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FLOW: Volume 2 – Exploring the Real Estate Investment World

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In our most recent series written by Jamie Cornehlsen, Denver CFA and founder of Capstone, FLOW examines how we seek out investments and make selections based on current market trends and future forecasts. Part two of our series takes a look at the positives and negatives of real estate investing.

After deciding against purchasing the liquor store, my next move was onto real estate. I have several friends that thrive in the area of real estate investing and have learned that hiring a management team can provide relief from having to do the maintenance and the management yourself, so I began the search.

I focused primarily on residential properties as well as multi-family units.

I had determined that I wanted to get at least a 10% return with this investment. Looking at the real estate industry, I figured I could get a minimum of a 7% return and in some cases, as great as 17%.

Recognizing the Three Components of Return

All investments have three components of return: earnings or cash generated each year, growth of earnings, and (hopefully) increase in valuation. Earnings are the cash flow that is generated and paid to you. The growth of earnings is the increase in those expected earnings over a period of time. Last, the increase in valuation is the upturn in price per unit from the time you buy to the time you sell.

In terms of stocks, earnings are dividends that are paid to you. If a particular stock is paying a 10% dividend yield, you as the investor can expect 10% from dividends. The increase in earnings is the rise of dividends each year paid out to you. If the stock was purchased for $10 and the dividend was originally $1 per share, but increased to $1.30 over the course of five years, then the increase in earnings was 30% total, or 6% per year.

Last, you might have purchased the stock for 10 times a dollar of earnings and sold for 15 times a dollar of earnings. This represents a 50% increase in the valuation over five years, or 10% per year. As a result, you would have a total annual return of 26% per year: 10% for dividends, 6% from growth in earnings, and 10% for appreciation.

Wouldn’t a return like that be nice to get now a days? Unfortunately, the stock market has only averaged about 4.5% a year for the past 15 years.

Looking into the real estate market, I found homes that I could rent and expect to receive a 7% return from the rental income. I estimated I could increase the rent by 2% per year, and expect to see a 1% increase in the valuation.

I looked at buying a home for $150,000 and charging an annual rent of $10,750 or 7%. I could expect the rental income to increase from $10,750 in the first year to $13,450 at the end of a five-year period; roughly a 1% increase per year. At the end of five years, I could anticipate selling the property for $165,000, which in total would earn me a return of 10%. This would be good!

The Reality of Real Estate Investing

However, weighing into this grand plan would be the cost of annual maintenance, the expense of personally managing the home or hiring a property manager, and the toll of having a potentially unruly renter.

In the end, I decided that although I might be able to earn a great return on a real estate investment, I would still have to put up with the risk and hassle of managing the rental to some extent, in which the costs may outweigh the benefits of such a return.

My next FLOW post specifies how and what I decided to invest in.

Can You Chase a Winner in Investing?

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One of the most frequent behaviors in 401-K plans is for participants to move their money to the fund choices that did best in the past year. It is a good use of common sense — to think that the fund that did better has a smarter manager and is a better place for making money in the future than a manager whose fund did poorly last year.

Unfortunately, research does not back up this concept. S&P (Standard and Poors) keeps a scorecard that tracks whether or not outperforming funds continue their success over time. This month, they released their updated findings. Their research tracks funds across several time frames, various fund types, and also filters funds by top quarter and top half. The basic idea is that if fund managers’ good performance is due to their skill rather than luck, it will continue over time. Sadly, the research they do almost uniformly shows that this is not the case. For instance, of the funds that were in the top quarter of US stocks for a one-year period in September of 2013, only 4.28% remained in the top quarter in September of 2015. Far from persisting, there is some indication in these numbers that they do worse than you would expect by pure chance. There are some areas where managers seem to operate a bit better, such as emerging market bonds and multi- cap funds (that is, funds where the manager can decide whether to buy small, medium, or large size companies and can move amongst the areas according to their discretion).

Many would take this as a sign to always choose a passive index over an actively managed fund. At Capstone, we don’t think that is necessarily the best conclusion to draw from the data. We do think that expenses make it difficult for managers to outperform indexes over time, especially in large and transparent indexes. So, it makes sense that a great manager can show his mettle more frequently in thinly-traded emerging market bonds than in the S&P 500 Index. We think it also makes sense that managers can perform a bit better in a multi-cap fund, as they are able to use their skills more if they aren’t constrained in terms of what they can buy and sell.

We also think a healthy mix of passive indexes and skilled managers remains the best way to capture gains and regulate risks. Looking at who performed well last year delivers results that are largely due to chance. Looking under the hood of a fund at the philosophy, process used, culture of the people involved (e.g. is your manager putting your interests above his or hers, do they have skin in the game by investing in the fund themselves, etc.), and the performance of the fund can give you accurate long-term results.

Simply looking at how funds performed last year is why all fund literature reminds you that “past performance does not necessarily predict future results”. Research says much the opposite.

By Ted Schwartz, CFP®

How Impact Investing is changing the Financial Advising Industry

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For many individuals, financial investing and philanthropy aren’t often placed in the same category; however, more shareholders are turning to a new method of investing that merges values and promising financial returns together.

Impact investing, otherwise known as ESG (environmental, social and corporate governance) investing, is the act of making investments into companies, organizations, and funds with the intention of producing a positive social or environmental impact alongside a financial return. This form of socially responsible investing serves as a guide for various investment strategies. Simply put, impact investing is about identifying a meaning behind your money.

Earlier this month, a company called ImpactAssets launched two new products with the idea of impact investing in mind. According to the company, the Microfinance Plus Note and the Global Sustainable Agriculture Note were developed to offer minimal interest rates and provide a strong liquidity feature and are available to end-investors with a minimum investment of $25,000.

The Microfinance Plus Note allows ImpactAssets to lend to regulated emerging market organizations that generate small business loans, while the Agriculture Note is designed to encourage sustainable farming cooperatives that help farmers around the world stabilize their profits and farm productively.

These two products are just some of the examples of the blooming impact investing options for end-investors, many of whom anticipate their investment dollars to closely match their personal values and also wish to see the value of their investments expand.

The Enticement of Impact Investing

Impact investing challenges the long-held beliefs that social and environmental issues should only be addressed by philanthropic organizations, and that market investments should focus entirely on delivering the highest of financial returns.

What makes impact investments so appealing to advisors and investors alike is that they do not focus primarily on philanthropy, but rather an alternative investment with a socially and economically beneficial twist. While many advisors are skeptical of the success of such investments, the truth of the matter is that more and more brokerages are getting into impact investing. Firms are experiencing a demand from more of their clients to create products that generate a positive impact and advisors are losing assets to larger firms.

To learn more about impact investing and how to incorporate strategies into your investment opportunities, contact us today.

Stay tuned for part two on how impact investing is changing the way millennials spend their dollars and prepare for retirement.

Retirement is Your Responsibility

Preparing for retirement can often be difficult. As individuals, we have very limited ability to see ourselves in the future, including what our healthcare expenses may be or any hiccups that may occur, such as a job loss.

Because we lead such busy lives, most individuals don’t really think about retirement.

It becomes our responsibility to know how to invest and identify if we are going to need that money at any given point. PBS Frontline discusses this and more of the struggles of retiring in a segment titled The Retirement Gamble.

Essentially, the video segment concludes that if you’re going to die at 69 years of age, you will need to save a heck of a lot less money than if you plan to make it to 95.

As grim as it sounds, it truly becomes the individual’s responsibility to know the amount that will need to be saved and how long he or she is planning to live.

The Demise of Pension Plans – Controlling Your Own Retirement Fund

In the past, pension plans were much easier for the individual to comprehend and help to prepare for retirement. These type of plans were automatic, companies funded the plan for you, and even hired someone to manage it.

In the 1990s, companies underfunded pension plans because the stock market was rising higher. Many companies thought they could use their pension plans to fund other projects. This led to the pensions being underfunded and too costly to continue. This drove greater use of the 401k.

With companies out of the pension business and 401ks being the more suitable retirement option for working individuals, more Americans are facing the difficult process of having to prepare as early as possible for a comfortable quality of life in post-working years. We must face the reality that it is our responsibility to plan for retirement.

Impact Investing Does Not Mean Losing Money

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Many people believe that doing well, or simply doing the right thing means losing out or under-performing.

Realistically, this is not the case.

Those who are ardently determined to do well are often willing to give up a bit of a return. This has led mainstream investors away from doing well while investing. We believe both can be achieved through the selection of smart investments.

The Merging of Financial Investments and Humanitarianism

At Capstone, doing well means managing two strategies: the MaxBalanced Sustainable portfolio and the Equality Funds, Inc. strategy. These two investment approaches promote positivity by improving the environment and giving all individuals equal rights in the workplace despite sexual orientation, respectively.

By having a dual purpose of doing well and offering favorable returns, the lines are blurring between philanthropy and investing.

Recently, an article titled Impact Investing Done Right was published on Barron’s that discusses how the lines are being obscured.

In the article, author Robert Milburn cites a study conducted by San Francisco-based KL Felicitas Family Foundation that found companies that obsessively took care of the environment and/or their employees were more likely to outperform more conventional firms over extended periods of time.

Financial Matchmaking: Aligning Your Investments with Your Values

Consequently, there is a way to coordinate your investments so that they not only promote greater returns, but support your personal values and interests.

Investing in philanthropic areas that generate an impact are actually proving to be wise choices after all.

Millennials may be leading the charge in pursuing investments that influence society, but many of these individuals are anticipating their older generations to follow suit and do well by the environment and of each other in order to combat current issues and redeem greater returns over time.

For more information on making smart investment decisions, contact us today.

Forget Cyber Monday! Stop Spending and Start Saving to Prepare for a Life of Restylement – Part 2

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Thanksgiving has come and gone and many of us likely found ourselves partaking in the elaborate spending process of Black Friday and Cyber Monday to prepare for the holidays. Grandiose sales and deals can be enticing, but in order to plan for a life a restylement, one must understand the importance of tracking your expenses and developing a budget to adequately prepare for life after work. In part two of our series on restylement, we integrate the idea of intentional saving to understand what is financially needed in your post-working years so that you can sustain a similar, if not better quality of life.

Intentional Savings

Once you know how much you have to provide for the future, you can begin investing into your restyled life. If your needs are not in the near future, you can invest these savings more aggressively.

The landscape of retirement has changed, which is the result of two factors. First, people are not wishing to just retire; they are wanting to continue a stimulation of their mind and body. Second, the recent shift away from pensions has hindered the majority of people’s financial ability to simply select when and how they will retire.

Saving for something as abstract as retirement is challenging. The difficulty behind this process is knowing when we will need it and how much we will truly need. For most of us, this action requires a saving method that eliminates our power of control. Participating in a company-sponsored plan like a 401(k) is a successful, safe way to achieve a retirement goal. Another method is to set up automatic withdrawals from a specific account.

There are company-sponsored plans including 401(k) and 403(b) plans. There are also individual retirement accounts (IRA) and Roth IRA options, as well as individual and joint brokerage options. The best way to utilize the various account type options will depend heavily on your specific situation.

Maximizing a company-sponsored plan is the easiest option for retirement saving, as the funds are deducted before you receive your paycheck and are difficult to access until you reach the age of retirement – the definition of intentional saving. For others, the flexibility of a broader range of investment options available in non-company sponsored plans is more favorable.

Saving For Restylement

With so many people changing how they are saving for their later years, it is more important than ever to understand why and how you want to live.

One of the most common questions we are asked is: “How much do I need for retirement?” The answer to that depends on your individual situation. Think about your personal finances. How much do you spend? How much income will you have available in retirement, including Social Security, pensions, and real estate income?

Regardless of where you are in terms of approaching a time of restylement in your life, the best methods you can practice in order to prepare is to save every available dollar and invest them accordingly.

To review, in our two-part series, we have covered emergency funds, saving for major goals and top priorities, and how to properly fund for your restylement. What is left is funding a legacy – leaving money to children or funding a charitable organization.

Once you have covered funding for all your other priorities, you can then begin directing excess savings to your restylement goal and invest according to the conditions of the goal.

Preparing for your restyled life is an abstract concept. We work hard, pay our bills, buy what we need or want, and rinse and repeat this cycle on a routine basis. But if we want to live intentionally, we need to restyle our lives, and save and invest intentionally.

Investing in Opportunities – The Key to Identifying Ideal Outcomes

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Working with so many individual business owners, it’s easy to gain a respect for their ability to have a vision and execute on opportunities. At Capstone, what we aim to do is help these business owners and entrepreneurs carry over their knowledge and acumen into investing in other areas.

In a recent article titled Investing Versus Flipping, author Chris Brightman of Research Affiliates does a great job of bridging the knowledge and experience that business owners have and applying it to investing in stocks and bonds. Additionally, he identifies the key to investing in any opportunity, whether it be companies, real estate or stocks and bonds, with the premise being “short-term price volatility as opportunity; high price as risk.”

Specifically, the example provided describes the difference between investing in real estate in Orange Country, California versus Atlanta, Georgia. Brightman exclaims:

“I am buying cheap houses in Atlanta with long-term expected after-tax returns of 5%. These home investments seem safe to me. Comparable houses in the OC are far more expensive. I estimate long-term after-tax returns of only 1% for investing in houses in Orange County. I judge these high housing prices as creating risk to achieving my return goal for retirement.”

Aim High, Buy Low – The Advantage of Investing in Emerging Markets

This same example can be applied to different opportunities in stocks as well. Today’s high-priced U.S. stock market provides quite a bit of risk. However, emerging markets like Brazil, Malaysia and China sell at lower prices and are harbingers of higher returns.

Take some time to enjoy Brightman’s article, and transpose your skills as a business owners to investing opportunities for maximum growth.

Lived, Accumulated and Retired – A Wise Approach to Preserving Your Wealth

As an individual investing in a 401k, there are many things you can do to ensure that you get to a healthy retirement: saving more, working longer, and certainly using a Dynamic portfolio that relates more to wealth rather than last year’s hot investment.

For those who are lucky enough to have lived, accumulated and retired at the right age, it does not matter what allocations you have. However, for those who entered retirement around 1965, or in the past 10 years, the risk of running out of money is much greater.

Wealth and Returns

In Investing for Retirement: The Defined Contribution Challenge, Ben Inker and Martin Tarlie, both from GMO, suggest  — and I reiterate in The 401k Retirement Challenge and Static and Target Date Funds – a Curse on the Industry – that individuals focus more on wealth than they do returns. This is no small feat. Between CNBC and the press blaring what current returns are, it is hard for individuals to turn the other way. More specifically, Inker and Tarlie state:

“We believe that the right way to build portfolios for retirement is to focus on how much wealth is needed and when it is needed, with a focus not on maximizing expected wealth, but on minimizing the expected shortfall of wealth from what is needed in retirement.”

This suggests that 401k investors take a different approach. The premise of this course is to focus on the wealth that is necessary in order to get to the desired goal (note that this approach does not discuss returns or benchmarks).

  1. Determine how much you want/need (i.e. an investor thinks she needs $50,000 a year in retirement).
  2. Determine what value you will need in your portfolio to achieve that income (ex: $800,000 at a 5% constant withdrawal rate).
  3. Decide how much you will need to save and contribute to the portfolio to reach this goal.
  4. Design a Dynamic portfolio to accomplish the expected goal.
  5. Review the portfolio annually. Look at where you currently are versus the progression to the goal. Draw a line and a glide path to get to that goal with reasonable expectations. Ask yourself why you may be above or below that line and what might you need to do in order to stay at — or rise above — that line.

The industry — and especially 401k providers — seem to think investing more aggressively at a young age and reducing stock exposure is the way to go. Many of these investors are under the belief that once an individual enters retirement, any and all short-term losses are simply not recoverable.

Forecasting for more than one year out is difficult for most people. Regrettably, valuations do not tell us much about what will happen in the coming week, month, quarter or even the next few years. However, valuations can tell us the expected investment returns over the course of a 10, 15, and even 20-year period of time.

Individuals have come to believe that they should expect 10% in returns. Why shouldn’t they, given the recent strong returns over the last 5 years? Nonetheless, it’s important to remember that investment returns of the stock or bond market are anything but constant.

What Did You Do in the Last Stock Market Downturn?

Were you one of the many individuals who sold stock when the market began to sink in 2008?  How much had the market fallen before you sold?

These are two good questions to ask yourself, as the best way to predict your willingness to take future risks is to analyze how you reacted in the last go-around.

If you did sell when the market was down, perhaps now is the time to do something different with your portfolio. For example, Craig L. Israelsen suggests diversifying across seven asset classes dispersed into 12 different mutual funds, in what he calls the 7Twelve portfolio.

This is very similar to the Yale endowment that looks to gain a higher investment return by allocating share between several investment strategies and classes.

Some investors who are diversified across multiple assets groan when the S&P 500 is on a tear, as they believe they could be earning more if they were in an index fund that tracked the S&P 500.

The S&P 500 is an index of 500 of the largest companies in the United States. The weighting of each stock is based on its market cap. Apple has the largest market cap assuming the greatest position within the index, with a weighting of 4.03%, while the smallest holding, Diamond Offshore Drilling represents just 0.01%. Consequently, if the top 10 companies are doing well in the S&P 500 index, the overall index usually performs well. However, the index excludes small companies in either the mid-cap 400 index or the small-cap 600 index. These are companies that are even smaller than Diamond Offshore drilling.

Additionally, the S&P 500 leaves out other investments, such as real estate, commodities, infrastructure, international stocks and bonds. There are times that having these additional investments help in doing two things: smoothing out returns to avoid significant losses, and producing stronger returns by not losing as much as the S&P 500. However, when the S&P 500 is the strongest, investors grumble about not having all their investments in one place, often forgetting they can lose all the gains they have experienced recently.

However, these investors are the same individuals who sell quickly when the stock market declines.

Celebrate the Little Things

There are two additional strategies that behavioral finance has taught us. One is to rejoice over the small wins. The second is to pay less attention to your investments.

Weber’s law states that we prefer to experience small, continual wins rather than one sizeable gain. Rather than looking for a single grand lottery payday, we should be searching for the things that benefit us day in and day out.

Divert Your Attention

Second, we all know of people who look at their investment statements weekly. If you find yourself concerned about whether your account has gone up or down on a weekly basis, you should think about tucking those reports away and create a schedule to view them on a monthly, quarterly, or even annual basis.

It’s also important to avoid selling out when there is a decline in the market. Refraining from this can significantly benefit your returns over time. Recent research conducted by Vanguard indicated that average annual returns can increase by almost 2% per annum if individuals continue to hold their investments as the stock market corrects.

Hang On To Your Investments Longer

The pain associated with loss is often greater than what is felt with gains. As a result, people tend to avoid monetary losses at all costs. When individuals have loss aversions, they tend to sell all of their investments during periods of market disruption. While freeing themselves from low-value investments may be comforting at the time, this decision often results in stocks being sold at the worst possible moment.

The reactions that individuals have to market fluctuations are often reoccurring; therefore, if you sold out in 2008, it is highly likely you will do the same the next time the market takes a turn for the worse. Consequently, you should look to diversify your investments.

No matter what your approach to buying and selling may be, it is always helpful to remove your focus on the day-to-day gyrations of the stock market and look for ways to enjoy the small wins throughout your investment process.

Plan Now, Savor Late – How Preparing For Retirement Early Can Help You Achieve Your Goals

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Helping people fulfill their goals and accomplish their dreams is a wonderful profession to be in. In my career, one of the primary areas of focus is retirement. Clients are continually asking if and when they can retire and how long they can go before they will run out of money in retirement.

I am here to tell you … you can do it. Will it require a fair amount of work? Yes. Will it take some sacrifice? Yes. But you can do it.

Determining Your Financial Goals in Preparation for Retirement

In a recent Forbes article titled, “Can You Retire With $2 Million?”, author Jeff Rose discusses the hurdles many hopeful retirees face when it comes to creating an investment strategy that fits their needs, desires and most importantly, their budgets.

The article focuses primarily on portfolio allocation. While asset allocation strategies are undoubtedly important, I would personally prefer to help clients figure out what their goals are and the best methods we can apply to get them there.

In conversations with clients and prospects, we often hear that personal goals have not been established and many of these clients are still unsure of what they would love to do on a daily basis upon entering retirement.

At Capstone, we do the heavily lifting in terms of looking at the numbers. We want to hear from you, our client on your passions and what you would like to do throughout your retirement. What makes you happy? What gives you the freedom and allows you the lifestyle you enjoy?

In the Forbes article, four important questions were asked:

• What will a typical day look like for you in retirement?
• What hobbies or activities do you think will keep you the busiest?

• What will you be doing in retirement that you are not able to do now?
• What are the challenges, opportunities, and strengths that will either help or hinder you from achieving these goals?

One client we have enjoys nothing more than going out in the yard and raking leaves on a beautiful Colorado day. Another individual is looking forward to helping underprivileged kids attend college. One particular client is anticipating the ability to spend more time on the tennis court and the golf course. Many others are trading in their desk job so that they can spend time with their grandkids.

Developing a plan is unique to all. Thinking about the plan is fun and exciting. It is amazing what you can do when you take the time to strategize and dream. To help begin outlining your plan for retirement, contact us today.