credentials that all require rigorous training. The most basic one is Certified Financial Planner, or CFP. The ones focused specifically on retirement income are much more recent credentials and therefore far fewer people have them. The Retirement Management Analyst, or RMA was established in 2010, and the Retirement

 

SINGER: MACRO MATTERS TRANSCRIPT

August 28, 2015

Why are events in Greece and China so important to investors? In a rare interview, top performing, five star rated Portfolio Manager, Brian Singer of the William Blair Macro Allocation Fund explains why macro matters.

Brian Singer Portfolio Manager, William Blair Macro Allocation Fund

CONSUELO MACK: This week on WEALTHTRACK, as tensions flare up in Greece, the Middle East and China, five-star fund manager Brian Singer decides which strategies to follow to keep his William Blair Macro Allocation Fund moving in the right direction. That’s next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. Most of the top rated money managers we interview on WEALTHTRACK are what are called “bottom up” investors, they build their portfolios one security at a time, stock by stock, bond by bond by carefully analyzing the fundamentals of the security itself, the company it represents, the business it’s in, and the customers it serves.

This week’s guest takes a different approach. He is what is known as a macro investor. He is Brian Singer, Portfolio Manager of the William Blair Macro Allocation Fund which he and his team launched when they joined William Blair in late 2011.

The Macro Allocation Fund is rated five-star by Morningstar and has outperformed its Multialternative Category handily over the last three years with over nine percent annualized returns. Prior to joining William Blair, Singer was Head of Investment Strategies at his namesake firm, Singer Partners and prior to that was Head of Global Investment Solutions and Americas Chief Investment Officer for UBS Global Asset Management.

Singer’s top down approach doesn’t involve choosing individual securities. It does mean actively managing across asset classes, geographies, currencies and risk themes.

I began the interview by asking Singer why macro matters in a portfolio?

BRIAN SINGER: Well, it’s interesting. If you think back to the Cold War, the world was very geopolitically stable back then, and after the Berlin Wall went down in 1989 something changed, and we’re really not that geopolitically stable these days. You could call it Ukraine. You might call it Greece these days, the Middle East, but there are a lot of developments like this in regions around the world that portfolios need to navigate, and it’s this type of macro management that enables those portfolios to navigate the rough waters of geopolitical instability.

CONSUELO MACK: But there have always been geopolitical events. I mean World War I, World War II. I could think of the Russian Revolution and everything else. But is it because the markets are now global now? We’re much more interconnected so that, therefore, something that happens in the Ukraine that might not have affected us 40 years ago does. Is that why macro matters more now than it has in the past?

BRIAN SINGER: I would say a couple things. One is if I tried to identify an analogous period to the world we’re in today, it really is the first three and a half decades of the last century, 1900 to 1935-ish, but back then most investors were very wealthy, and now wealth is spread across the population, and individuals have savings, retirement accounts that they actually need to invest themselves, and for that reason this type of concern is now propagated throughout all of society, just not a narrow portion of society. But it did exist like that before, and we’ve returned to that today but for the masses, not just for the elite.

CONSUELO MACK: What does a macro asset allocation strategy mean to you?

BRIAN SINGER: Most portfolios are very well diversified from a bottom up perspective. In other words they have lots of security selection across stocks and across bonds. What they don’t tend to have is diversification across asset classes and countries that is thought of in a dynamic manner and that’s what a macro allocation fund is from our perspective, a compliment to existing portfolios that allocates across asset classes, currencies, individual markets, credit categories and generally manage the broad macro exposures of the portfolio.

CONSUELO MACK: But Morningstar, for instance, calls you a Multialternative fund. So are you an alternative investment? Do you zig when equities zag for instance? I mean is it that kind of diversity that it brings?

BRIAN SINGER: When Morningstar categorizes us in the multi-alternative realm, they observe that we are broadly diversified across equities, bonds, currencies, multi, and alternative because we can go long and we can go short in all of these. We’re also fundamental in nature. Most of these alternative funds are more momentum-oriented. We’re not. We’re fundamental in nature. We go through an economic analysis and a macro thematic analysis of these developments all around the world and consider what the implications are for asset prices in the portfolios. Because of that, we tend to be zagging when everybody is zigging. When prices go down, we’re observing that prices are probably moving further below fundamental values, and we’ll tend to step in in that type of environment. But it also means we tend to have a longer-term investment horizon than a lot of investors.

CONSUELO MACK: The big macro themes that you’re following evidently there are five of them, so currencies, global economic growth, geopolitics, commodity super cycle and interest rates. Why those five?

BRIAN SINGER: Those are the things that we find today, today, and they’ll evolve over time but today are having the greatest influence on asset prices, either compelling them away from fundamental values or toward fundamental values, and they’re providing us in our analysis with the best insight to actually take positions where we feel we actually understand something deeper or to a greater degree than is already priced into the market, and that’s where it becomes valuable for us. The geopolitical analysis is, for example, one of the most powerful things that we’ve introduced to the portfolio over the course of the last decade. It really wasn’t necessary when I got into the industry. We were still in the Cold War back then, and there were developments but not like what we see today on a day-to-day …

CONSUELO MACK: Because they were stable. You had these two big super powers, and they pretty much determined … they kept things…

BRIAN SINGER: I hate to say it. Mutually-assured destruction is scary but it’s stable and it was, and now we don’t have mutually-assured destruction, and it’s just not stable.

CONSUELO MACK: So there is no dearth of geopolitical events going on in the world right now. Which ones are you paying the most attention to? Which have the biggest investment implications?

BRIAN SINGER: Right now, right now I would say I’ll give you three of them. I hate to say three out of four. That doesn’t narrow it down too much, but I would Greece, Middle East and China, and I’ll just briefly mention why in each of those.

CONSUELO MACK: No, absolutely.

BRIAN SINGER: In the case of Greece there’s been a negotiation between Greece and the euro zone that is very, very important existentially to the euro and the integrity of the euro zone. The negotiations were such that they really focused on trying to stem the growth of populism in the euro zone. The Germans and the euro group had to make sure that Syriza, the party in Greece, a populist party couldn’t be deemed successful, because if they were deemed successful it would cause populism to arise elsewhere in the euro zone and threaten the euro. That had to be stopped, and from that perspective we had the view importantly that whatever happened, it would have to be so painful for Greece that no other populist party would want to go that route, and that’s what it was. It led us then from a portfolio management perspective to be cautious, to reduce risk until the pain was actually propagated through the system and now as we’re beginning to get approvals, we’re beginning to add exposure back into Europe, European equities in particular.

CONSUELO MACK: And reduce risk where? In your entire portfolio or just the ones that would be affected in Europe?

BRIAN SINGER: Both.

CONSUELO MACK: Both.

BRIAN SINGER: I would like to say what would be only affected in Europe, but the problem is that markets move in this kind of safe haven concept, risk on, risk off. So things tend to move up and down together, and we’ll take positions across currencies, bonds and equities to de-risk the portfolio. Examples of that.

CONSUELO MACK: Please.

BRIAN SINGER: We shorted Italian bonds. Why? If there’s a scare in Europe, the peripheral bonds of Italy, Spain, Portugal, things like that will tend to increase in yield. That was a risk management tool for us. It helped offset some of the risk that we had. We had equity exposure in Europe and in Italy and Spain predominantly. We reduced that as we went into this. Now we’re increasing that. We’ve eliminated our short to Italian bonds. We’ve eliminated that risk hedge, and now we’re introducing risk again by buying into France, Spain and Italy, the equity markets in France, Spain and Italy in Europe.

CONSUELO MACK: And what are you shorting?

BRIAN SINGER: The shorts that we have in the portfolio are really focused in on, I would say a little bit the U.S. We don’t have much exposure to the U.S. We’re net long bonds, I’m sorry net long equities, in the portfolio mostly in Europe and in the emerging markets. We don’t have a lot of shorts in equities. We do have shorts in fixed income, mostly in European fixed income where rates are just so astoundingly low. That’s really the short position that we have as an offset.

CONSUELO MACK: And actually that’s what I meant to ask you. Who are you betting against in Europe?

BRIAN SINGER: Who are we betting against there? We had very, very large shorts in the euro and the Swiss franc, very large shorts. The euro, however, we feel has dropped basically down to what we consider to be fundamentally appropriate, and we’ve brought our short position down to a very, very small position, very, very small position in the euro. Basically we’ll just say flat the euro now, but we remain short the Swiss franc. The Swiss franc has been a safe haven. It’s very overvalued because of that. The price of the Swiss franc has gone up dramatically against other currencies, and we’ve increased our short there as we’ve reduced the euro zone short here more recently.

CONSUELO MACK: Brian, you mentioned the Middle East and ou mentioned China. Middle East first.

BRIAN SINGER: Middle East. Middle East is very important because of crude oil prices, energy prices. What we believe is that the negotiations that have occurred throughout the Middle East, this is a game theater of geopolitics. The Shia population is based in Iran, and Iran has a partner in these negotiations and that’s Russia, and they both draw a lot of their power from energy. The Saudis are the basis of the Sunni population, and they had a coalition partner called the United States, but they no longer have that partner, and they needed to exercise some power to minimize the influence of Iran until they were able to build out their strength base. Our view was that they would manage to a lower crude oil price. They still are.

CONSUELO MACK: The Saudis would manage to lower which they have done.

BRIAN SINGER: I’ve been doing this for 25 years. The world always anticipates crude oil coming on line faster than it will come on line, but a couple of years from now it will begin to come on line, and we believe that will maintain a downward pressure on crude oil prices between what Saudi Arabia is doing, what fracking is doing around the world and what is ultimately going to be Iran bringing oil on line in a few years. So from our perspective, crude oil price is not going back up above 100, literally maybe staying 40 to 55 dollars a barrel when we’re looking at something like a Brent Crude Oil.

CONSUELO MACK: Therefore, how do you invest in that expectation?

BRIAN SINGER: Well, we don’t invest directly in commodities, but what it does do is influence our assessment of fundamental value for the energy sector. It influences our thoughts about commodity currencies. So the energy sector right now we’re saying that there’s a depressing effect on earnings. We do have a small long position in energy, but we have mitigated the size of that because of the downward pressure on oil prices. With respect to the commodity currencies, we’re generally looking at it and saying this is part and parcel of being on the back side of a commodity super cycle, and the downward pressure of that on the commodity currencies is what leads us to be short things like the Australian dollar and …

CONSUELO MACK: Canadian dollar?

BRIAN SINGER: …and the New Zealand dollar. We were short the Canadian dollar, but oil sands came off line a while back. That kind of played itself out, and we’ve taken that short position off. We’re neutral right now on the Canadian dollar.

CONSUELO MACK: Lower commodity prices are good for commodity consumers, and one of the biggest commodity consumers in the world is China which you also mentioned is on your radar screen. What’s your analysis of China which most of us focus on the negatives that are occurring in China.

BRIAN SINGER: I know, and our trajectory in China has been … up until about three or four months ago, it was the largest emerging market position we had in the portfolio. After the dramatic run-up that occurred, we cut the position in half.

CONSUELO MACK: In the stock market.

BRIAN SINGER: In equities, in Chinese equities, and now we’re beginning to nibble again and being to get exposure again or increase our exposure a little bit again to China. Why have we done all of this? There’s been so many negative perceptions about China. Debt. Yes, they do have a debt problem. Their debt to GDP is about what it is in the United States. The United States would die, would die, to have the debt to growth dynamic that China has. And that growth can chew through that bad debt, not bad debt, high levels of debt very, very quickly. Second thing is infrastructure building and over building, empty cities and all of that. Yes, there has been a massive amount of infrastructure. But it doesn’t mean that all infrastructure investing there is bad, and there’s a very good reason to build empty cities in China. You can build railroads and roads to the people in Western China from Eastern China. In China you basically have access to a welfare system based on the city that you live in. If you live in rural China, you don’t have access. So there’s a very strong incentive to migrate these individuals into cities, and building empty cities don’t stay empty for long. Third thing, shadow banking. Everybody talks about shadow banking, it being illegal. No, no, no, no, no. In China if you come out of communism and you don’t have the concept of financial intermediation because that’s not part of an anti-capitalist system, then lending, resource allocation has to come through some mechanism, and it’s called informal shadow banking. Is there bad shadow banking? Yes. Is there very good shadow banking? Yes. It’s valuable in an economic sense. So we see kind of both sides of this. That said, things got out of hand. In the course of the last six to nine months, there was so much leverage that was being brought into the equity markets, and there was so much buying on the part of …

CONSUELO MACK: Individuals.

BRIAN SINGER: … small retail investors, it boosted equity prices. The substance of that is very, very small. These are small retail investors. The equity market there is tiny compared to the economy. This is not the end of Eastern civilization as we know it in China. It is a hiccup. Final thing is China is very focused on making the Chinese yuan the reserve currency for Southeast Asia. To do that, they have to have stability in their capital markets. They are in the process of pulling out all the stops to stabilize the situation there and make sure it doesn’t happen again. Will bad things happen again? Yes. They happen everywhere. They happen in Europe. They happen in the U.S. It’ll happen there again, but from our perspective now we’ve flushed a lot of the bad out of the system. A lot of the bad lending behind the equity market, a lot of it, not all of it has come out of the system, but it’s time from our perspective to begin to think the fundamentals will reassert themselves, and it’s time to go back in.

CONSUELO MACK: How do you invest in China?

BRIAN SINGER: There are a number of ways to do that. We tend to invest in what are known as the H shares which are listed in Hong Kong.

CONSUELO MACK: Hong Kong.

BRIAN SINGER: But we do have access to larger cap and smaller cap securities in China through the H shares. We like the involvement of institutions. We like the involvement of the Hong Kong regulatory oversight and things like that. It doesn’t mean that there aren’t often great opportunities in A shares. There are, but from our perspective we’ve been able to get the exposures that we want, the macro exposures that we want, by going into those shares in China, and there are a number of ways to do it. There are ETFs that can be used. There are mutual funds that can be used. It’s an easy, easy market to get exposure to.

CONSUELO MACK: And you mentioned that China several months ago, and you got out and reduced your exposure after the big market run-up, but that it was half of your emerging market exposure. Do you think that’s going to be kind of the level that you’re going to be involved in China going forward?

BRIAN SINGER: The answer to that is no. It was yes, but things have changed. First is time has passed, and a lot of the value has been realized as the equity market has gone up. Yes, it’s come back down, but it did capture a lot of that. The second thing that’s very, very important is President Obama was able to get fast track authority for the Trans-Pacific Partnership, the big trade agreement between the U.S., Canada and a number of other Asian markets. It is the small Asian markets that will benefit from the free flow of goods, service and capital that hopefully will arise from that Trans-Pacific Partnership. What we did when we moved money out of China, we moved some of it to Vietnam.

CONSUELO MACK: How does the central bank explosion that we’ve seen around the world of this unprecedented accommodative policies …how does that affect your investment strategy?

BRIAN SINGER: It is incredibly important for us both in the long term and in the short term. For example, these central banks have an objective with their monetary policies of boosting asset prices, housing prices, equity prices and things like that and lowering interest rates. What’s the incentive? Borrow and invest in real estate and equities. That’s the incentive. It leads to corporations investing in capital projects that may otherwise not be profitable because interest rates have been held lower than their financing costs have been held lower. So in the end we look at it and say there’s been a lot of misallocation of resources that do need to be worked out of the system. What that means over the next ten years in mostly the developed world is we’re likely to see a relatively low-growth environment. We want to be cautious now and positioned to take advantage of the resurgence that occurs when all of those resources, the misallocation of resources worked out of the system and a lot of the technological developments that have occurred over the course of the last decade begin to really hit and increase productivity around the world. That’s the long term. The short term means that these central bank activities are influencing the supply of money and really having a tremendous influence on exchange rates. It means for us that the greatest opportunities where we’re taking most of the risk in our portfolios is in currencies, going long some currencies, short other currencies. We’re long the Southeast Asian currencies. The reason is they’re emerging market currencies that have not bloated their balance sheets like the developed market. They have not incurred the type of debt levels that a lot of the developed countries have, and many people remember 1998 when there was the Asian flu or the emerging market currency crisis. They’ve cleaned up their act since then. So they’re really the sterling players on the block. These are the good investment opportunities, and we’re long the Indian rupee, the Indonesian rupiah, the Malaysian ringgit, the Korean won. We are short some others like the Thai baht and the Philippine peso, so we’re not long all of them but we’re long those. We’re also long the Chinese yuan. The Chinese yuan is a unique case. Yes, they’ve been stimulative in terms of their monetary policy, but with an objective of making the yuan a reserve currency for Southeast Asia, they have to have a stable and/or appreciating currency, and we believe they will focus as much as they can on actually managing that currency to that objective, and that creates an opportunity.

CONSUELO MACK: One investment for a long-term diversified portfolio. We ask each of our guests on WEALTHTRACK at the end of every conversation with them, what would you have us all own long term?

BRIAN SINGER: And in long term I’ll say ten to twenty years, and I suggest that you contact my kids and ask them if this worked out for them, because this is what we’ve done for their portfolio. We have put their portfolios predominantly in emerging markets because we want to take advantage of the growth of the population there, the increased integration of their economies with each other and with the developed world, and the realization that going forward the contribution to world growth will come more from emerging markets, and it already is, than it’s coming from developed markets.

As capital markets, equity markets take advantage of that, that’s a wonderful thing for the long term and, as I mentioned, those are the central banks that have the sterling balance sheets, fiscal policies that are in pretty good shape right now. They’re adopting very pro-market regulations relative to what is happening in the developed world. That’s a long-term scenario. As I like to say, that’s a tidal wave that you want to ride, and don’t get caught up in the small little waves that bounce up and down around that. Ride that tide. Stick with that tide.

CONSUELO MACK: Emerging market stocks.

BRIAN SINGER: Emerging market stocks.

CONSUELO MACK: Is there a particular vehicle that you have put your children’s portfolios in?

BRIAN SINGER: I have chosen, because I do this for a living, to provide exposure on an individual country basis so there is focus on individual countries. However …

CONSUELO MACK: So individual country funds or a portfolio of them.

BRIAN SINGER: Individual country funds, but you don’t have to do that. You could invest in ETFs, very efficient, very cost-effective that invest in large cap emerging market companies. Great. Small cap emerging market companies and even in frontier markets, so the smaller than emerging countries and the equity opportunities that are available there. Those are the things that I would invest in. They can be done passively. They should be done passively if you don’t have the opportunity to do a lot of research or invest in a manager who really knows what they’re doing, picking stocks or picking countries in those areas.

CONSUELO MACK: Brian Singer, what a treat to have you for the first time on WEALTHTRACK. Thank you so much for joining us.

BRIAN SINGER: Consuelo, thank you. I enjoyed being here.

CONSUELO MACK: At the close of every WEALTHTRACK we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point is take Brian Singer’s advice and invest some money in emerging market stocks.

Emerging markets are where the most dynamic growth is going to occur over the long term. And that’s where they belong, in the long time horizon, growth part of your portfolio.

They are called emerging for a reason – they have emergencies, as we have seen in China’s red hot then ice cold stock markets, which are heavily represented in most emerging market funds. Among the emerging market index funds and ETFs that Morningstar recommends are Vanguard’s Emerging Markets Stock Fund and its matching ETF.

Next week, for our Labor Day weekend program we are going to talk to one of our favorite guests about the essentials of planning for retirement and managing it with personal finance and Social Security guru Mary Beth Franklin.

In the meantime to see more of our interview with Brian Singer, specifically his favorable views on Bitcoin, visit our website wealthtrack.com and click on the EXTRA feature. Also continue to reach out to us on Facebook and Twitter.

Thank you for watching. Have a super weekend and make the week ahead a profitable and a productive one.

RYON & FRIDSON: RELIABLE RETIREMENT INCOME TRANSCRIPT

August 2, 2015

Believe it or not, both short and long term interest rates are at a 5,000 year low. And no, that is not a typo. No wonder there is a global search for income! On this week’s WEALTHTRACK we are discussing how to find reliable income producing investments for retirement. Thornburg Investment’s Five star rated municipal bond manager, Chris Ryon and fixed income guru Martin Fridson reveal their secure income strategies.

CONSUELO MACK: This week on WEALTHTRACK, as sources of income either dry up or become too expensive our intrepid guests , five- star rated municipal bond fund manager Chris Ryon of Thornburg Investment Management and fixed income guru, Martin Fridson of LLF Advisors find streams of income in out of the way places, next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. As a journalist I am the fortunate recipient of research from some of the financial industry’s top firms. One of the headlines that caught my attention recently came from Bank of America Merrill Lynch. It read: “The Lowest Interest Rates in 5000 Years.”

I knew that rates were at record lows but I had no idea that it went back five millenia. Here’s the chart. Yup, it starts at 3000 BC. It shows both short term and long term interest rates and it takes us, in a very compressed fashion, to the present 5000 year low. That’s what I call putting today in historical context!

It is no wonder that there is a global search for income. Of course not all interest rates are trading at record lows. Indeed some have been going up, especially where there is trouble.

Take triple tax exempt municipal bonds issued by Puerto Rico, whose credit rating was reduced to junk status last year. The U.S. territory is the third largest municipal bond issuer in the country, after California and New York despite the fact that its population is the size of Oklahoma’s and its GDP is smaller than that of Kansas. Unfortunately and not surprisingly, it is broke, which is why its rates have soared.

But issuers such as Puerto Rico and Greece are the exception not the rule. Government and corporate bonds have been in a three decade bull market, driven higher as interest rates fell, which led stock investor Warren Buffett to opine as early as 2012 that “Bonds should come with a warning label.”

Should they? Where else can you go for income? This week’s guests are two income pros.

Martin Fridson is the Chief Investment Officer of Lehmann Livian Fridson Advisors, a wealth management firm specializing in income investing that he co-founded in 2013. Fridson is a recognized expert in fixed income. Once dubbed the “Dean of the high yield bond market” he was the youngest person ever inducted into the fixed income analysts society hall of fame. Christopher Ryon is a Municipal Bond Portfolio Manager at Thornburg Investment Management. Among the multiple funds that he manages is the Limited Term Municipal Fund, rated five-star by Morningstar. Before joining Thornburg in 2008 Ryon was the head of the Long Municipal Bond Group at Vanguard Funds where he oversaw the management of more than $45 billion dollars in 12 intermediate and long-term muni funds. Thornburg is a sponsor of WEALTHTRACK but Ryon is here because of his independently recognized track record.

I began the interview by asking both guest if bonds should indeed now carry a warning label?

CHRIS RYON: Bonds have an important place in a well-diversified portfolio. Yes, we’re at the tail end or what appears to be the tail end of a 30-year bull run in bonds, but investors should realize there’s a reason to keep them in their portfolios. You want to have stocks, bonds, real estate, cash even though it doesn’t yield a lot, and the reason being is it provides ballast in case we’re wrong and rates stay at a low level for a prolonged period of time, and they also move counter cyclically to your stock portfolio. So in a well-diversified portfolio they have an important place even if in today’s environment they are overvalued.

CONSUELO MACK: Warning label. Should they have them, Marty?

MARTIN FRIDSON: Well, I think that may be a little extreme in that they’re going to be all right from a credit quality standpoint if you’re keeping an eye on that, and what you really need to be concerned about is a permanent loss of capital. You shouldn’t wake up in the middle of the night in a cold sweat about some volatility which we’re likely to have, but really the key thing is to avoid the permanent capital losses that would come from owning bonds of insufficient quality such as they default and you lose both your interest and your principal.

CONSUELO MACK: You mentioned volatility. One of the big issues being raised among bond observers is the lack of liquidity in the bond market, so Chris, how big a concern for you is the illiquidity in the bond market?

CHRIS RYON: It’s significant. We’ve had regulations and regulators have been trying to … they’ve pushed investors out the risk spectrum because of the Fed’s very accommodative stance on short part of the market. Jeremy Stein noted that in February of 2013. At that time he goes, “If losses are incurred by people who have moved out the risk spectrum, that’s fine as long as it’s not systematic.” Now they’re beginning to worry about that, and my big concern is that they put on more regulation to fix a problem of this over-accommodative Federal Reserve policy. Zero interest rates were important when we were losing 500,000 jobs a month like we were between May of ’08 and May of ’09, but right now we’re adding 250,000 jobs a month. Now the liquidity has shrunk especially in the municipal bond market. Dealer …

CONSUELO MACK: Why especially in the municipal bond market?

CHRIS RYON: Well, it has shrunk in all segments of the market, but as a municipal bond manager I’m overly sensitive to what’s happening in my market. Dealer inventories in municipal bonds have shrunk from about seven and a half percent of volume in mutual funds and ETFs down to two and a half percent. So that’s a two-thirds shrinkage. In the corporate market we’ve also seen as investors have moved into bonds out of stocks and out the risk spectrum that right now ownership of corporate bonds and ETFs and mutual funds has risen to about 20 percent which is in line with the municipal bond market, but that used to be less than 10 percent because corporate bonds were owned more by institutions than indirect retail ownership. Now what happens is in the municipal bond market when retail ownership gets spooked by rising rates, they sell their mutual funds. What happens if we have a double barrel event and you see selling in municipal bond mutual funds and corporate mutual funds at the same time? A dealer’s going to have to make a choice. Where do I allocate capital? That could exacerbate the problems and cause bigger price disruptions.

CONSUELO MACK: How worried are you about liquidity in the fixed income markets, Marty?

MARTIN FRIDSON: Well, I agree with everything that was said, but I want to put this in perspective a little bit. It’s always ugly when you get into a bear market. You have price gaps and drops that are not just the quarter of a point but very sharp drops in a single day. That’s happened in all the previous cycles, and it will happen again in the next cycle. When you talk about the dealer inventories, it’s very important to keep in mind that it’s not as if the dealers were ever there stabilizing the market. I mean that’s what specialists on the New York Stock Exchange were required to do with their capital. There’s never been an obligation for the so- called market makers in the corporate bond market to use their own capital and lose money. One of the things that you can count on is when the bear market begins you’ll hear the phrase, “Don’t try to catch a falling knife.” This phrase comes back in every cycle as if it’s never been heard before, and dealers are just going to step aside as they have in previous cycles until the prices start to look attractive. There is some effect of the clampdown on proprietary trading, but I think there are some hedge funds and other players who will step into that role of being the bottom fishers when that time comes. So I think it’s going to be hard even after the fact to say how much worse this cycle was because of the regulatory changes which I agree are problems, so for me to sit here and say, “Here’s how it’s going to be,” is even more crazy because you’re not in the same circumstances that you were, and it’s going to be very hard to compare. So it’s going to be a difficult period as rates ratchet up, no question.

CONSUELO MACK: What is the strategy then for individual investors? As Marty was just saying before that one of your goals is to avoid the permanent loss of capital. You want to preserve principal. What kind of a strategy? How do we protect ourselves from that? How are you doing it at Thornburg?

CHRIS RYON: There are two ways. First of all, investors have to have a proper investment horizon. We suggest two to three years. I also …

CONSUELO MACK: That’s as opposed to six months.

CHRIS RYON: As opposed to 60 days. I’ve had phone calls from advisors saying, “My client moved from a money fund to your bond fund. This was when the taper tantrum hit and has lost money.” I go, “What’s their investment horizon?” “Well, they had a three-month investment horizon,” and I told him that I know you want me to tell you everything’s going to be okay, but with that short of an investment horizon, I can’t say it. If you told me it was a year or two years, the probabilities rise that everything would be okay.

CONSUELO MACK: If you’re investing in bond funds or bonds for instance, then you should stick with them because if you guys have done your homework, the credit quality should be fine. You’ll get your money back. You won’t have the permanent loss of capital.

CHRIS RYON: Yes. If you go back to 1994 when the Fed started raising rates, short term rates go up 200 basis points. Long-term rates go up 100 basis points. Intermediate and long- term bond funds as measured by some indexes woefully underperformed short-term bond funds over that 12-month period, but if you had stuck it out and held it for two years, ’94 and ’95, the annualized return of intermediate and long bond funds outperformed the short bond funds because rates started coming down at the end of ’95 when the market realized the Fed was serious about fighting inflation. Short-term rates stayed elevated. So those losses were with you for a longer period of time.

CONSUELO MACK: Right. And Marty, I have to ask you because in the past when we’ve had you on WEALTHTRACK you were the high-yield bond guru. Here you are. You’ve got a new firm that you founded last year with two other partners, and its goal is investing for income and preservation of capital. What role do bonds have in the portfolios that you’re managing now?

MARTIN FRIDSON: We make some use of them. We have some high-yield bonds. They’re a little bit rich right now, not drastically overpriced but probably would be a bigger portion of our portfolios at some future point when they’re genuinely attractive. We use some corporate bonds particularly short-term corporate bond funds as kind of a liquidity buffer, but the biggest part of our portfolio is our preferreds.

CONSUELO MACK: Preferred stocks. Right?

MARTIN FRIDSON: Preferred stocks. Well, not all of them are actually stocks. We use the term “preferreds” because they’re a variety of instruments where in some cases the underlying asset is actually a bond. A trust has been created that pays out to the preferred holders.

CONSUELO MACK: And what’s the advantage of preferreds? And again, you’re managing money for high net worth individuals. So these are for individuals who are looking for steady income.

MARTIN FRIDSON: That’s right. Well, one of the great advantages of them is that it’s not really an institutional market. A lot of the issue sizes are too small for a big money manager to get involved in. They wouldn’t really be able to buy in big enough size.

CONSUELO MACK: And is that a plus?

MARTIN FRIDSON: Yeah, because there’s less research. You do see some pricing anomalies that come up, so you have an opportunity to buy at attractive levels. We’re not looking to generate high turnover, but we can add some value by buying issues that are just generally underpriced and riding them back up.

CONSUELO MACK: And what about the liquidity issue with preferred securities?

MARTIN FRIDSON: You don’t want to be in a position where you’re forced to liquidate at a bad time. You want to stay liquid enough so that you’re not in that position because the liquidity won’t be great. They can gap down when the market sells off, but we’re able to for the individual investors fill orders if we decide to move into a name. It may take a little bit of time to complete it, but we don’t find that to be an insurmountable problem.

CONSUELO MACK: And speaking of an individual’s market, the municipal bond market is certainly an individual investor’s market. Right?

CHRIS RYON: Yes. You have 42 percent of the market being held by either individuals or by individuals in separately managed accounts. Another 18 percent is held in mutual funds, ETFs and closed-end funds, exiting out money market funds. So that’s close to 60 percent is retail ownership.

CONSUELO MACK: And Chris, how risky is the municipal bond market? Because obviously Puerto Rico has been a major headline recently. How do you analyze it?

CHRIS RYON: Overall the credit in the municipal bond market is improving.

CONSUELO MACK: It is.

CHRIS RYON: Tax revenues are getting better. States are doing better. Underfunded pensions in some stated have been modified and are getting better as stock returns go up. There are, though, these pockets of highly advertised issues, Chicago being one, Detroit, Stockton, and Puerto Rico being the latest, and you can analyze your way out of those. We don’t own Puerto Rico. We haven’t owned it for years because we felt their debt load has just been unsustainable. Chicago on the other hand has the economic wherewithal to fix their problems. The question is, do they have the political wherewithal to fix them?

CONSUELO MACK: And so therefore, are you investing in Chicago securities?

CHRIS RYON: We’re looking at it closely. Right now it’s a matter of price. But yes. At the right price we’ll be buying Chicago.

CONSUELO MACK: Individuals looking at investing in municipal bonds. Obviously there are the tax advantages. Again, how risky is that market?

CHRIS RYON: You still have credit risk and you have duration risk since price sensitivity changes in yields.

CONSUELO MACK: To interest rates. Right.

CHRIS RYON: And we’re at very low levels of interest rates, so an investor has to be cognizant of the price sensitivity of the portfolios or funds they’re investing in. The other thing an investor has to be cognizant of is how is that fund structured. There are three ways to structure a municipal bond portfolio, especially in the short and intermediate segment of the markets. You could barbell the portfolio which means invest at the extremes of the portfolio’s investment universe. You could …

CONSUELO MACK: So have short-term bonds and long-term bonds.

CHRIS RYON: Exactly.

CONSUELO MACK: That barbell.

CHRIS RYON: Right, and nothing in the middle, or you could bullet the portfolio which means concentrating your investments in the middle of the investment universe, or the method we prefer is to ladder our portfolios.

CONSUELO MACK: And explain what laddering is.

CHRIS RYON: Laddering is that we invest in every segment of the portfolio’s investment universe. So in a one to ten-year fund like our Limited Fund, we’ll invest in every maturity. We’ll overweight the maturities slightly that we think are cheap and underweight those that we think are rich, and over the long term that structure has paid out handsomely, beating the other two structures over the last 20 years by 20 to 25 basis points. It doesn’t work all the time. It works 60 to 70 percent of the time, and that’s assuming you’re right 100 percent on your decisions on when to reweight. As I like to say, if I was in major league baseball and I was batting .600 to .700, first I’d be in line for a drug test and then maybe put in the Hall of Fame.

CONSUELO MACK: So Marty, I’m intrigued by the specializing in income, in steady current income and preservation of capital. What are the different types of securities aside from preferred that you’re looking at?

MARTIN FRIDSON: We also use Master Limited Partnerships and Real Estate Investment Trusts. Within some of the bond categories we’ll look at closed-end funds particularly when you have very large round lot sizes that make it out of the league of our clients to participate in directly.

CONSUELO MACK: And dividend-paying stocks. Right?

MARTIN FRIDSON: Yes. Dividend-paying common stocks are a very important component because what people lose sight of is that if you retire today at 65, you have a life expectancy of more than 20 years. Although inflation has been low by the standards of what a lot of us remember back in the ‘70s, it works like compound interest. So even a fairly low level of inflation builds up so that if you retired 20 years ago with literally a fixed income, say a pure bond portfolio, long-term bonds and the income stayed where it is, you’ve actually lost 38 percent of your purchasing power over that time.

CONSUELO MACK: Wow, but by having this fixed income portfolio that’s not growing with inflation.

MARTIN FRIDSON: Right, and so we think about what that means to your lifestyle. Imagine you go to the golf course and they only let you play 11 holes. That’s how big a hit.

CONSUELO MACK: Tragedy.

MARTIN FRIDSON: That’s how big a hit it’s been. So you need a growth component, and the dividend-paying common stocks, not the ones with the highest yields today but the ones that have a long record of increasing their dividends and the prospects of continuing to do that without sacrificing too much in current yield on the overall portfolio, you can build in that protection against that erosion of purchasing power over time.

CONSUELO MACK: So that’s a core part of your portfolio are these common stocks with growing dividends. But another mission of yours aside from steady income, current income is also preservation of capital. So here we’ve had a six-year bull market. People have been looking for income vehicles, so I’m assuming that any stock paying a dividend has been looked at and acquired. How expensive, how dangerous are these levels as far as the preservation of capital aspect?

MARTIN FRIDSON: They’re not a big part of it, and these companies are going to be around. Like any other stock, they can rise or fall with the market, but that has to be looked into the total part. I mean if you look at our investors, these are people who are looking to live on their income. Let’s say they have a million dollars in a 401(k) plan. They have to generate $50,000 a year over and above the Social Security income. Buying your growth stocks with one or two percent yield is just not going to do it for them. So they have to look at other vehicles, and they have to be realistic and say we’re not going to have a steady growth quarter by quarter for the next 20 years. There’s going to be some volatility in the portfolio, and if you can accept that you can earn that sort of return in the five to six percent range with a variety of those vehicles that we’ve talked about.

CONSUELO MACK: Any munis?

MARTIN FRIDSON: We use them a little bit.

CONSUELO MACK: A little bit?

CHRIS RYON: Use them more.

MARTIN FRIDSON: At this point. Well, we probably will at a future point. We’ve been a little concerned about the volatility, some of the issues that Chris mentioned, but we have them in the short-term area muni funds, and there are certainly a lot of very solid municipalities out there. So if you have some that have some problems, there are many others you can buy that are very sound.

CONSUELO MACK: One of the issues that’s come up in concerns about the bond market is that you hear out there that bond mutual funds are dangerous and that ETF bond funds are dangerous as well because of liquidity issues. So Chris, how dangerous are bond mutual funds and ETFs at this point?

CHRIS RYON: They’re not dangerous at all. It depends on how the manager’s managing these risks. For example, we’ve decided to take our durations into the bearish range because valuations have been on the rich side. To manage liquidity we’ve decided to sit with double- digit reserves. We want to be a liquidity provider when the market has these big disruptions, and we think we’ll be able to provide a lot of value at that time. ETFs are another question. ETFs have been advertised that you are buying them with daily liquidity, and the analogy I like to use is if you have an ugly dog and you put a blanket over it, you still have an ugly dog. So if you have an illiquid market, high yield or municipal bonds, and you put a distribution channel of an ETF over it, you still have an illiquid market. If people want their money back, the ETF just like a mutual fund is going to have to sell bonds to be able to give them money back.

CONSUELO MACK: At the end of every conversation on WEALTHTRACK, we ask for the one investment for a long-term diversified portfolio. So Chris Ryon, what would it be? What should we all own some of do you think?

CHRIS RYON: Well, I’ll be a bit of a homer because I like the municipal bond market. I especially like the intermediate portion of the municipal bond market.

CONSUELO MACK: And intermediate meaning …

CHRIS RYON: Let’s say 12 to 20 years because in that portion of the curve you pick up about 80 to 90 percent of the income of a long municipal bond at about 65 percent of the duration risk. So to me that is, if you’re a value-oriented investor, you’re getting paid to take that kind of risk there.

CONSUELO MACK: Right. And again, a longer-term horizon, and we asked long-term diversified portfolio. That’s kind of the sweet spot now.

CHRIS RYON: That’s what I think it would be, and you have to have at least a five-year horizon for something like that.

CONSUELO MACK: Okay. Marty, what would yours be?

MARTIN FRIDSON: Well, I think every investor who is looking to earn income should have a liquidity buffer in the portfolio, and that might be five or ten percent of the total. We’re not talking about cash. Not talking about Treasury bills but short-term corporate bonds, short-term municipal bonds. You just don’t want to be thrown into the situation where you have to sell at the worst possible time. So if you have that buffer to take care of cash needs that might arise, might be unforeseen, you put yourself in a stronger position to deal with the market over the long run.

CONSUELO MACK: So we’ll leave it there. Chris Ryon from Thornburg Investment Management, thank you so much for being with us for the first time on WEALTHTRACK.

CHRIS RYON: Thank you.

CONSUELO MACK: Thank you so much for being with us, Chris Ryon from Thornburg Investment Management. Thanks for joining us for the first time on WEALTHTRACK and, Martin Fridson, once again. You’ve been on WEALTHTRACK many times over the years but now with a new firm, LLF Advisors. Thanks for being with us.

At the close of every WEALTHTRACK we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s action point is: Diversify your income sources.

Marty Fridson says his job is to be an income analyst, not an advocate, which is why he has switched his focus from what he characterizes as slightly rich high yield bonds to other sources of income, including dividend growing stocks and preferred securities.

Chris Ryon specializes in municipal bonds but he runs diversified portfolios of them and ladders the maturities in his selections to rotate risk and return.

In this record low interest rate environment, fraught with uncertainty, varying your income sources is the safest bet.

Next week is the beginning of the summer fund raising season on public television, so we are going to revisit a popular topic – retirement! We’ll hear from highly regarded financial advisor Jonathan Pond. He has some simple steps to see us through, no matter what our circumstances.

To hear more of our interview with this week’s two investment pros, including Ryon’s assessment of Puerto Rico’s woes and Fridson’s agnostic views on income opportunities go to our website wealthtrack.com and click on the EXTRA feature.

DOLL: BIG BUSINESS TRANSCRIPT

July 24, 2015

How expensive are large company U.S. stocks, the cornerstone of just about everyone’s retirement portfolio? Nuveen’s widely followed Chief Equity Strategist and large cap mutual funds manager, Robert Doll says there are high quality, dividend paying businesses worth owning for long-term value and income.

CONSUELO MACK: This week on WEALTHTRACK, picking the perfect portfolio potion for earnings and dividend growth. Nuveen’s star strategist and large cap funds Portfolio Manager Bob Doll shares his formulas for long term portfolio performance next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. Two of WEALTHTRACK’s most enduring investment themes in the decade since our launch Have been the power of compounding and the wisdom of diversification. The results over time of compounding, reinvesting dividends, capital gains and interest has been described as the most powerful force in the universe.

For instance $10,000 invested for the last ten years in the S&P 500, without re-invesing dividends and capital gains would be worth $17,318 dollars today. That’s an annualized return of nearly 6% and a cumulative return of 73 %.

But take that same ten thousand dollar portfolio, and reinvest the dividends and capital gains and you would have more than doubled your initial investment to $21,377, and gotten annualized returns of nearly 8% and a cumulative gain of 114%.!

As far as diversification goes the reality is that many investors are not that diversified among different asset classes. And in their stock portfolios they tend to hold hefty chunks of large company U.S. stocks in both actively managed and index funds.

It turns out that was not a bad position to be in over the last decade, especially during the now seven year old bull market when U.S. stocks ended up outperforming many international ones. As we just described $10,000 invested in just the S&P 500, with dividends and capital gains re- invested would have more than doubled your money.

That same $10,000 invested in a portfolio equally invested in the S&P, plus U.S. small cap and mid cap stocks and foreign developed country stocks and emerging market ones would have netted you about $500 more.

In retrospect, for this decade at least, diversifying by size and geography hardly seems worth the trouble! Is it? And what is the outlook for those large cap U.S. stocks that dominate so many portfolios?

This week’s guest specializes in that popular category and has been a WEALTHTRACK guest since the very beginning. He is Robert Doll, Chief Equity Strategist and Senior Portfolio Manager at Nuveen Asset Management where he manages the firm’s large cap equity series which includes running at least nine mutual funds including the traditional large cap value, growth and core funds, three large cap specialty funds: Nuveen Core Dividend, Concentrated Core And Growth and three alternative funds: Core Plus, Equity Long/Short and Market Neutral funds. Doll also writes widely followed Weekly Commentaries and 10 Annual Predictions, for which he recently did his midyear review.

I started the interview by asking Doll how expensive large cap stocks have become?

BOB DOLL: Well, they’re a lot more expensive than they used to be after the stock market’s tripled in the last six years, but earnings have done really well, Consuelo, and therefore their price/earnings ratios or other ways to measure valuation, they’re not all that expensive, and I’d go another step to say relative to other places you can put the money … cash, bonds … stocks are not expensive.

CONSUELO MACK: And so that’s U.S. large cap stocks are not expensive, but if I looked at other stocks in small caps, mid caps, they still come out okay?

BOB DOLL: They’re about the same in the U.S. You have to go overseas to get cheaper valuations, but then you get what you pay for. Things in the U.S. have been and likely are going to be pretty good going forward from an economic standpoint, and it’s more mixed overseas. I come back to you have to pay up to get quality.

CONSUELO MACK: Earnings outlook. There’s been a lot of talk about the fact that U.S. corporate balance sheets are in great shape but that the earnings growth is decelerating or at least not accelerating as quickly and, therefore, the outlook is not as positive as it has been during the bull market of the last six years. What’s your view?

BOB DOLL: I can’t disagree with that. However, we’ve been in an earnings slowdown phase. The economy was weak in the early part of the year. Oil price decline, dollar rise, all these things work against earnings. We’re beginning to anniversary some of that, and I believe the U.S. consumer will spend more money in the second half of the year. So I think earnings expectations will actually rise in the second half of the year. It is a necessary condition to have a good stock market in the second half.

CONSUELO MACK: So why are U.S. as consumers going to spend more in the second half of the year?

BOB DOLL: Jobs have improved noticeably. Some people are starting to get wage increases. Their net worth is at an all-time high. The oil dividend has still not been spent. So you line these things up, and I think the consumer’s ready to spend a little money. Not going to set any records but enough to talk about.

CONSUELO MACK: Is it time to take profits after this bull market run?

BOB DOLL: No one ever faults someone for ringing the cash register and taking a bit of a profit. The good news is your question is not black and white. It’s shades of gray. If I were at the beginning of this bull market fully invested and I’ve enjoyed a tripling of stocks, of course take a little money off the table. Sadly I find too many still sitting with a lot of cash and really have to think about putting money in, believe it or not, as opposed to ring the cash register. The ball game is far along.

CONSUELO MACK: And you said that when you go out and talk to clients, which you do a lot, one of the major questions that you get is, is it too late for me to get in? And you also told me that this is the least-believed bull market in your entire career.

BOB DOLL: I think so. Least-believed bull market and economic recovery. I mean there are still a lot of people who think we’re in a recession six years, actually in our seventh year now, of economic recovery, and I think that the tentativeness of the recovery, the slow recovery in jobs, the absence of wage rate gains, people have neighbors that have been laid off, they have kids living in their basement, all this has fostered an attitude that something’s not quite right. As a stock investor, I love this “Goldilocks” economy; making forward progress not too strong. If we get a strong economy, Consuelo, we’re going to worry about inflation and the Fed tapping on the brakes. Let’s just enjoy this stop-and-go economy while we have it.

CONSUELO MACK: The stop-and-go economy. Has it worked to our advantage then in extending the recovery and the bull market and, therefore, how do you answer the question to someone who says to you, “Bob, is it too late to get in?”

BOB DOLL: I think this economic recovery could set a record for longevity. It’s certainly going to go in the history books as one of the longer ones because it’s that already. I think there are a number of years left because we don’t have the excesses that usually cause bear markets to begin and recession. So I think it’s not too late at all. Now having said that, the easy money in this bull market is sadly in the rearview mirror. We’ve had a powerful move; twenty plus percent gains for six years. I can’t see that for the next six years. But can I see high single digits? Probably.

CONSUELO MACK: Can you say high single digits?

BOB DOLL: Yes, I can. So how do we get there? Earnings plus dividends. Earnings growth, four to six percent per annum which is below the long-term average, two percent for the current dividend. Four to six plus two means six to eight. That’s kind of my next ten-year target for U.S. equities.

CONSUELO MACK: I mean historically the eight percent is about in the ballpark or maybe it was even higher.

BOB DOLL: Eight for price. It’s 11 for total return. So six to eight means I’m on the less than usual because, again, the rearview mirror’s been so beautiful.

CONSUELO MACK: So dividends are really important for us for total return.

BOB DOLL: They are. They’re very important and, as you and I talked earlier, it’s about dividend growth. In an economy that’s improving where interest rates are likely to creep higher, we are in a place where as a result of that yield stocks, stocks that look like bonds, are probably going to lag. So what’s the alternative? Find companies that have positive dividend growth and a low payout and great free cash flow.

CONSUELO MACK: So Bob, you run so many different portfolios. I mean I’m not sure. Is it nine mutual funds? I mean that’s the number that you’re running?

BOB DOLL: Correct, nine mutual funds. One investment process, nine different sets of portfolio construction rules if you will.

CONSUELO MACK: So tell me what the investment process is. What do they all have in common?

BOB DOLL: They all have in common that we believe to beat our benchmarks and our competition, combining multifactor quantitative models with deep fundamental research. Two separate research processes that come together.

CONSUELO MACK: Are there securities that you have in common among all of these different portfolios? There are.

BOB DOLL: There are.

CONSUELO MACK: All right, so the for instances that would meet the value box and would meet the growth box for instance.

BOB DOLL: Correct, correct. We use the Russell organizations who’s the guru at deciding what’s growth and what’s value.

CONSUELO MACK: What’s value.

BOB DOLL: And they have decided in their infinite wisdom in the Russell 1000, which is our universe, about 250 of them are part growth and part value, so you can own them anywhere.

CONSUELO MACK: And so what are some of the largest positions that you have that are in several of your portfolios?

BOB DOLL: The largest company in the world, Apple Computer, is in all our portfolios.

CONSUELO MACK: Even a value portfolio Apple is?

BOB DOLL: Even a value portfolio. CONSUELO MACK: Why?

BOB DOLL: Because it’s partly in the value index. So if Russell says it’s a value index, now I’ve got to beat that index. I think I can beat it by owning some Apple Computer.

CONSUELO MACK: And what’s your view of Apple, whether or not you want to define it as growth or whatever, core or value?

BOB DOLL: I think despite how well Apple has done over multiple years, it’s still a good place to be invested. You know, it falls between the cracks. I talk to growth investors who say, “You know, it’s not the growth it used to be,” and then I talk to value investors who say, “It’s not cheap enough to call it a value stock.” It falls between the cracks. I think it’s priced to hit some singles and doubles. I mean the old days when the valuation was very high, they had to hit home runs to justify the price of the stock. No longer.

CONSUELO MACK: Do you have a projection that you make for an Apple, for instance, of what a target would be?

BOB DOLL: We don’t have target prices. When we own a stock, we have our reasons for owning it, and if those reasons stay in place, yeah, there’s a point in valuation where it gets to be too much, but we don’t have targets. We just keep revisiting the stock and the alternatives we have for the use of the money.

CONSUELO MACK: And how often are you turning over when you trade an Apple, for instance? How does that work?

BOB DOLL: So we trade around core positions, Consuelo. So we’ll have a core position, and when the stock underperforms for a bit and looks a little cheaper, we’ll add to it. Conversely, when it’s run hard, we’ll let a little bit go. So we trade around those core positions

CONSUELO MACK: But unless something goes drastically wrong in your expectations, you’re not going to get out of the company entirely.

BOB DOLL: That is correct.

CONSUELO MACK: So what are some of the other core positions that you think represent the kind of research that you do?

BOB DOLL: We like a lot of health care names, so a name in health care, United Healthcare, the granddaddy of the health care service, the HMO space. A consolidator, a market leader. Margin improves. Good top-line growth, good free cash flow. I mean the list of things that we look for, this company check, check, check.

CONSUELO MACK: The large cap universe. A lot of people will say, “Look, you’re better off in an index fund in the large cap universe because it’s a well-known universe”. Kind of everybody owns it. That’s where Wall Street does its own research. What’s your response to that? I mean are there treasures to be found that no one else has found in the large cap universe, or is it really well-mined?

BOB DOLL: Is it well-mined. There is no question about it. It is a very efficient part of the capital markets. Having said that, the first place I usually go when somebody challenges me is here’s the track record in the products that we manage. We’ve outperformed. Not all the time but most of the time and, more importantly, over time. So there’s some evidence that if you have a process, a discipline that makes sense and you stick to it and you get up a little earlier and you work a little bit harder, you can win. Now the average active manager in the last few years as you know has not done a very good job, and so the money has moved in a passive direction. The monkey’s on the back of we active folks. We’ve got to show the numbers to get the money back. If we don’t, shame on us.

CONSUELO MACK: The market capitalization model which is that basically you continue to pay up for the most expensive stock … the more valuable a stock, the bigger its position in an index … is that a problem? I mean is that a problem for index investors in that they’re owning more and more concentrated in a few stocks, one of them being Apple as you just said? So is that a problem?

BOB DOLL: It can be. As stocks get more expensive, they become bigger in the index, and you’re going to own more of it. Well, wait a minute. I think I want to buy them when they’re cheap, not when they’re expensive.

CONSUELO MACK: And therefore, so an Apple. I mean you’re owning it too. Does that make you an index hugger? Your active share, something that we’ve talked about on WEALTHTRACK before, is pretty high. Right?

BOB DOLL: Correct. Our active share runs 75 to 80 across our products on average.

CONSUELO MACK: And active share means how you differentiate yourself from the index.

BOB DOLL: Correct.

CONSUELO MACK: That’s your benchmark, so the Russell 1000 in your case. Right?

BOB DOLL: That’s right. So another way to look at it is, what do you own versus what don’t you own? The index owns them all. We happen to like companies that have strong unit growth and don’t need pricing power, health care, technology. We don’t like companies that require pricing power, energy and materials. There’s an investment bet that we are making relative to the benchmark. If you don’t do a little homework and try to figure that out, you’re stuck owning health care, technology, materials and energy in the proportion of the market. I think you can do a little better than that with a little bit of homework.

CONSUELO MACK: Bob, what kind of pressure are you under as a portfolio manager to match or to beat the benchmark?

BOB DOLL: Having done it over 30 years, there are many periods where I’ve underperformed, and you look in the mirror. You say, “Have I lost it? What’s the matter? Has this gone off the tracks?” That’s when it’s tempting to say, “You know what? Let’s change our discipline,” but that’s the exact time most likely when you want to dig in and dig deeper and stick to what got you there. So the answer to the question is I think part of being a good investor is being a disciplined investor. It doesn’t mean you don’t listen to the market. The market’s right. You’re not, but the process needs to make sense and be stuck to over time.

CONSUELO MACK: Tell me what the market is telling you now.

BOB DOLL: I think the market is saying that the economy in the U.S. is okay, perhaps improving. It’s saying that financial assets are not particularly cheap across the board, stocks and bonds.

CONSUELO MACK: And this is probably largely because of the Fed’s zero interest rate policy, and we’ve all had to go up the risk spectrum they call it.

BOB DOLL: And that’s exactly what the Fed wanted us to do, and we have, and so we’ve bid the price of these other assets up over time.

CONSUELO MACK: And what is the market telling you is inexpensive or is undervalued?

BOB DOLL: So part of that depends on how you see the future. I come back to energy stocks. Let’s talk about energy stocks. Everybody knows they’ve had a hard time. Does that make them cheap? Well, not necessarily. And does cheapness mean you want to own it? You need cheapness plus a catalyst to recognize the value, and in the case of energy that time will come but we think it’s not yet.

CONSUELO MACK: What about financial stocks? I mean do you own big banks?

BOB DOLL: We do and more than we have in some time.

CONSUELO MACK: And why is that? Why?

BOB DOLL: First of all, the big banks are arguably the cheapest cyclical in the marketplace, and we want to own cheap cyclicals in an environment that’s improving. Secondly, as interest rates begin to go higher, the fundamentals of the banks get a bit better. Thirdly, as we’ve seen in the second quarter earnings that have already been released, that we’re moving away from all this talk about the bank’s balance sheet and their credit problems and their litigation issues. Now we’re focused on good old-fashioned fundamentals.

CONSUELO MACK: Among your ten predictions that you make every year and that you’ve just reviewed recently is a prediction about the Fed. Right?

BOB DOLL: Yes.

CONSUELO MACK: The Fed’s been delaying again and again and again.

BOB DOLL: Delaying, delaying, delaying.

CONSUELO MACK: You’re still betting that it’s going to happen again this year.

BOB DOLL: Correct.

CONSUELO MACK: That the first trigger pull, the hike will happen.

BOB DOLL: And there are a lot of reasons why. The one I keep emphasizing is the starting point. Fed funds are at zero. When it got to zero, we had an emergency in 2008, 2009. This is 2015. The economy is standing up on its own two feet, and I think zero Fed funds are totally inappropriate for the environment which we’re in, and we’re all concerned. Is the Fed going to raise rates from zero to a quarter? Oh my goodness. What consternation around a 25 basis point move. If we were at some high number going higher, different argument. I’m not arguing for high rates. I’m not arguing for punitive rates. I’m just arguing for appropriate rates.

CONSUELO MACK: But that’s what you think they should do. They haven’t done it yet.

BOB DOLL: Correct. I think if you watch Janet Yellen’s comments over the last … she’s signaling they’re going to go there. I think the Fed’s dying to get started, Consuelo. They’ve been waiting. They’re watching us because it’s all we talk about, and so they’re concerned. What are we going to do to the markets and the economy? They’ve worked hard to get the system back on track after the near depression a few years ago, but I think this is the time they will get started unless there’s an absolute disaster between here and mostly likely September.

CONSUELO MACK: And what will it do when they do raise interest rates 25 basis points, a quarter of a percentage point, to the markets to the economy? You’re saying no effect. It’s so baked in.

BOB DOLL: I think we’re going to wake up and say, “Well, what’s new today from yesterday? It’s a quarter instead of … okay, now what changes in the world?” If I’m a bond investor, I can’t be quite so arrogant about my answer.

CONSUELO MACK: No. Absolutely not.

BOB DOLL: As that affects the curve, but again if we were thinking the Fed’s going to start this process to get to a punitive level on the economy, then it’s a different argument, but they’re looking to move rates from very low to still low.

CONSUELO MACK: We talked about why you would own some of the fundamentals that go into owning a stock and the reasoning. You also have portfolios that short stocks, some alternative portfolios. What makes you short a stock?

BOB DOLL: Sort of the opposite of what makes us buy a stock to be cook-bookish about it. That is to say, to own a stock we want cheap companies with improving fundamentals. It’s over simplifying but not really. On the short side? Expensive stocks with deteriorating fundamentals, and so if we identify sectors in the marketplace … and we think there are some. I mentioned before we don’t like bond-like equities. We’re short some bond-like equities.

CONSUELO MACK: So you mean like utilities and …

BOB DOLL: Correct. Utilities is a good example. Homebuilders is another. We think that homebuilders have been overdone a bit in the marketplace, so we have some shorts in the homebuilding area. High P/E stocks or a collection of high P/E stocks that we think trees don’t grow to the sky, so whether that’s in health care or technology. Even though we like the areas and have a lot of longs, we’ve got a few shorts in those areas too.

CONSUELO MACK: What does a long-short fund do in a portfolio? Most of us have long- only portfolios. Why are you running these alternative equity funds, the long-short fund for instance?

BOB DOLL: What they give investors is more bang for the buck if you will. If you put a dollar in a long-only fund, you’ve got a dollar working for you. If you use a long-short fund, ah, now you have the long side and the short side working for you. I like to say I have 17 fundamental research analysts, and they go about their business and they analyze companies, and they come back and they say, “I looked at these six companies. Three we like. Three we don’t.” In a long-only portfolio you take the three you don’t and you throw it in the trashcan. If you have a long-short portfolio, ah, if the analyst is any good now we can make some money on this side and some money on this side for our investors.

CONSUELO MACK: U.S. stocks have outperformed foreign ones which you have predicted in the past that they would. What’s going to happen in the future?

BOB DOLL: I think it’s a little harder to make that argument now. Non U.S. economies are beginning to do a bit better. Certainly Japan has done better. Parts of Europe are doing better. If you have a lot of patience, the emerging markets are not all that expensive. There are issues. You have to hold your nose to buy them, but you can’t have a monolithic U.S. portfolio only as actually has been the case in recent years. If you didn’t diversify and own U.S. large cap, you actually did really well. Diversification has detracted from your performance. That’s not normal and I would never counsel having all your eggs in any one basket.

CORTAZZO & FRANKLIN: SUCCESSFUL RETIREMENT TRANSCRIPT

July 17, 2015

When you retire and how you invest can mean the difference between a comfortable retirement and a disastrous one. How do we go the distance in retirement without running out of money? Award winning personal finance experts, Macro Consulting Group’s Mark Cortazzo and InvestmentNews’ Mary Beth Franklin share their strategies for retirement success.

CONSUELO MACK: This week on WEALTHTRACK, two personal finance champions show us how to train for the big retirement race, keep our portfolios in shape and able to go the distance. Macro consulting’s award winning Financial Planner Mark Cortazzo and InvestmentNews’ Social Security maven Mary Beth Franklin share their retirement workouts next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. As WEALTHTRACK celebrates its tenth anniversary year we have invited some of our regulars back to discuss how much has changed and how much remains the same since 2005.

One thing that has changed for everyone is that we are all ten years older, no exceptions, ten years closer to retirement and in some cases our viewers are now in retirement.

Another big change over the past decade is that interest rates have plummeted. Short term interest rates have been at or near record lows ever since December of 2008 when the Federal Reserve lowered its key short term interest rate, the Federal funds rate to zero. Much of the rest of the world has followed by lowering their official lending rates. That has set off a worldwide search for income.

Another major shift has occurred in stock prices. The S&P 500 which began WEALTHTRACK’s launch at the 1,222 level in July of 2005 peaked in October 9th of 2007, only to suffer its biggest decline since the 1930s, a 57% drop to its March 2009 low during the financial crisis. It took years for the S&P to surpass its old high.

According to one of this week’s guest’s award winning Financial Planner Mark Cortazzo when you retire and how you invest can mean the difference between a comfortable retirement and a disastrous one.

He cites three hypothetical examples. He calls them the “Three Brothers”. They each retire with a million dollars, they each withdraw 60,000 a year, or 5,000 a month, but retire three years apart. Brother 1 retires in 1997, as the tech bubble was gaining steam.

Brother 2 retires in 2000 at the top of the market, just before the tech bubble bursts and Brother 3 retires in 2003 as the credit bubble that imploded in 2009 was in its infancy.

But here’s the scary part. By 2015 there was a wide discrepancy in their investment results and under one scenario the middle brother had almost run out of money.

Scenario one has them all investing only in the S&P 500, by 2015 Brother 1 had $1.64 million in his portfolio… Brother 2 had only $63,945 left in his retirement account! And Brother 3 had $1.65 million.

Scenario two has them all investing the million dollars in a diversified stock portfolio, evenly divided among five asset classes, international developed country stocks, U.S. small cap, large and midcap and emerging market stocks. The results were quite different and much improved. Brother 1 would have doubled his money to nearly $2 million, Brother 2 would have one million, what he started his retirement with and Brother 3 would have $2.4 million.

What are the lessons to be learned from these outcomes?

Joining us is Mark Cortazzo, a Certified Financial Planner, Founder and senior partner of Macro Consulting Group, an independent financial planning firm established in 1992. Cortazzo was recently named to the Barron’s Top Advisor List for the seventh consecutive year, among many other recognitions.

Mary Beth Franklin is contributing editor at InvestmentNews, a leading trade publication for financial advisors. She is an award winning personal finance journalist, a recognized expert on Social Security and the author of a recently published book, “Maximizing Your Social Security Retirement Benefits.”

I began the interview by asking them why there was such a huge and frightening discrepancy among the “Three Brothers” portfolio results, especially under scenario one when they each invested their million dollars in the S&P 500.

MARK CORTAZZO: Really the only difference between the three brothers was the day they turned 65 and what happened the following three years. The first brother, the first three years the market went up, and they were taking withdraws from profits. The second brother, the market started going down, and those withdraws were eating into the principal, and the percentage of the remaining account value that that withdraw represented got bigger and bigger, and you get to a point where even if you have very strong performance and it’s on a small dollar amount, it’s still not enough to overcome that withdraw, and this cascading effect continues to erode your principal even in a bull market.

CONSUELO MACK: Right, and then the third brother …

MARK CORTAZZO: Got a fast start. He started in ’03, got the first three years where the market did quite well, and they’re both in great shape and, the middle brother, he better hope that he was very nice to the other two brothers, because he might end up living with one of them.

CONSUELO MACK: Exactly. Mary Beth, how common is this outcome where you have these vast discrepancies among retirees?

MARY BETH FRANKLIN: Well, it’s critical now. Particularly we have so few of the guarantees that the previous generation retirees had where there was traditional pensions, where there were guaranteed retiree health benefits. Now people don’t have those guarantees, and they are more heavily reliant on their investments. So consequently when they retire or when they start taking those withdrawals are going to make a huge difference in the outcome.

CONSUELO MACK: We can control when we’re going to retire now, except there are still people who have to retire at 65 or even in the early 60s for health reasons, for company policy reasons, whatever. So Mark, so how do I avoid being Brother 2 and ending up with $66,000 to live on in 2015?

MARK CORTAZZO: It goes back to you can avoid risk, you can manage risk, and you can transfer risk. You can manage risk by setting up a pool of money that will create an income stream for you for a certain period of time, five years, six years, and if the market isn’t doing well, that bond comes due. You have that pool of money. You can spend that. If the market is doing well, take some of that froth. Take some of that profit. Use that to live off and spend and keep this war chest there that will buy you time, because the markets in decline but they’ve come back, and if you were able to wait it out and not have to sell good equities at a bad time, you would have been fine.

MARY BETH FRANKLIN: I think …

CONSUELO MACK: So Mary Beth, I know you’ve had a strategy for an emergency fund for a long time.

MARY BETH FRANKLIN: Right. Part of the idea is what some people call the buckets of money strategy or time segmentation where you divide your assets into time frames. Maybe you have two to three years of cash that this is going to handle your out-of-pocket expenses, and maybe in years four through up to ten you have some sort of fixed investments, even if it’s a dividend-paying stock; that you’ve got some sort of predictable income coming in. And then you stay invested for the long term, maybe in years ten and beyond because, face it, a typical retirement now could last 30 years or more, so you’re still a long-term investor even in retirement, but the idea of these different buckets of money is no matter what happens to the stock market today, I don’t need that money for 10 years. I can sleep at night. I can stick to my retirement plan, and I think this is why you’re going to see an increasingly important role for financial advisors in the retirement income phase. This stuff is complicated, and people are going to need help.

CONSUELO MACK: We’re in that phase where we’re not accumulating our savings. We’re actually starting to distribute our savings. So Mark, you said up to six years of cash to pay your expenses for six years. That’s a lot actually.

MARK CORTAZZO: Well, and what we’ve done for clients is we’ve done a laddered strategy. So they’re getting a blended yield that is comparable to what inflation’s at on a tax- free basis, and it’s not there to make you money. It’s there to protect you, and protection costs money whether you’re buying an annuity to protect you. It costs money. You’re sacrificing performance by being in lower-returning investments for protection. So you’ve got to make a choice of how much upside do you want and how much protection do you want, and as you get closer to retirement or in retirement, if you make that call wrong, you don’t have a lot of time or resources to recover from that. So it is a critical decision.

MARY BETH FRANKLIN: There’s this increasing philosophy in retirement income planning of creating this floor, some sort of predictable or guaranteed income, whether it’s a combination of annuities, Social Security, maybe if you have a pension to at least cover your fixed costs in retirement.

CONSUELO MACK: You create a floor that every year will cover, I think, your …

MARY BETH FRANKLIN: Your essentials.

CONSUELO MACK: … your essentials, the food and shelter essentially and transportation, whatever it is.

MARY BETH FRANKLIN: And then on your discretionary income, maybe you can’t take a cruise every year, but with the stock investments perhaps, maybe that’s going to fund the cruise every other year, and you can adjust accordingly, but I think it’s very important again where there are fewer sets of guaranteed income to create your personal pension in some sort of way, whether it’s buying an annuity or exercising a Social Security claiming strategy that’s going to result in more money so that those fixed costs are covered.

CONSUELO MACK: Before we get to that, because I do want to talk about how you create those income streams, is I just want to finish with the “Three Brothers”, and the other example, the discrepancy was the difference between just being invested in an S&P 500 for instance fund and a diversified stock portfolio, a huge difference.

MARK CORTAZZO: Huge difference.

CONSUELO MACK: Why? So how important is global diversification among just your stock portfolio?

MARK CORTAZZO: Well, 10 years ago we were having the exact same conversations that we’re having today, and that was people, all they want to talk about is being invested in the S&P 500 and comparing what they did the last year or two or three to the S&P 500.

CONSUELO MACK: I think 20 percent plus annualized returns over the last six years, the S&P 500.

MARK CORTAZZO: Absolutely, and the last time that happened was at the end of the ‘90s.

CONSUELO MACK: That should tell us something.

MARK CORTAZZO: The trees don’t grow to the sky as they say, and what happens is you get rotations. We’ve had a lot of things where the Fed’s been helpful. The dollar’s been strong. Rates have been low that have been very, very strong catalysts for large U.S. companies. That is starting to shift. Diversification across small cap, mid cap, large cap, international, emerging markets during a drawdown left you with significantly more wealth. The last 15 years a diversified portfolio with a little bit in each of that, the rate of return was double that of the S&P. We have this short-term reference point that the last one year, two year, three year S&P has done great, and diversification now seems lame, and your portfolio manager or your financial advisor is going to be wrong. I would much rather be wrong in a bull market and earn you a little bit less than be wrong in a bear market and have you be wiped out.

CONSUELO MACK: I see.

MARY BETH FRANKLIN: And that’s it. Diversification is key, but over the last 10 years the difference is we’re in an increasingly global economy.

CONSUELO MACK: We’re also dealing with obviously over the last 10 years just record low interest rates. So how has that changed your clients’ portfolios and their ability to get the kind of income that we all need in retirement?

MARK CORTAZZO: What has happened is the avoiding risk strategy. When we sat here the first time, money markets were paying four percent. If you had a million dollars and you just parked it in the bank, you were making $40,000 a year.

CONSUELO MACK: Which we would love those days to return.

MARK CORTAZZO: And you could have avoided risk and had that significant income stream cover your shortfall. Today at the bank, you’re earning $2,500 a year, and that’s not covering any base costs. So people have been forced to take risks, and they have gone down in credit quality and out in maturity on their fixed income just trying to grab yield and the concern I have with that is that they’ve been rewarded for taking risk because rates have continued to decline. I was in the market working at a bank as an investment officer in ’94 when we had seven increases, and those bond funds that were the best performers when rates were coming down got absolutely hammered when rates went up, and we haven’t experienced that and most of these fixed income investors haven’t experienced that. That is a bad, very expensive lesson to learn during your retirement. So that’s one of the things that we would focus on.

MARY BETH FRANKLIN: I think it also shows how people in retirement are going to have to pull a lot of levers. It’s not just about investments. For some people it might be continued employment, whether it’s consulting work or all those guys who really want to work part-time at Home Depot and play with the toys, or maybe it’s looking at your home equity. It could be selling the big house, moving to something smaller, banking the difference, or paying off your mortgage and living at a lower cost. So that’s where people are going to need the advice of which one of these sources of income. Is it my investments? Is it my home equity? Is it continued employment? Is it an inheritance or rental income? All these pieces are going to make up the future retirement income. A lot more decisions involved.

CONSUELO MACK: And Mary Beth, let me ask you about your specialty which is Social Security. You have made an industry out of maximizing Social Security. It’s something that we all took for granted and just didn’t really pay much attention to. It turns out there are huge discrepancies in what you can get from Social Security if your strategies are correct. So how key is Social Security now in this income-starved world?

MARY BETH FRANKLIN: It is critical for two reasons in an era where so few people have traditional pensions anymore and in this low interest rate environment because, for example, for every year you’re willing to postpone collecting your Social Security benefits beyond your full retirement age which is currently 66 up until age 70, you’re going to earn an extra eight percent per year.

CONSUELO MACK: For a lifetime.

MARY BETH FRANKLIN: That’s a 32 percent increase. You can’t get a risk-free eight percent a year anyplace else.

CONSUELO MACK: And you’re dealing with a lot of high net worth individuals, but is it valuable? Or how valuable is Social Security to them?

MARK CORTAZZO: It’s extremely valuable. It’s one of those things. What we try to do is focus on the things that clients have control over. If they have pensions and they can take a lump sum or they can take only on their life or different options for their spouses, focusing on what their options are and making the right decision, Social Security is something you have options available to you. Understanding what they are and how to maximize them based on your individual circumstances, longevity in your family, your current health, your spouse’s current health. So things that you have control over, maximize those. We don’t have control over interest rates or the stock market. Those we have to hedge and manage risk, but there are plenty of things in people’s retirement lives that making good decisions can be more important than getting a better investment return.

CONSUELO MACK: Mary Beth, speaking of the search for income, annuities used to be a dirty word. Are they still?

MARY BETH FRANKLIN: In some circles they are still a dirty word, and you know, there are good annuities and there are bad annuities, but the difference is you have to figure out what is your purpose. If you’re looking for guaranteed income, you have to pay for that privilege.

CONSUELO MACK: But the point is you get a guarantee even though the insurance industry doesn’t want to say it’s a guarantee.

MARY BETH FRANKLIN: Exactly.

CONSUELO MACK: But you get a stream of income for life. Right?

MARY BETH FRANKLIN: Exactly, and the darlings of the industry at least among the academics at this point, not so much around consumers yet, is the idea of investing a little bit of money now to pay out way in the future, like when you’re 80.

CONSUELO MACK: Longevity insurance.

MARY BETH FRANKLIN: Longevity insurance.

CONSUELO MACK: Or deferred income. Whatever.

MARY BETH FRANKLIN: It’s a deferred income annuity, and it’s like the ultimate roulette wheel of investing. It’s red or black. If you live to 85 you’re going to get a great payoff. If you don’t, you don’t.

MARK CORTAZZO: If I’m 65 and I have this income stream that’s going to kick in at 80 or 85, I know that’s the end game. I just need to make it to shore and I’m fine.

CONSUELO MACK: What are the other things that you can control? And I’m thinking of taxes for instance.

MARK CORTAZZO: Taxes, cost, where you own what you own, where you draw from. Those are all very, very important things. Right now we have taxable money, IRA money, Roth money. There’s different pools, different pots of money. The cost and the tax consequences on your investment is very, very important, and we see this all the time. People have a 50/50 mix of stocks to bonds in their IRA and outside their IRA, and they own the same investments, and they have high-yield funds, and things are throwing off lots of income, and they’re not using it but they’re paying taxes every year on those distributions. If they just shifted those assets to the account that was deferred, their return doesn’t change. The amount of money that they have doesn’t change, but they’re not sharing it with Uncle Sam, and when you pay that $10,000 in tax, you don’t lose $10,000. You lose what that $10,000 would grow to over the next 30 years which is a big number.

CONSUELO MACK: That’s another way to look at it.

MARY BETH FRANKLIN: And the same idea of asset location is if you have those growth stocks that are throwing off capital gains which could be taxed at 15 or 20 percent, but they’re inside your traditional IRA. When you pull the money out, it’s at your ordinary income tax rate, so that idea of putting the appropriate assets in the appropriate vehicle. The other thing that I’ve seen changed over the past decade as far as retirement income planning goes, it used to be the hierarchy of how you tapped assets. Grab Social Security at 62 because, heck, it’s just greens fees, no big deal. Then we’re going to drain the brokerage account and hold onto that IRA, that Holy Grail of retirement income.

CONSUELO MACK: Until you have to distribute at 70.

MARY BETH FRANKLIN: Until you have to have it at 70 and a half. That may not be the smartest strategy anymore for several reasons. One is so many people do not realize that how much they’re going to pay for their Medicare premiums is tied to their income, and if they wait until 70 and a half to start tapping that IRA, it might be a big chunk of money that’s then going to push up their Medicare premiums. Wouldn’t they be better off taking a little bit out each year to supplement some of their other income so they don’t get pushed into that big high premium?

CONSUELO MACK: Oh, that’s really interesting.

MARK CORTAZZO: Taking a little bit from each of the pots where you can blend your tax rate down, and right now the magic number is like $250,000, $400,000. You hit those numbers in income, all of these bad things happen to you. So you can get the same cash flow. You can get the same spendable income, and you’re just taking a little bit from your left pocket and a little bit from your right pocket. It changes how much the government gets and also can help you prevent hitting some of these penalty numbers.

MARY BETH FRANKLIN: And for years we’ve been talking about the value of converting some of your traditional IRAs to Roth IRAs, but I think now we have an even better reason, and one of it is this Medicare premium. If you know now if you convert a little bit of your traditional IRA each year, maybe up to the top of your tax bracket, that you are creating this tax-free pot of money in retirement and, as Mark said, you draw some from the fully-taxable IRA, some from the tax-free Roth IRA, some from your brokerage account that has a preferential tax rate, you’re going to hold down your overall tax bill in retirement, and that’s going to leave you with more spendable income. Just like we say on the accumulation phase; it’s not what you make. It’s what you keep. It’s even more important in retirement.

CONSUELO MACK: In the transition from the accumulation to the distribution phase, what is one or two of the biggest mistakes that retirees make in that transition?

MARK CORTAZZO: The biggest one is the things that have helped get them there and all of the things that they’ve been taught that make them a good investor are the things that can hurt you the most as a retiree. You have been taught about dollar cost averaging. When the market goes down, that’s good because you’re buying more and more shares on the dip. So when you’re accumulating money, time and volatility are your friend. I want the market to dip because I get to buy on sale.

The longer I’m investing, the greater my opportunity is to hit that expected rate of return. So you’ve been rewarded and been successful because you’ve done these things. When you retire and you flip the switch, time and volatility become your enemy, and that decline in the market with you drawing hurts you, and the longer you live, the greater the chance of you failing and running out of money. So you literally have to flip a switch the day that you retire and unlearn everything that you’ve learned because it’s a completely different game when you start drawing from the portfolio.

CONSUELO MACK: Biggest mistake that you can think of that people make in that transition?

MARY BETH FRANKLIN: I think on the accumulation side people deal with rules of thumb. I should save 10 to 15 percent of my gross income. I should aim to withdraw four percent of my portfolio in retirement. The mistake they make is rules of thumb are great for the long term, but when you get up to the actual retirement, you want hard numbers. If you’ve never created a budget in your life, you want to know how much your costs are going to be and what your expected sources of income are and match them up, and if there’s a gap, you want to know that before you retire and figure out how to fill it.

CONSUELO MACK: All right, so that’s the best thing that you can do in that transition. What’s the best thing that you can do, Mark, in the transition aside from what Mary Beth just said which sound brilliant.

MARK CORTAZZO: I think taking an inventory of the risk within the portfolio is very, very important. Fixed income, like we said, we’re seeing a lot of things that people go through a risk profile online. They say, “I’m going to be a 50/50 mix.” They come in to us because they want us to double check what they’re doing, and the 50 percent of the portfolio that they have that’s in fixed income is in preferred stocks and is in high-yield bonds and things that are …

CONSUELO MACK: Risky.

MARK CORTAZZO: … very risky. They’re called fixed income, but they act like stocks. High-yield bonds went down almost as much as the equity markets in ’08. So these are things that are named one thing, but they’re stocks in drag. They’re not bonds. High-quality bonds did very well in ’08, and they buffered some of that hit.

CONSUELO MACK: You know what the final question is. You’re both WEALTHTRACK regulars. So Mary Beth, one investment for a long-term diversified portfolio?

MARY BETH FRANKLIN: Well, I consider Social Security claiming strategy is probably one of the best “investment” decisions a pre-retiree can make. Don’t make it lightly. I don’t care what decision they make; just make an educated decision.

CONSUELO MACK: And you have a terrific book on that very subject which will be on our.

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