Predictions and Advice, Rate Hikes and Gifting

Predictions and Advice

As 2015 draws to a close, we’d like to take this opportunity to first say that we appreciate our relationship with you, our clients and community members. We wish you a very peaceful and prosperous 2016.

For many, year-end will provide an opportunity to reflect, and to make plans for the year ahead, financially and otherwise. One thing we can be certain of: there will be no lack of attention-grabbing news from self-proclaimed advisors, pundits, and experts eager to help you formulate or influence your plans, or minimally, to cause you to doubt your current plan. Some of the advice will be sound; much of it, however, will be noise. How can anyone know the difference?

We recently read an opinion column in the Dallas Morning News that reminded us of how difficult it is for the layperson to even figure out who they can trust for sound financial advice. The article mentioned how a couple was heading from Paris to Normandy on a ~$9,000 Viking cruise. This was one of their annual incentive trips provided at no cost to the couple by the insurance company that employed the wife. She introduced herself to the columnist as a financial advisor and explained that she wins this perk annually for her “production”. Of course, every dime of that incentive trip ultimately comes from the savings of people that her company counsels about making “good plans for retirement”. One metric of measuring the quality of any “news” or “advice” comes from the age old adage – follow the money. Be wary of those whose incentives are not aligned with yours.

Another New Year’s tradition is the prominent predictions we are about to be awash in via the media channels. In small print will be the disclosure “past performance is not indicative of future results”. While this is clearly and demonstrably true for investments, as people, we simply cannot get comfortable with the concept of randomness. Instead, we seek solutions for that which we cannot reliably predict. Rain dances won’t actually cause it to rain; a broken mirror won’t actually cause seven years of bad luck. Yet, the news channels will be filled with articles, charts and historical data proclaiming ‘patterns’ which enable predictability. And, for every prognostication made, you can count on the exact opposite prediction being proclaimed by an equally “credentialed expert” or source.

The problem with many of these predictions is an assessment of causation due to mistaken correlation. While some patterns can be discovered and relied upon, some of the data truly is random. The trick is accepting and understanding what is random, and not to waste time and money guessing what can’t be reliably predicted, e.g. the year-ending value of the S&P 500 (or, any other benchmark for that matter). This frees up time and energy to focus on things that actually are reliable and dependable, albeit maybe not as flashy as some of what we’ll read about in the weeks ahead. At Pauley Financial, we don’t pretend we can predict what the market will bear in 2016, but we DO know that the long-term trend has always been one of growth (with corrections along the way), and that there are many savings, investment, and tax strategies that can be reliably employed to help you achieve your goals.

With that preface as a backdrop, we thought we’d pass along our thoughts on the recent U.S. Federal Reserve rate hike and provide an anecdotal mention of a widely publicized donation by Mark Zuckerberg.

The Recent Rate Hike

On December 16th, the U.S. Federal Reserve Board finally made its initial move in what tends to be a multi-month/year process of changing the direction of interest rates for the economy. This is the first time the Fed has raised rates since 2006. Since 2008, returns on short-term bonds have been at or near zero percent. This is, in large part, a consequence of the Fed targeting the Federal Funds rate (the interest rate at which depository institutions lend reserve balances to other institutions overnight) at less than 0.25%. The low-interest rate era was meant to encourage banks to lend by making their cost of funds cheap, with the outcome of providing liquidity to the credit markets to promote investing and economic activity. These efforts were part of the Fed’s Quantitative Easing (QE) program to pull/push us out of the credit crisis associated with the sub-prime mortgage debacle.

As part of the QE, the Fed also purchased more than $3.5 trillion worth of Treasury securities and home mortgage pools, increasing the supply of money available in the market place for lending/liquidity – a greater supply of money pushes the ‘cost’ of money (interest rates) lower.

Pulling back on these interventions is a balancing process which began with the Fed reducing its purchase of Treasury/mortgage securities in the secondary markets – one of its tools at its disposal for influencing interest rates higher. It is now employing another tool in its toolbox by raising the Federal Funds rate. Higher rates mean higher borrowing costs as the Fed shifts its focus from stimulating the economy to a focus on keeping it from overheating. Overheating could result in higher inflation and its associated negative impacts.

Markets are likely to be more volatile following these Fed moves; but, as we have said in the past, there are many forces impacting the short-term psychology of the markets beyond just the actions of the Fed. Despite the confident analyses you read in the papers and see on financial news channels, journalists trying to draw links between headlines and stock movements can be as random as the moves themselves.

As the economy reacts to anticipated future rate hikes, the Fed will evaluate the impact against its dual mandate of moderate inflation and low unemployment before making additional changes. Steering an $18 trillion dollar economy is like steering an aircraft carrier – you can’t (and shouldn’t) try to turn it on a dime.

It’s also worth noting that the Fed has announced no plans to sell the nearly $4.2 trillion worth of various bonds—including the aforementioned Treasuries and mortgages—that it purchased while trying to stimulate the economy. Selling the bonds would, of course, have the opposite effect buying the bonds had – increasing interest rates and attempting to cool the economic engine.

Facebook CEO's Milestone Donation

Finally, it may comfort you to know that Mark Zuckerberg, Facebook’s Founder and CEO, whose ~$45 billion donation to charity was widely publicized, did so in the same fashion that we have been recommending and executing for our clients. Gifting appreciated securities allows the charity (in this case, the Chan-Zuckerberg Initiative) to sell the stock and to avoid paying taxes on the built-up capital gains.

If you’d like to learn more about this effective tool for meeting your charitable intent, feel free to email or call us. In the meantime, best wishes for a relaxing and family-filled New Year’s celebration. Please remember those families that cannot be together because of the service men and women, and first responders, who are out there serving the rest of us.

Happy New Year,

-Your Pauley Financial Team