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If the Market is at an all-time high, is now a good time to invest?

On February 19, 2020 the S&P 500 Index hit an all-time high, closing at 3,386.15 as part of a historic bull run that started on March 9, 2009. Over the next 23 trading days the index fell nearly 34%, amidst the uncertainty stemming from the COVID-19 outbreak. Fast forward to August 18th and you’ll see it only took 126 trading days for the S&P 500 Index to make the round trip from peak-to-trough-back-to-peak. For investors, the question many are asking is, “why invest when the market is at an all-time high?”

When markets hit all-time highs, investors may wonder whether they have already missed the rally and are better off waiting for a pullback rather than getting into the market. They may consider taking profits now, weary of an imminent downturn. Some investors may make tactical decisions that do not align with their initial investment plan based on their beliefs on what may happen next.

More often than not, one major fear is driving similar reactions to these scenarios: what if I make an investment today and the price goes down tomorrow?

Good news is, the data makes a compelling case as to why investors should not do any of these things. The below exhibit suggests that new market highs have not been a harbinger of negative returns to come. The S&P 500 Index went on to provide positive average annualized returns over one, three, and five years following new market highs.

Average Annualized Returns After New Market Highs

S&P 500, January 1926-December 2018

Past performance is no guarantee of future results. New market highs are defined as months ending with the market above all previous levels for the sample period. Annualized compound returns are computed for the relevant time periods subsequent to new market highs and averaged across all new market high observations. There were 1,115 observation months in the sample. January 1990–Present: S&P 500 Total Returns Index. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. January 1926–December 1989; S&P 500 Total Return Index, Stocks, Bonds, Bills and Inflation Yearbook™, Ibbotson Associates, Chicago. For illustrative purposes only. Index is not available for direct investment; therefore, its performance does not reflect the expenses associated with the management of an actual portfolio. There is always a risk that an investor may lose money.

Source: Dimensional Fund Advisors

To Bit or Not to Bit: What Should Investors Make of Bitcoin Mania?

Bitcoin and other cryptocurrencies are receiving intense media coverage, prompting many investors to wonder whether these new types of electronic money deserve a place in their portfolios.

Cryptocurrencies such as bitcoin emerged only in the past decade. Unlike traditional money, no paper notes or metal coins are involved. No central bank issues the currency, and no regulator or nation state stands behind it.

Instead, cryptocurrencies are a form of code made by computers and stored in a digital wallet. In the case of bitcoin, there is a finite supply of 21 million,¹ of which more than 18.5 million are in circulation. Transactions are recorded on a public ledger called blockchain.
People can earn bitcoins in several ways, including buying them using traditional fiat currencies³ or by “mining” them—receiving newly created bitcoins for the service of using powerful computers to compile recent transactions into new blocks of the transaction chain through solving a highly complex mathematical puzzle.

For much of the past decade, cryptocurrencies were the preserve of digital enthusiasts and people who believe the age of fiat currencies is coming to an end. This niche appeal is reflected in their market value. For example, at a market value of $57,000 per bitcoin,4 the total value of bitcoin in circulation is less than half of a percent of the aggregate value of global stocks and bonds. Despite this, the sharp rise in the market value of bitcoins over the past weeks and months have contributed to intense media attention.

What are investors to make of all this media attention? What place, if any, should bitcoin play in a diversified portfolio? Recently, the value of bitcoin has risen sharply, but that is the past. What about its future value?

You can approach these questions in several ways. A good place to begin is by examining the roles that stocks, bonds, and cash play in your portfolio.

Expected Returns

Companies often seek external sources of capital to finance projects they believe will generate profits in the future. When a company issues stock, it offers investors a residual claim on its future profits. When a company issues a bond, it offers investors a promised stream of future cash flows, including the repayment of principal when the bond matures. The price of a stock or bond reflects the return investors demand to exchange their cash today for an uncertain but greater amount of expected cash in the future. One important role these securities play in a portfolio is to provide positive expected returns by allowing investors to share in the future profits earned by corporations globally. By investing in stocks and bonds today, you expect to grow your wealth and enable greater consumption tomorrow.

Government bonds often provide a more certain repayment of promised cash flows than corporate bonds. Thus, besides the potential for providing positive expected returns, another reason to hold government bonds is to reduce the uncertainty of future wealth. And inflation-linked government bonds reduce the uncertainty of future inflation-adjusted wealth.

Holding cash does not provide an expected stream of future cash flow. One US dollar in your wallet today does not entitle you to more dollars in the future. The same logic applies to holding other fiat currencies — and holding bitcoins in a digital wallet. So we should not expect a positive return from holding cash in one or more currencies unless we can predict when one currency will appreciate or depreciate relative to others.

The academic literature overwhelmingly suggests that short-term currency movements are unpredictable, implying there is no reliable and systematic way to earn a positive return just by holding cash, regardless of its currency. So why should investors hold cash in one or more currencies? One reason is because it provides a store of value that can be used to manage near-term known expenditures in those currencies.
With this framework in mind, it might be argued that holding bitcoins is like holding cash; it can be used to pay for some goods and services. However, most goods and services are not priced in bitcoins.

A lot of volatility has occurred in the exchange rates between bitcoins and traditional currencies. That volatility implies uncertainty, even in the near term, in the amount of future goods and services your bitcoins can purchase. This uncertainty, combined with possibly high transaction costs to convert bitcoins into usable currency, suggests that the cryptocurrency currently falls short as a store of value to manage near-term known expenses. Of course, that may change in the future if it becomes common practice to pay for all goods and services using bitcoins.

If bitcoin is not currently practical as a substitute for cash, should we expect its value to appreciate?

Supply and Demand

The price of a bitcoin is tied to supply and demand. Although the supply of bitcoins is slowly rising, it may reach an upper limit, which might imply limited future supply. The future supply of cryptocurrencies, however, may be very flexible as new types are developed and innovation in technology makes many cryptocurrencies close substitutes for one another, implying the quantity of future supply might be unlimited.
Regarding future demand for bitcoins, there is a non zero probability5 that nothing will come of it (no future demand) and a non-zero probability that it will be widely adopted (high future demand).

Future regulation adds to this uncertainty. While recent media attention has ensured bitcoin is more widely discussed today than in years past, it is still largely unused by most financial institutions. It has also been the subject of scrutiny by regulators. For example, in a note to investors in 2014, the US Securities and Exchange Commission warned that any new investment appearing to be exciting and cutting-edge has the potential to give rise to fraud and false “guarantees” of high investment returns.6 Other entities around the world have issued similar warnings. It is unclear what impact future laws and regulations may have on bitcoin’s future supply and demand (or even its existence). This uncertainty is common with young investments.

All of these factors suggest that future supply and demand are highly uncertain. But the probabilities of high or low future supply or demand are an input in the price of bitcoins today. That price is fair, in that investors willingly transact at that price. One investor does not have an unfair advantage over another in determining if the true probability of future demand will be different from what is reflected in bitcoin’s price today.

What to Expect

So, should we expect the value of bitcoins to appreciate? Maybe. But just as with traditional currencies, there is no reliable way to predict by how much and when that appreciation will occur. We know, however, that we should not expect to receive more bitcoins in the future just by holding one bitcoin today. They don’t entitle holders to an expected stream of future bitcoins, and they don’t entitle the holder to a residual claim on the future profits of global corporations.

None of this is to deny the exciting potential of the underlying blockchain technology that enables the trading of bitcoins. It is an open, distributed ledger that can record transactions efficiently and in a verifiable and permanent way, which has significant implications for banking and other industries, although these effects may take some years to emerge.

When it comes to designing a portfolio, a good place to begin is with one’s goals. This approach, combined with an understanding of the characteristics of each eligible security type, provides a good framework to decide which securities deserve a place in a portfolio. For the securities that make the cut, their weight in the total market of all investable securities provides a baseline for deciding how much of a portfolio should be allocated to that security.

Unlike stocks or corporate bonds, it is not clear that bitcoins offer investors positive expected returns. Unlike government bonds, they don’t provide clarity about future wealth. And, unlike holding cash in fiat currencies, they don’t provide the means to plan for a wide range of near-term known expenditures. Because bitcoin does not help achieve these investment goals, we believe that it does not warrant a place in a portfolio designed to meet one or more of such goals.

If, however, one has a goal not contemplated herein, and you believe bitcoin is well suited to meet that goal, keep in mind the final piece of our asset allocation framework: What percentage of all eligible investments do the value of all bitcoins represent? When compared to global stocks, bonds, and traditional currency, their market value is tiny. So, if for some reason an investor decides bitcoins are a good investment, we believe their weight in a well-diversified portfolio should generally be tiny.7

Because bitcoin is being sold in some quarters as a paradigm shift in financial markets, this does not mean investors should rush to include it in their portfolios. When digesting the latest article on bitcoin, keep in mind that a goals-based approach based on stocks, bonds, and traditional currencies, as well as sensible and robust dimensions of expected returns, has been helping investors effectively pursue their goals for decades.

FOOTNOTES
1. Source: Bitcoin.org.
2. As of March 12, 2021. Source: Coinmarketcap.com.
3. A currency declared by a government to be legal tender.
4. Per Bloomberg, the end-of-day market value of bitcoin was $57,624.01 USD on March 11, 2021.
5. Describes an outcome that is possible (or not impossible) to occur.
6. “Investor Alert: Bitcoin and Other Virtual Currency-Related Investments,” SEC, 7 May 2014.
7. Investors should discuss the risks and other attributes of any security or currency with their advisor prior to making any investment.
Source: Dimensional Fund Advisors
The opinions expressed are those of the author and are subject to change. The commentary above pertains to bitcoin cryptocurrency. Certain bitcoin offerings may be considered a security and may have different attributes than those described in this paper. Dimensional does not offer bitcoin.
This material is not to be construed as investment advice or a recommendation to buy or sell any security or currency. Investing involves risks including possible loss of principal. Stocks are subject to market fluctuation and other risks. Bonds are subject to increased risk of loss of principal during periods of rising interest rates and other risks. There is no assurance that any investment strategy will be successful. Diversification does not assure a profit or protect against loss.

Why Are Small Cap and Value Stocks Outperforming As of Late?

When you’re shopping for toothpaste, you might check the price tag before heading to the counter to make the purchase. If you happen to find a 12oz tube of Colgate for $4 and a 12oz tube of Crest for $3, odds are you are going to go with the Crest – its human nature to pay less if your “expected return” will be the same. In the case of toothpaste, you’re getting fluoride from either option, but paying less makes the return on that investment higher. You care what things cost and price matters, it’s why price-tags are front and center for nearly everything you can purchase – clothes, cars, food, travel etc. This theory can and should be applied when making investment decisions as well, no matter what “environment” we’re in. 

Analysts will make the case that the recent outperformance of small cap and value stocks relative to their large cap and growth counterparts is being driven by a multitude of factors – inflation, rising interest rates, presidential policy, and economic recovery, among others. While these factors may contribute, at the end of the day it goes back to basic economic theory. We know that not all stocks have the same expected return, however, through principles of valuation and using information in prices, we can identify stocks with higher expected returns. A stock’s current price reflects information about expected future cash flows discounted by the expected return. All else equal, companies with lower relative prices (value stocks) and lower market capitalization (small cap stocks) should have higher expected returns. Exhibit 1 helps provide some empirical backing to this theory, showing the return experience of a small cap value index versus a large cap growth index. $1 invested in 1926 would have grown to $329,946 in the small cap value index, whereas that same $1 invested in the large growth index would have only grown to $8,890, a stark difference.

However, over the last decade, investors taking this approach to investing may have been disappointed in their returns, especially when looking across to their large cap growth brethren. The 10-year periods ending each month of 2020 were the 12 worst 10-year periods in history, when comparing small cap value stocks to large cap growth stocks.

It’s been a trying time for many investors, and while we expect positive small cap and value premiums every day, there are periods of underperformance, just like there are for all risk premia. Take the equity premium for example – this premium is recognized by nearly all investors, however, at the start of this century we went through a 13-year period when one-month treasury bills outperformed the S&P 500!

For investors, rather than trying to avoid downturns or time when to get in and out of the market, you may have a better investment experience by staying disciplined so you don’t miss out on the eventual recoveries, as we have seen over recent months with small and value stocks. Exhibit 2 highlights the positive performance of a few of Dimensional’s small cap and value focused strategies. For the 6-month period ending February 2021, Dimensional’s US Small Cap Value portfolio outperformed the S&P 500 by nearly 40%! Since the market bottom on March 23rd last Spring as a result of the COVID-19 pandemic, the S&P 500 has done well, returning 73.1%, the Dimensional US Small Cap Value Portfolio has done considerably better, returning 130.28%.2

So, what can we expect going forward? Based on the historical data we don’t expect to experience the underperformance of value relative to growth like we did in the 2020, where the 39% differential was the greatest calendar year underperformance ever. 3 On the flip side, we also know the returns we’ve experienced in recent months may not be sustainable at the current level of outperformance. What we do know is that there is sound economic theory and robust empirical evidence that support investing in value and small cap stocks and we expect these premiums to show up every day. We also know price matters, and paying a lower price implies a higher return.

We believe investors may be best served by making decisions based on sound economic principles supported by a preponderance of evidence. While markets and economies are constantly evolving, the theory that underpins the size and value premia is evergreen.

Exhibit 1

Past performance is no guarantee of future results. Actual returns may be lower. In USD. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Fama/French US Small Value Research Index: Provided by Fama/French from CRSP securities data. Includes the lower 30% in price-to-book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973) that have smaller market capitalization than the median NYSE company. Fama/French US Large Growth Research Index: Provided by Fama/French from CRSP securities data. Includes the higher 30% in price-to-book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973) that have larger market capitalization than the median NYSE company.

Exhibit 2

Performance data shown represents past performance and is no guarantee of future results.  Current performance may be higher or lower than the performance shown.  The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.  To obtain performance data current to the most recent month-end, visit us.dimensional.com. 
Source: Dimensional Fund Advisors 
Source: Morningstar. Small Cap Value is represented by the Fama/French US Small Value Research Index. Large Cap Growth is represented by the Fama/French US Large Cap Growth Research Index. 
Source: Morningstar. Returns for periods shorter than one year are not annualized. Short term performance results should be considered in connection with longer term performance results. 
Value stocks are represented by the Fama/French US Value Research Index. Growth stocks are represented by the Fama/French US Growth Research Index.  
4 Market bottom is 3/23/2020. Returns are from 3/24/2020-2/28/2021 
This information is provided for registered investment advisors and institutional investors and is not intended for public use. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.  
Past Performance is no guarantee of future results. Indices are not available for direct investment. 
5This information is for educational purposes only and should not be considered investment advice or an offer of any security for sale.  
A registration statement, including an Information Statement/Prospectus, relating to the reorganizations of four tax-managed mutual funds (“Converting mutual funds”) into newly-created series of the Dimensional ETF Trust (“New ETFs”) has been filed with the Securities and Exchange Commission on Form N-14 but has not yet become effective. Information contained in the registration statement is not complete and may be changed. Once effective and complete, the Information Statement/Prospectus providing details about the reorganizations will be sent to shareholders of the Converting mutual funds. The New ETFs will not be sold to the general public until after the reorganizations. This communication is not an offer to sell the shares of the New ETFs.  
Consider the investment objectives, risks, and charges and expenses of the Dimensional funds carefully before investing. For this and other information about the Dimensional funds, please read the prospectus carefully before investing. Prospectuses are available by calling Dimensional Fund Advisors collect at (512) 306-7400 or at us.dimensional.com. Dimensional funds are distributed by DFA Securities LLC. 
ETFs trade like stocks, fluctuate in market value, and may trade either at a premium or discount to their net asset value. ETF shares trade at market price and are not individually redeemable with the issuing fund, other than in large share amounts called creation units. ETFs are subject to risk similar to those of stocks, including those regarding short-selling and margin account maintenance. Brokerage commissions and expenses will reduce returns. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. This information should not be relied upon as a primary basis for an investment decision. Raghuram Rajan is not affiliated with Dimensional Fund Advisors.  Dimensional Fund Advisors LP does not endorse, recommend, or guarantee the services of any advisor, certification organization, advisory or consulting firm.  Raghuram Rajan is paid by Dimensional for his presentation. 

  

Real Investing is Not a Popularity Contest

Tulips were first imported from Turkey to Western Europe in the late 1500s. The unique, exotic look of these flowers soon captured the attention of the upper classes and quickly appeared in the gardens of affluent Dutch aristocrats. Over the course of the next several decades, tulips became a status symbol of wealth and sophistication highly sought after by the Dutch middle class. This demand led to tulips being listed on the Amsterdam stock exchange in 1636.

At its peak, a single tulip bulb could be worth thousands of florins, a gold coin of varying weight and purity. Historians debate their exact value at the time, but a rough estimation would put this amount equal to $500,000 or more in today’s dollars. Could such an amazing run last? Of course not, and tulips’ value would come crashing back down to earth over a three-year period ending in 1638. This is regarded as one of the earliest, most extreme asset bubbles in history. And like the tulip trade centuries ago, markets have provided examples of this type of phenomenon in recent decades and even in the first few months of this year.

GameStop and Bitcoin have recently caught the attention of investors and garnered headlines as money piled into each and they generated atmospheric returns, high volatility, and the occasional swift price correction. Why? That can be a difficult question to answer given the short time frame in which each swing occurred. Some might point to excess liquidity in the markets or a pent-up demand that has fueled a collective fear of missing out among investors. Others might point to markets becoming less efficient. Benjamin Graham, the late economist regarded as the father of value investing, is quoted as saying, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.” This wisdom holds as true today as when it was first spoken. Market participants tend to purchase securities in the short run as if they were participating in a popularity contest. And thus, security prices move rather quickly up or down. This is no different from the Dutch and their tulips in the 17th century. This type of short-term behavior can cause a disconnect between the price of a security and its fundamental value. However, as efficient markets continue working, the price of a security will come to reflect the fundamental value of the issuing company.

This is a part of the long-term approach that backs your portfolio. Its path aims to avoid short-term popularity contests, which often reflect nothing more than short-term noise, and instead leverages decades of collective market knowledge that has been weighed against the test of time.

When you are ready to talk about your investments, need to inform us of family or work-related changes, or want to discuss your financial planning needs, reach out. We are ready to help.

Sincerely,

Squire Wealth Advisors

Revisiting the 4% Rule

Saving for retirement is not easy, but using your retirement savings wisely can be just as challenging. How much of your savings can you withdraw each year? Withdraw too much and you run the risk of running out of money. Withdraw too little and you may miss out on a more comfortable retirement lifestyle.

For more than 25 years, the most common guideline has been the “4% rule,” which suggests that a withdrawal equal to 4% of the initial portfolio value, with annual increases for inflation, is sustainable over a 30-year retirement. This guideline can be helpful in projecting a savings goal and providing a realistic picture of the annual income your savings might provide. For example, a $1 million portfolio could provide $40,000 of income in the first year with inflation-adjusted withdrawals in succeeding years.

The 4% rule has stimulated a great deal of discussion over the years, with some experts saying 4% is too low and others saying it’s too high. The most recent analysis comes from the man who invented it, financial professional William Bengen, who believes the rule has been misunderstood and offers new insights based on new research.

Original research

Bengen first published his findings in 1994, based on analyzing data for retirements beginning in 51 different years, from 1926 to 1976. He considered a hypothetical, conservative portfolio comprising 50% large-cap stocks and 50% intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. A 4% inflation-adjusted withdrawal was the highest sustainable rate in the worst-case scenario — retirement in October 1968, the beginning of a bear market and a long period of high inflation. All other retirement years had higher sustainable rates, some as high as 10% or more.1

Of course, no one can predict the future, which is why Bengen suggested the worst-case scenario as a sustainable rate. He later  adjusted it slightly upward to 4.5%, based on a more diverse portfolio comprising 30% large-cap stocks, 20% small-cap stocks, and 50% intermediate-term Treasuries.2

New research

In October 2020, Bengen published new research that attempts to project a sustainable withdrawal rate based on two key factors at the time of retirement: stock market valuation and inflation (annual change in the Consumer Price Index). In theory, when the market is expensive, it has less potential to grow, and sustaining increased withdrawals over time may be more difficult. On the other hand, lower inflation means lower inflation-adjusted withdrawals, allowing a higher initial rate. For example, a $40,000 first-year withdrawal becomes an $84,000 withdrawal after 20 years with a 4% annual inflation increase but just $58,000 with a 2% increase.

To measure market valuation, Bengen used the Shiller CAPE, the cyclically adjusted price-earnings ratio for the S&P 500 index developed by Nobel laureate Robert Shiller. The price-earnings (P/E) ratio of a stock is the share price divided by its earnings per share for the previous 12 months. For example, if a stock is priced at $100 and the earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE divides the total share price of stocks in the S&P 500 index by average inflation-adjusted earnings over 10 years.

5% rule?

Again using historical data — for retirement dates from 1926 to 1990 — Bengen found a clear correlation between market valuation and inflation at the time of retirement and the maximum sustainable withdrawal rate. Historically, rates ranged from as low as 4.5% to as high as 13%, but the scenarios that supported high rates were unusual, with very low market valuations and/or deflation rather than inflation.3

For most of the last 25 years, the United States has experienced high market valuations, and inflation has been low since the Great Recession.4-5 In a high-valuation, low-inflation scenario at the time of retirement, Bengen found that a 5% initial withdrawal rate was sustainable over 30 years.6 While not a big difference from the 4% rule, this suggests retirees could make larger initial withdrawals, particularly in a low-inflation environment.

One caveat is that current market valuation is extremely high: The S&P 500 index had a CAPE of 34.19 at the end of 2020, a level only reached (and exceeded) during the late-1990s dot-com boom and higher than any of the scenarios in Bengen’s research.7  His range for a 5% withdrawal rate is a CAPE of 23 or higher, with inflation between 0% and 2.5%.8 (Inflation was 1.2% in November 2020.)9 Bengen’s research suggests that if market valuation drops near the historical mean of 16.77, a withdrawal rate of 6% might be sustainable as long as inflation is 5% or lower. On the other hand, if valuation remains high and inflation surpasses 2.5%, the maximum sustainable rate might be 4.5%.10

It’s important to keep in mind that these projections are based on historical scenarios and a hypothetical portfolio, and there is no guarantee that your portfolio will perform in a similar manner. Also remember that these calculations are based on annual inflation-adjusted withdrawals, and you might choose not to increase withdrawals in some years or use other criteria to make adjustments, such as market performance.

Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, including your withdrawal strategy.

 

All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Asset allocation and diversification are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss. Rebalancing involves selling some investments in order to buy others; selling investments in a taxable account could result in a tax liability.

The S&P 500 index is an unmanaged group of securities considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.

1-2) Forbes Advisor, October 12, 2020
3-4, 6, 8, 10) Financial Advisor, October 2020
5, 9) U.S. Bureau of Labor Statistics, 2020
7) multpl.com, December 31, 2020

What are SPACs?

Former NBA champion Shaquille O’Neal, former Speaker of the House Paul Ryan, hedge fund manager Bill Ackman, tennis legend Serena Williams and former MLB player Alex Rodriguez all have one thing in common, they are all involved with Special Purpose Acquisition Companies (SPACs). The hot new craze has caught Wall Street’s attention, and seemingly the attention of celebrities as well.

In 2020 we saw a resurgence in SPACs, as 248 new SPACs raised roughly $82 billion throughout the year, eclipsing the level from the previous decade.1 The SPAC boom has showed no signs of slowing down in 2021, as sponsors have raised nearly $26 billion in January alone, a monthly record.2

SPACs are also known as “blank-check companies” with no operating history. They are designed to raise funds through an initial public offering (IPO) in order to finance an acquisition, merger, or similar business combination with a private company. The SPAC may identify a targeted industry or business in the IPO prospectus; however, it is not obligated to pursue a target in the specified industry, and often does not, which may change the risk profile of the investment. SPACs are typically required to complete a business combination within a two-year period following the IPO, and if they are unable to do so the SPAC is liquidated, and shareholders receive their pro-rata share of the IPO proceeds. 

So, how do SPACs differ from traditional IPOs, the method in which many investors may be familiar with how companies go public? We can think of a traditional IPO as a company looking for money while a SPAC is money looking for a company. SPACs tend to be quicker to market than traditional IPOs, as the process can take a few months, much shorter than the 24-36 month process for a traditional IPO. In addition to the benefit of speed, SPACs provide retail investors with early access, something not generally available in traditional IPOs, as shares are reserved for certain clients of the underwriting banks. For many SPACs, the sponsors/founders receive a 20% allocation, leading to dilution in the company and potential misaligned incentives. Because SPACs generally must use the money they’ve raised within two years or return it, they may be incentivized to get any deal done, regardless if it’s a good one.

Terence Kawaja, the founder of the boutique bank Luma Partners quoted “As a guy who was doing deals in the market in 1999, it feels exactly like it did then. I worry about the public investors.” SPACs are simply another way for companies to raise capital and investors should be aware of the inherent pros and cons. Rather than being worried about missing out on the newest investment fad, investors should work with their advisor to build a long-term plan that will help them achieve their financial goals.

Source: Dimensional Fund Advisors

February Investor Letter

In 1984, 33-year-old Gary Kusin started an educational software retailer named Babbage’s. Started in Dallas, Texas, Babbage’s quickly expanded from educational software to focusing on Atari and Nintendo video games. Little did Gary know at the time, but his company would one day become a symbol of a market movement and capture the attention of households, Congress and regulators across the United States. But before we get into what Gary Kusin’s small company became, we need to understand a few key terms and mechanics of a stock market.(1)


Stock markets are exchanges, and in their simplest form are simply open-market auctions. Think Sotheby’s or a local estate auction, where potential buyers raise their paddle until only one buyer remains – but at a much larger scale. Thousands of buyers meet thousands of sellers every day through brokers on stock exchanges,(2) and the items of interest are shares of a company’s stock. Generally, none of the money in these transactions goes to the company; rather the two parties barter for existing shares of the stock. Most of this activity has moved digitally, but the fundamentals are the same: every transaction has a buyer and a seller, and presumably both sides think they are getting a good deal.


Occasionally an investor may see a stock that they believe is overvalued. In other words, they believe that buyers are willing to pay more for that stock than what it is actually worth. For those brave investors who are so convicted that a stock price is trading higher than its true value, a process exists for them to bet against the company. Through a broker, the investor connects with another investor who owns shares of the stock, borrows the shares and then sells them. This is called shorting the stock.(3) Assuming the price of the stock declines, the investor can buy back the shares at a lower price and return them to the lender, pocketing the difference in price. However, just as a bank may monitor a borrower’s credit worthiness, the lender of the shares needs protection to ensure that the borrower will eventually be able to repay the loan. The broker of the deal monitors how much it would cost for the borrower to purchase the shares compared to how much money the investor has available in their account. If the price of the stock rises too much, the broker can demand the investor either put more cash into their account or return the shares. If the investor is forced to return the shares, they must go back out to the market, find a buyer willing to sell and repurchase them. This, known as a margin call in financial jargon, essentially just protects the lender against someone
taking on a loan they can’t repay.


So, what does all this have to do with a software retailer from the 80s? In 1999, fifteen years after being founded, Barnes & Noble purchased Babbage’s for nearly $200 million.(4) Three years later, Babbage’s was combined with other similar retailers, and the company went public under a new name, GameStop.(5) Now, nearly 20 years after going public, GameStop has become a stock market phenomenon with the stock price jumping from $18.84 on December 31, 2020 to $325 at the end of January, a 1,625% jump in a single month.(6)


For those watching the financial media (or social media for the matter), the obvious question is how can this happen? Well, a lot of investors were betting against GameStop at the end of last year – a lot. In fact, every share of GameStop had been borrowed and sold, at least once.(7) In January, more investors started to take interest in buying shares of GameStop, partially spurred by speculative investors in an online forum,(8) and that demand pushed the price of GameStop higher. As the price continued to climb, the investors who had borrowed shares were forced to either put more money into their account or buy shares at a higher price to close their loan. As the price of GameStop’s stock climbed, more investors bought shares to cover their loans, which created more demand for shares of GameStop’s stock, which continued to push the price higher. This phenomenon is called a short squeeze, and the cycle continued throughout January, with the stock hitting a high of $483 on January 28.(9)


What does this all mean for your portfolio? Honestly, not a lot. As one of our clients, you own thousands of stocks to mitigate the risk of any short-term dysfunction of any single name in the markets. Investors who bet against GameStop were wrong, at least for now, and they had to buy a lot of GameStop stock to make up for their error. If margin calls didn’t exist, January may have looked very different for the price of GameStop’s stock. But, margin calls exist to protect lenders and they functioned as expected. Thousands of buyers met thousands of sellers, and they agreed to exchange shares of a stock for an agreed upon price.


We know that on any given day, the stock market can look like a casino with random outcomes. But, when viewed over longer horizons, the outcomes are logical. That is why we continue to encourage our clients to look past the daily noise – no matter how entertaining – and keep a long-term focus. And in case you’re wondering, we don’t think that it’s a good time to buy GameStop’s stock.



(2) Brokers, or more often market makers, would be similar to auctioneers in our example – they are a neutral party that help to
facilitate the trade, generally for a small commission.
(3) This all happens in a very opaque part of the market called the securities lending market. Shorting a stock is extremely risky, and
therefore this generally only happens at an institutional level. This is a vital source of information in an open, free market – this
communicates negative sentiment towards a stock and creates a way for insightful investors to profit from companies that are
setup to fall in value.
(9) source: finance.yahoo.com
This information is for educational purposes only and should not be construed as specific investment, accounting, legal or tax advice.
Investing involves risk including loss of principal. Information from sources deemed to be reliable but its accuracy and completeness
cannot be guaranteed. IRN-21-1776

Isn’t Investing in the Stock Market Just Gambling?

It should come as no surprise that the biggest football game of the year ranks as one of the most popular events to gamble on. The American Gaming Association estimates that over 23 million people in the US will wager around $4.3 billion on the big game.1 It should also come as no surprise that some of the money wagered will be lost, as the old adage goes ‘the house always wins.’

Recent speculative events in the financial markets have provoked many to question if investing in the stock market is akin to gambling. While there may be similarities, such as the risk of losing money, the probabilities of having a positive experience in the stock market are much greater than traditional gambling, especially when you take a long-term approach.

When you buy a stock, you become an owner of that company and are entitled to a claim on earnings and dividends into perpetuity. Stock prices fluctuate based on new information and the expectations of companies to generate profits, and prices settle at a level where there is a positive expected return. When you gamble, money is simply transferred from one party to another and no value is created, but odds are generally stacked against the players.

Exhibit 1 illustrates the historical outcome of success when investing in the stock market, using the S&P 500 as a proxy. Even over the shortest time period, 1-day, there has been a 56% chance of achieving positive returns. As you extend the time frame the probability of earning positive returns in the market increases. 

The longer you sit in a casino the greater the odds you’ll walk out a loser, the longer you stay invested in the stock market, historically, the greater the probability you’ll experience positive outcomes. Unlike gambling, we believe the house is on the investor’s side when taking a disciplined, long-term approach to investing.

Source: 1The Lines: How Much Money Will Be Bet on the Super Bowl In 2021?
Source: Dimensional Fund Advisors

 

COVID Will Likely Impact Your 2020 Tax Return

The CARES Act, a direct response to the economic turmoil caused by COVID-19, sought to provide economic support to millions of Americans. This support extended to the way taxes are filed and processed for 2020, creating additional benefits depending on your circumstances. Read on to learn five ways the events that took place in 2020 could affect your taxes. 

Impact #1: Stimulus Checks & Tax Credits

Millions of Americans received stimulus checks during 2020 and early 2021 – the first for $1,200 and the second for $600. These stimulus checks were also referred to as Economic Impact Payments or Recovery Rebate Credit. According to the IRS, if you did not receive these payments (and were eligible to do so) then you may be able to deduct them from your 2020 taxes.1 There are a few requirements you must meet before filing for this reduction.

You must:1

  • Be a U.S. citizen or resident alien during 2020

  • Must not be claimed as a dependent during 2020

  • Have a Social Security number for employment before your 2020 tax return is due

Impact #2: CARES Act & Retirement Accounts

The CARES Act allowed individuals with a 401(k), 403(b), 457(b) and Thrift Savings Plan to withdraw their funds without incurring the standard 10 percent tax rate from an early distribution.2 Instead, these withdrawals were considered coronavirus-related distributions.

If you chose to take a withdrawal during 2020, your taxes may be impacted in a few ways:2

  • They will count as income tax over a three- or one-year period, depending on your choice.

  • They can be repaid before the end of the three-year period to receive a tax refund.

Impact #3: Charitable Gift Deductions

Charitable deductions are often a great source of tax relief for filers. In 2020, the CARES Act provided some changes to charitable donations, allowing filers who take a standard deduction to benefit from charitable donations as well. Tax filers taking a standard deduction may now deduct $300 of cash donations on top of their standard deduction.3

Impact #4: Unemployment Benefits

There are a variety of unemployment options for those that lost their jobs. All unemployment benefits are considered taxable income for 2020, but whether they are taxed will depend entirely on the type of program.4 Make sure to check with your unemployment benefits provider to determine whether or not you will need to pay taxes on your unemployment. 

Impact #5: Tax Benefits for Business Owners

Business owners received two main benefits through the CARES Act, the Credit for Sick and Family Leave and the Employee Retention Credit.5 When filing taxes at the end of the year, consider whether the year’s changes allow you to benefit from other tax breaks beyond the CARES Act.

For example, many small business owners may have been forced to close down their physical location, opting for more remote work. Depending on the circumstances, these business owners may be able to claim their home as a home office, gaining a home office deduction on their 2020 taxes. Similarly, consider whether the changes created by 2020 make you eligible for other deductions and tax changes. 

2020 was a challenging year, and understanding the support that’s available can help promote your own financial wellbeing this tax season. Whether you’re filing your taxes soon or still gathering your papers, remember to consider these potentially impactful changes. 

2020 Year End Commentary

A Taoist story tells of an old man who accidentally fell into the river rapids leading to a high and dangerous waterfall. Onlookers feared for his life. Miraculously, he came out alive and unharmed downstream at the bottom of the falls. People asked him how he managed to survive.

“I accommodated myself to the water, not the water to me. Without thinking, I allowed myself to be shaped by it. Plunging into the swirl, I came out with the swirl. This is how I survived.”(1)

Think back to March when the government shutdowns were starting. Think about the forecasts and predictions being made. By late March, the S&P 500 had sold off over 30% of its value from its high in the middle of February, and small caps had sold off even more.(2) Looking back on the markets and the dreary expectations, would you have expected global markets to post double-digit returns for the year? Would you have guessed that emerging market stocks would perform in line with the S&P 500 for the year, with both markets up over 18%?(3) What about small caps? Would you have expected U.S. small cap stocks to return 20% for the year when there was so much uncertainty around whether many of these companies could survive the pandemic?(4)

The changing landscape from COVID benefited companies like Amazon and Zoom, so their growth during the year made sense, but would you have expected Tesla to post such extraordinary gains? The stock closed 2019 at less than $84 per share, but by the end of 2020, it was trading over $700 per share.(5) Tesla was added to the S&P 500 in December with a total market value of over $600 billion, making it the largest stock ever added to the index.(6) Looking back, we would like to believe we saw it coming (or at least that the signs were there), but if we are honest – doubling down on Tesla in January 2020 looked like a bet against the ‘smart money.’ At the end of 2019, roughly one out of every five shares of Tesla were betting on the stock price falling, not going up!(7) 

When we look at 2020, we are reminded that whether we are talking about industries or individual stocks, predicting the market is extremely difficult. Some people get lucky, but the skill to have repeat performance is rare. A recent study performed by S&P Dow Jones found that the top performing funds from June 2010 through June 2015 were more likely to liquidate or change their investment style than to continue to outperform over the next five years.(8) And that is the smart money – these are funds managed by professionals that invest millions in trying to be the best and have the edge.

We call this the loser’s game, and we choose not to play it – you have worked too hard to accumulate your wealth. Instead, we have designed your portfolio to flow with the markets, not to time or try to predict the markets. We invest across hundreds of stocks, dozens of countries and all sectors. In 2020, amidst the uncertainty, we rebalanced your portfolio to take advantage of lower prices and tax loss harvested to offset capital gains in other areas of your portfolio – we focused on what we could control. We continue to balance the stock risk in your portfolio with high quality fixed income to dampen changes in your total portfolio value. We stick with the strategy that we decided upon before the emotions took over. In other words, we plunge with the swirl, and we come out with the swirl – this is how we help you progress towards a successful retirement.

When you have questions about your investments, need to inform us of family or work-related changes, or want to discuss your progress towards your financial goals, reach out. We are ready to help.

-Squire Wealth Advisors

References:

Taken directly from: http://truecenterpublishing.com/zenstory/goflow.html; Cross reference: https://taoist-arts.com/News_-_Views/Chinese_Philosophy_/Zen_and_Taoist_Stories/zen_and_taoist_stories.html
From Morningstar Direct. From 2/20/2020 (the market peak) to 3/22/2020 (market bottom), the S&P 500 Index lost 31.8 percent and the Russell 2000 Index lost 40 percent.
From Morningstar Direct. From 1/1/2020-12/31/2020, global markets, as measured by the MSCI ACWI IMI index, returned 16.3 percent (with net dividends reinvested). The S&P 500 Index returned 18.4 percent compared to 18.4 percent for the MSCI Emerging Markets Investible Market Index (with net dividends reinvested).
From Morningstar Direct. From 1/1/2020-12/31/2020, the Russell 2000 Index returned 20 percent.
Source: finance.yahoo.com, historical prices.
Source: https://www.advisorperspectives.com/commentaries/2020/12/17/tesla-the-largest-cap-stock-ever-to-enter-s-p-500-a-buy-signal-or-a-bubble, retrieved January 4, 2021
Technically, this is called ‘short interest,’ and it is a measure of the percentage of outstanding shares that are sold short in the market. In December 2019, the short interest in Tesla ranged from a high of 20.1 percent at the beginning of the month to 18.3 percent at the end of the month, meaning that roughly one of every five shares were sold short. Source: Morningstar Direct.
Of the top 50 percent of performing funds from June 2010 to June 2015, 38.6 percent remained in the top half over the next 5-year period, 13.4 percent were merged or liquidated, and 28.1 percent changed their style. Source: U.S. Persistence Scorecard Mid-Year 2020, published December 8, 2020, retrieved January 4, 2021https://www.spglobal.com/spdji/en/spiva/article/us-persistence-scorecard.
Important Disclosure: Information presented herein is for educational purposes only and should not be construed as specific investment, accounting, legal or tax advice.  Certain information may be based on third party data which may become outdated or otherwise superseded without notice.  Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed.  Performance is historical and does not guarantee future results. Indices are not available for direct investment.  Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Total return includes reinvestment of dividends and capital gains.  By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party websites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The contents of client letter is for informational and educational purposes only. The information presented is not to be construed as investment, tax, financial, accounting or legal advice. Individuals should make their own evaluation and consult with a professional based on their individual circumstances. The information contained within this presentation is based upon data and information available at the time and may become outdated or change without notice. IRN-21-1695