Finance 101: March 2024
In March the financial advisors at Ruedi Wealth Management wrote four more columns for The News-Gazette’s business extra section. Make sure to look for them every Saturday in the weekend edition of the paper, but in case you missed any in March all four are below.
If You Want Peace, Prepare for War
Paul Ruedi
Publius Flavius Vegetius Renatus was a Roman writer with expertise in military affairs who famously wrote the phrase “si vis pacem, para bellum” – “if you want peace, prepare for war.” The idea behind the phrase is that preparations for stressful events should be made before they occur, not when they are at your doorstep, or even worse, are already taking place.
When stocks are going through a perfectly normal temporary decline, I will constantly remind my clients of the permanent uptrend in stocks and how “this too shall pass.” But lately, with the stock market pushing to all-time-highs, I have switched our message to one of caution. It may seem strange, but while everyone is at peace after such strong stock returns, I feel the need to prepare them for the next battle.
Though we hope the upward momentum in stocks will continue, if history is any guide the upward progress of the stock market is going to be interrupted by temporary declines. After all, I’ve learned to expect a typical correction of 10% about every year. I have also learned to expect a bear market, a decline of 20% or more, every five years or so. If that wasn’t bad enough to think about, I have seen the stock market cut in half during the 2008 financial crisis. It could happen again.
But the next big stressor may not show up in the form of a sudden, temporary decline; it could very easily show up in the form of a long stretch of poor returns. After all, during the lost decade from 2000-2009, the S&P 500 produced a -9% return over an entire decade. Yes, this is only one group of stocks, but the point remains the same: stocks can go a long time without producing a positive return.
It is important to prepare for these possibilities now, while everyone is calm, cool, and collected, so you are not surprised if they show up. Investors may be able to mentally prepare themselves for such events, but they likely lack the expertise to make sure these events will not derail their financial goals.
Though we can’t predict when these events will take place, we are able to account for them in our financial planning process. If you aren’t sure how to build a financial plan that can stand up to temporary declines or long stretches of poor returns, you may want to consider working with a financial planner.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
Wealth Illusions
Paul R. Ruedi, CFP®
People like to add up all their assets to get a sense of their net worth or how “wealthy” they are. But as I think about how people often keep score, I can see how many people could be under the impression they are wealthier than they actually are. There are many types of wealth illusions, but I can think of three that many people fall for.
The first is thinking of home equity as money in the bank. Though it is nice to see the gap between the price of your home and the balance on your mortgage increase, thinking of this home equity as an asset you can readily use is a mistake. In order to access that equity you would either need to sell the home or borrow against the equity in some form. Both of those come with costs, some more substantial than others.
A couple with a $500,000 house and $400,000 remaining on their mortgage may feel like they have $100,000 to add to their net worth. But when you consider a typical 5% realtor commission ($25,000) may be required to access that equity, that asset is really only worth $75,000. They may also need to make repairs to get the house ready to sell and could potentially owe taxes on the sale as well, further reducing their proceeds from any sale.
People do the same thing when they ignore the taxes they will owe when they withdraw funds from their investment accounts. This is particularly pronounced with traditional IRAs. If you distribute funds from a traditional IRA, you will owe taxes on the entire withdrawal at your ordinary income tax rate. That can take a big bite.
Investors also frequently forget about the taxes on gains in a typical brokerage account as well. If you sell something at a gain in a taxable account, you will owe taxes on the gains portion of whatever you sell. That can be at a rate as high as 23.8% for long-term gains with the net investment income tax, or even higher for short-term gains. Keep in mind, positions that have been held for long periods are often mostly made up of gains.
Moral of the story, you shouldn’t think of certain assets as money in the bank and ignore the costs to turn them into usable spending money. Wealthier people are actually more likely to fall victim to wealth illusions as a result of their higher tax brackets. If you aren’t sure exactly how your assets will translate into usable cash for spending, you may want to talk to a financial planner.
Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.
March Madness Manager Selection
Paul R. Ruedi, CFP®
According to the NCAA roughly 60-100 million March Madness brackets are filled out each year. With so many people filling them out, you would expect to see some very good brackets and very bad brackets. But are these brackets a result of luck or skill? Will we ever be able to determine the difference?
I have always found it fascinating to see how the avid basketball follower’s expert bracket picks are often outshined by a completely uneducated guesser. With so many people attempting something that has so many elements of random chance, you will inevitably get a handful of people who just absolutely nail their bracket. If my experience is any guide, these big winners are a result of random luck rather than actual skill in picking the winners of basketball games.
It would be silly to expect a March Madness bracket winner to repeat that performance. But people do something similar when they choose investment fund managers based on recent performance. Thousands of funds are started. A select few inevitably have stellar performance. But are these managers truly skilled, and likely to repeat that performance? Or is it another case of thousands of coin flippers producing a few lucky streaks of ten heads in a row?
If you look at historical fund performance data, it sure seems more like the latter. Studies have consistently shown that out of all the funds that attempt to beat their benchmark, roughly 4 out of 5 fail to do so in any given period.
If you look at that small fraction of winners, the majority will not go on to beat their benchmark over the following period of time. Even if a fund manager outperforms a benchmark over a long period of time, with so much variability in investment returns, that performance will likely be not be statistically significant enough to distinguish whether it was a result of skill or just a lucky streak.
Moral of the story, a winning investment manager’s short-term performance is likely a result of luck, just like the performance of the winner of your March Madness bracket group. Though managers may use these hot streaks to tell a compelling story and attract assets to their investment funds, the actual investors in those funds bear the risk that their managers’ luck runs out.
Rather than basing your portfolio on luck or the perceived skill of investment managers, a much more sensible approach is to simply buy and hold a diversified investment portfolio. If you aren’t sure how to do that yourself, you may want to talk to a financial advisor.
Paul R. Ruedi is a CERTIFIED FINANCIAL PLANNER™ professional with Ruedi Wealth Management in Champaign, Illinois.
Advances in Technology
Paul Ruedi
My sons and son in law often tease me about how much I talk about advances in technology, particularly those driven by artificial intelligence. But I simply can’t help it. The excitement of all the innovation that is going on right now actually keeps me up at night. Below is a list of nine advances in technology that took place over just this past month.
1) The first person to receive a Nueralink brain-computer interface is already using it to play chess and write tweets.
2) The company, Figure, has developed a robot that will listen to your commands and using artificial intelligence will be able to interpret those commands and carry out tasks.
3) The company, Cognition, announced DevOn, the world’s first AI developer. This could potentially replace the legions of engineers we currently use to do advanced software development.
4) The biggest rocket ever built surpassed orbital velocity.
5) Startup Extropic, developed thermodynamic compute thesis – the concept that you can use the laws of thermodynamics to do complex computing very efficiently.
6) The hospital Mass General successfully implanted a genetically edited pig kidney in a patient.
7) The University of Chicago successfully tested a vaccine on mice that instead of helping your body remember to fight off an invader, it actually helps the body forget to create a response. This could be huge in helping people with autoimmune diseases.
8) Researchers used AI to discover 6 antibiotic molecules that may be able to counter antibiotic resistant strains.
9) Nvidia announced the Blackwell chip – the most powerful processing chip ever created by far.
Advances in technology often create boosts in productivity that allow companies to do the same things with fewer employees, or produce more with the same number of employees. That gives us plenty of reasons to be optimistic about the future of companies and the stock market. Innovations that don’t boost productivity improve our lives in other ways.
With all these advances in technology, I can’t help but be optimistic about the future. Though there are always reasons to worry and be pessimistic, there are clearly always reasons to be optimistic as well.
Paul Ruedi is the CEO of Ruedi Wealth Management in Champaign, Illinois.
Disclaimer: Past performance is no indication of future results. You should not make any investment decisions without first performing your own due diligence and consulting your financial advisor.